What is Effectively Connected Income (ECI)?

How it works

ECI is the second of two main categories of US-source income paid to non-residents (the first is FDAP). The classification matters because the tax treatment differs sharply:

• FDAP: 30% gross-basis withholding (treaty-reducible), no deductions, reported on Form 1042-S.
• ECI: graduated rates on net income (after deductions), filed on Form 1040-NR (or 1120-F for foreign corporations), similar to how a US person reports trade-or-business income on Schedule C.

For a payment to be ECI, two things must be true:

1. The non-resident is engaged in a US trade or business.
2. The income is effectively connected with that business.

"US trade or business" is a low bar — regular, continuous activity in the US. Owning rental property usually doesn't qualify as a trade or business by itself (it's passive, FDAP). Flipping properties, running a US-based service business through a US LLC, executing services on US soil, or being a partner in a US partnership engaged in a US trade or business — all qualify.

Once the trade-or-business threshold is crossed, all US-source income from that activity is ECI. Investment income generated as part of the trade-or-business assets (interest on the operating bank account, dividends from a strategic stake) can also be pulled into ECI under the asset-use test or business-activities test. Foreign-source income normally stays foreign-source — but a US-based office can drag certain foreign-source income (rents, royalties, service fees) into ECI through the office-and-fixed-place-of-business rules.

Branch profits tax (foreign corporations)

For foreign corporations (not individuals or LLCs), the US imposes an additional 30% branch profits tax on the foreign corporation's US-branch earnings and profits not reinvested in branch assets (per PwC US Corporate Branch Income) — a parallel to the dividend withholding tax that would apply if the same business operated through a US subsidiary instead of a branch. Treaty rates can reduce the branch-profits tax to 0–15%, subject to anti-treaty-shopping limitation-on-benefits clauses.

§1446 partnership withholding

A US partnership engaged in a US trade or business with foreign partners must withhold tax on the foreign partners' share of ECI quarterly, at the highest applicable US tax rate (37% for individual partners, 21% for corporate partners). The partner reports the withholding on Form 1040-NR and claims credit. The partnership remains liable for the withholding even if the partner doesn't pay — major reason US partnerships are reluctant to admit foreign partners without modelling.

Examples

• Foreign founder's US LLC selling to US clients with on-site work. A French founder owns a single-member Delaware LLC that builds custom software for US enterprise clients on-site at their offices. Activity is regular and US-located. The LLC is engaged in a US trade or business; income flows to the French founder as ECI; he files Form 1040-NR and pays graduated rates on the net (after expenses).
• Foreign founder's US LLC selling SaaS from abroad. Same Delaware LLC, but the founder operates entirely from Lisbon, no US office, US clients buy the SaaS via a self-serve portal, no US employees. No US trade or business; income is foreign-source for the founder; no US tax. The LLC still files Form 5472, but on the income there's nothing to pay.

Common mistakes

• Assuming "US LLC = ECI by default". The LLC is just an entity; what matters is the activity. A non-resident's LLC operating entirely outside the US, with no US dependent agent, no US office, no US customers requiring on-site delivery, generally produces foreign-source income.
• Mixing ECI and FDAP on the same payment. A royalty paid by a US client is FDAP unless tied to a US trade or business — then it pulls into ECI. The classification follows the activity, not the payment label.
• Skipping deductions because of the 30% headline. ECI is taxed on net. Software, rent, contractors, travel — all deductible against ECI revenue. Filing without claiming them leaves money on the table.
• Forgetting state tax on ECI. US trade or business in California, New York or Texas often creates a state-level tax obligation on top of the federal, with their own apportionment rules.