Income earned by a non-U.S. person or business that is connected to a trade or business in the United States and is therefore subject to U.S. taxation.
What is Effectively Connected Income (ECI)?
Effectively Connected Income (ECI) refers to income that the U.S. Internal Revenue Service (IRS) considers to be directly linked to a trade or business conducted within the United States. If a non-U.S. individual, company, or other foreign entity earns ECI, they are generally required to file a U.S. tax return and pay taxes on that income at the same graduated rates that apply to U.S. persons.
A U.S. trade or business (USTB) exists when a foreign person or entity engages in regular, continuous, and substantial business activities in the U.S., such as maintaining an office, having employees or agents in the U.S., or otherwise having a significant operational presence.
ECI can include:
- Income from actively conducting business in the U.S.
- Providing services within the U.S.
- Selling products through a U.S. location or inventory.
- Certain investment income—such as rents, royalties, or dividends—if tied to an active U.S. business rather than being purely passive.
For example, if a non-U.S. resident owns a U.S. e-commerce company that stores inventory in U.S. warehouses and ships orders to U.S. customers, the profits from those sales are typically ECI. Similarly, if a foreign consultant travels to the U.S. to perform services for clients, the income from those services may be treated as ECI.
Importantly, ECI is different from FDAP income (Fixed, Determinable, Annual, or Periodic), which is generally passive and subject to flat withholding rates rather than graduated tax rates. Tax treaties between the U.S. and other countries can sometimes modify what is considered ECI or exempt certain activities, but they do not override U.S. tax rules for income that is clearly tied to U.S. business operations.
For non-U.S. founders with U.S. companies, understanding ECI is crucial, as it determines when the IRS expects a tax return to be filed and when U.S.-source income will be taxed like that of a domestic business. Misclassifying income as non-ECI when it should be reported can lead to penalties, back taxes, and interest.
