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What income goes on Form 1040NR?
The IRS divides nonresident income into two main categories: Effectively Connected Income (ECI) and FDAP income. The difference matters because each category is taxed differently.
Effectively Connected Income (ECI) is income that arises from working in the United States or operating a US trade or business.
- Wages from a US employer
- Self-employment income connected to US services
- Business profits from US operations
ECI is taxed at graduated rates, similar to how residents are taxed. You can usually deduct expenses that are directly connected to earning that income. In practice, this means careful tracking of business-related expenses can reduce taxable income.
FDAP income (Fixed, Determinable, Annual, or Periodical income) is usually passive US-source income. Common examples include:
- Dividends
- Royalties
- Rental income
- Certain types of US-source interest (although some bank deposit interest may be exempt from US tax for nonresidents)
FDAP income is typically subject to a flat 30% withholding rate at the source, unless a tax treaty reduces that rate. Unlike ECI, FDAP income is usually taxed on a gross basis, meaning you typically cannot deduct expenses against it.
When FDAP income is involved, Schedule NEC (attached to Form 1040NR) is typically used to calculate the tax separately from effectively connected income.