Taxes and the US tax system

The American tax system is that same “big and scary dragon” everyone has heard about, but few truly understand how it works. It is multi-layered, complex, and rather unpredictable: taxes are levied not only at the federal level, but each state has its own rules, rates, and even its own tax authorities. Add to this municipal fees — and you get a real labyrinth, in which it’s very easy to get lost.

For businesses or investors, the U.S. is a country of opportunities, but taxes often become the “turbulence zone.” Benefits, tax credits, special regimes for certain sectors — all of this can be used to the company’s advantage if you know the rules of the game. But if you ignore them — the IRS (the American tax authority) will quickly remind you…

In this guide, we will cover general information about the U.S. tax system: who and what pays, what the main taxes for businesses are, how they differ depending on the company form, and what nuances foreign entrepreneurs need to consider.

Basics of the U.S. Tax System

The U.S. tax system is built like a “matryoshka doll.” There is the federal level (federal taxes) — common for the whole country. This is where the basic rules are defined: income tax, corporate tax, estate and gift taxes. The Internal Revenue Service (IRS) is responsible — the main tax controller in the U.S.

The second level is the states. And this is where it gets most interesting. Each state has the right to decide which taxes to collect, what rates to set, and even whether a personal income tax is needed at all. For example, Florida or Texas have no personal income tax, whereas in California rates can “bite” at over 10%.

The third level is municipal (local taxes). Cities and counties can also introduce their own fees: from property tax to local sales taxes. This means that the same company in New York and, for example, in Miami may have completely different tax burdens, even if the business model is the same.

And here’s an important nuance: the U.S. follows the principle of worldwide taxation. That is, American residents pay taxes not only on income in the U.S., but also on everything they earn worldwide. For foreigners, the rules are slightly different — they pay taxes on income related to the U.S. (for example, rent from American real estate or income from a company registered there), although there are also pitfalls here, which we will discuss later.

What foreign businesses and nonresidents need to know

Before we move to the actual figures and taxes, let’s note important points regarding taxation of a nonresident business.

First and foremost — a U.S. nonresident is not automatically required to pay taxes on worldwide income like Americans. But if you earn income that “has a source in the U.S.” — you’re already in the game. For example: rent from property in Miami, dividends from an American company, profit from selling goods in the States. Taxes on this are not waived.

Second — withholding tax. If your company receives payments from American partners (royalties, interest, dividends), these funds may be taxed immediately at 30%. However, thanks to double tax treaties, the rate can be lower (for example, 5–15%). But for this, you need to submit Form W-8BEN or W-8BEN-E — without this the IRS simply won’t recognize your “nonresident” status.

Third — if you register a company in the U.S., you are formally considered a “domestic entity.” This means that the company becomes a U.S. tax resident, and all local rules apply. But the nuance is that a nonresident owner can structure operations to minimize federal income tax, for example through an LLC (which by default is “transparent” for the IRS, and taxes are paid at the owner level, not the company itself).

Fourth — reporting requirements are still not waived. Even if the company did not actually operate or earn income in the U.S., “zero” tax returns must be filed. Ignoring this results in penalties, which are often higher than potential taxes.

Fifth — for working with banks, payment systems, and partners, nonresidents need an EIN (Employer Identification Number). This is a tax ID for the business. Even if you have just one freelance contract in the U.S., without an EIN the partner is unlikely to pay you directly.

Sixth — don’t forget about the states. Even if you optimized federal taxes, the state may require its own. Therefore, it is always necessary to analyze not only the federal level but also the specific state where business is conducted.

Taxes for individuals in the U.S.

The American tax system for individuals rests on three pillars: residency, income, and reporting. Each has its own “nuances.”

1) Resident or nonresident?

Tax residency in the U.S. is determined not only by passport or green card. The “substantial presence test” applies — if you were physically present in the U.S. for more than 183 days over the last 3 years (counted using a special formula), congratulations: you are a resident and must pay taxes on all income worldwide.
Nonresidents, however, pay only on income that has a source in the U.S.

2) Federal Income Tax

Federal income tax in the U.S. always works on a progressive scale: the more you earn, the higher the rate you pay. But importantly: the rate applies not to all income, only to the portion within a certain range (tax bracket). So even if you reach the highest 37% bracket, it does not mean all your income is taxed at 37%.

For residents, the progressive scale ranges from 10% to 37%. For foreigners in the U.S. (nonresidents), the taxation scheme works differently. If a person earns active income in the U.S. — for example, salary from an American employer, payment for services, or rental profit through a registered business — the normal progressive income tax scale applies (10% to 37%). But when it comes to passive income, the situation is different: this includes dividends from American companies, royalties (payments for use of copyrights or technology), interest from bank accounts or bonds, and rent from real estate if it is not conducted as a business. In such cases, the IRS immediately withholds tax at the source — standard 30%, unless an international tax treaty allows a reduced rate.

Federal Income Tax brackets for 2025:

For single filers:

• 10% — up to $11,925
• 12% — $11,926 to $48,475
• 22% — $48,476 to $103,350
• 24% — $103,351 to $197,300
• 32% — $197,301 to $250,525
• 35% — $250,526 to $626,350
• 37% — over $626,350

For married filing jointly:

• 10% — up to $23,850
• 12% — $23,851 to $96,950
• 22% — $96,951 to $206,700
• 24% — $206,701 to $394,600
• 32% — $394,601 to $501,050
• 35% — $501,051 to $751,600
• 37% — over $751,600

For head of household:

• 10% — up to $17,000
• 12% — $17,001 to $64,850
• 22% — $64,851 to $103,350
• 24% — $103,351 to $197,300
• 32% — $197,301 to $250,500
• 35% — $250,501 to $626,350
• 37% — over $626,350

3) State Taxes

Don’t forget that states have their own income tax rates. There are “tax havens” like Texas or Florida (0%), but in California or New York the rate can reach 12%. That is, a resident of one state may pay significantly less or more than a resident of another.

4) Social Security and Medicare

If you work in the U.S., your salary additionally deducts contributions to social security (6.2%) and Medicare (1.45%). The employer pays the same. For freelancers, payroll taxes are double, since they are considered both employee and employer.

5) Capital Gains Tax

Short-term investments (stocks, crypto, real estate sold in less than a year) are taxed as ordinary individual income at rates from 10% to 37%. Long-term investments (held for over a year) — at preferential rates: 0%, 15%, or 20%, depending on income.

6) Estate and Gift Tax

Americans are known for this “pleasant surprise”: inheritance over $13.99 million (as of 2025) may be taxed up to 40%.

7) Tax Returns

Anyone receiving income in the U.S. is required to file a tax return (Form 1040 for residents or 1040-NR for nonresidents). Even if you owe nothing, failure to file results in fines and blocking of the tax number, without which you cannot proceed.

Taxes for companies in the U.S.: C-Corp, S-Corp, and LLC

In the U.S., corporate taxation is even more complex and depends on the type of company and chosen taxation system. This is especially important for foreign owners, because the company form determines whether you will pay federal taxes on U.S. income. For clarity, let’s consider all three company forms and their possible tax systems.

1) C-Corporation (C-Corp)

• Federal corporate tax: 21% on profit
• State taxes: 0% to 11.5%
• Dividends to owners: additionally taxed at individual level (federal + state)
• Feature: double taxation — profit is first taxed at corporate level, then dividends — at owner level

2) S-Corporation (S-Corp)

• Federal corporate tax: 0% (profit passes through to owners and taxed as personal income)
• Owner taxation: progressive rates from 10% to 37% for U.S. residents
• Limitation: only U.S. citizens or residents can be shareholders — foreign owners cannot participate without special schemes

3) LLC (Limited Liability Company)

LLC is the most popular form for foreign business. Taxation can be in two ways: as a corporation (C-Corp) or as a pass-through entity (taxed at owner level).

Scenario 1: LLC taxed as a corporation (C-Corp)

• Federal tax: 21% on profit regardless of whether the company operates in the U.S.
• State taxes: depend on economic presence in the state. For example, in Delaware, corporations not conducting business in the state do not pay state corporate tax (8.7%). In active states, the rate may be added.

Scenario 2: LLC as pass-through (owner level)

• Federal: LLC itself does not pay federal income tax. Only owners are taxed at income tax rates from 10% to 37% (progressive). For nonresidents, tax is paid only on Effectively Connected Income (ECI). If LLC income comes exclusively from outside the U.S. and there is no physical presence in the U.S. — federal tax is not paid.
• Passive income from the U.S. (interest, dividends) may be taxed at 30% withholding tax, or less under a tax treaty.
• State level: In Delaware, companies without in-state operations do not pay corporate income tax but pay a fixed franchise tax of $300. In Wyoming, no corporate tax exists, but annual franchise fee starts at $60 and Annual Report is required.
• Obligations: LLC with nonresidents must file annual forms with the state secretary and Form 5472 to the IRS regarding owner transactions, even if no tax is due.

Important: If an LLC (that chose pass-through taxation) begins earning U.S. source income or conducting business in the U.S., it must pay up to 37% for individual nonresident owners (progressive scale) or 21% if the owner is a legal entity. State taxation is analogous to corporate taxation — if the company operates in a specific state, additional state-level tax applies.

Franchise Tax in the U.S.

Franchise tax is not a tax on profit but a fee for the right to exist as a company in the state. It is levied regardless of profit or activity. For foreign owners of LLC or C-Corp, this is especially important: late payment or ignoring the tax can lead to fines or company deregistration.

In Delaware, franchise tax for inactive corporations starts at $225 (depending on number of shares). For LLC, a fixed $300 applies. Tax is paid annually during Annual Report filing, even if there is no profit.

In Wyoming, no corporate tax exists, but LLCs must file Annual Report and pay a license fee starting at $60. Other states may apply different calculation methods: fixed amounts or rates based on capital or share value.

For nonresidents, it is important to remember that franchise tax must be paid even if the company does not operate in the U.S. Ignoring this can create serious problems for foreign entrepreneurs.

Sales Tax in the U.S.

Sales tax is a tax on the sale of goods and certain services, paid by the end consumer but collected and remitted by the seller. There is no federal sales tax; all rates are set at state level, and sometimes at county and city level, so tax burdens can differ significantly.

Sales tax rates in states range from 0% (Delaware, Oregon, Alaska) to over 7–8% (California, Tennessee). Additionally, local authorities may impose taxes, making the total rate 10–11% in some cities.

Not all goods and services are taxed. Usually, sales tax applies to physical goods; services are taxed only in certain states. For example, in California, tax may apply to digital goods combined with physical goods or professional services, whereas in New York only to limited categories.

The seller is responsible for correct collection and remittance of the tax. The company must register in the state, keep sales records, and file reports regularly. Non-payment or miscalculation can result in fines and penalties.

For foreign companies, the key concept is economic nexus. If a nonresident conducts business in a state via online sales and sales exceed the threshold (usually $100,000/year or certain number of transactions), registration and tax collection are required. If the threshold is not met and there is no physical presence, sales tax often does not apply.

Special attention should be paid to online sales. After South Dakota v. Wayfair (2018), many states began requiring sales tax collection even from companies without physical presence if economic activity criteria are met. This means foreign online businesses must check in which states they need to register for tax collection and maintain sales records for correct reporting.

Thus, the American tax system is quite complex and multi-layered: federal taxes, state taxes, franchise fees, sales tax, and also special rules for nonresidents and foreign companies. For those just starting in the U.S. or planning investments, it is important to understand which company structure will be optimal, what types of taxes will need to be paid, and how to avoid unnecessary penalties.

Nonresidents and foreign businesses should pay attention to three key points: choice of company type (C-Corp, LLC), correct tax structure (pass-through or corporate), and compliance with all state requirements (Annual Report, franchise tax, IRS forms, and reporting control). Planning at the start can save thousands of dollars and prevent legal issues.

If you want to learn more about taxes in the U.S., or if you are planning to register a company in America, Azola Legal Services will assist with everything: from choosing the jurisdiction and company type to obtaining an EIN, filing tax returns, collecting necessary documents, and proper tax planning.