Navigating U.S. Tax Obligations: A Guide for Foreign Businesses

At a glance

• The main takeaway: Foreign companies doing business in the U.S. — no matter how minor — must adhere to U.S. tax compliance obligations (or risk unwelcome penalties).
• Impact on your business: Failure to comply with U.S. tax obligations can result in costly penalties, lost deductions, and additional scrutiny.
• Next steps: Work with an international tax advisor to assess whether your business needs to file IRS Form 1120-F.

The full story:

Expanding into the U.S. market can unlock significant growth opportunities for foreign companies. It can also bring a multitude of tax and compliance obligations that may not be obvious at first glance. One of the most important, and least understood, U.S. filings is IRS Form 1120-F, the income tax return required for foreign corporations with U.S. activity or income.

Missing this filing can lead to lost deductions, costly penalties, or surprise state taxes. Here’s what foreign companies need to know before doing business in the U.S.

What is Form 1120-F and why should your business care?

Form 1120-F is the U.S. Income Tax Return of a Foreign Corporation. Your foreign entity may need to file this if it has:

• Income that’s effectively connected to a U.S. trade or business (USTB),
• Certain U.S.-source income subject to withholding (like interest, royalties, or dividends), or
• A desire to claim deductions or tax treaty benefits related to that income.

Even without a U.S. subsidiary, simply licensing software, providing remote services, or sending employees to the U.S. for business purposes could trigger a filing obligation.

When is a foreign corporation required to file Form 1120-F?

You must file Form 1120-F if:

1. Your company is engaged in a U.S. trade or business at any time during the year. (This includes maintaining a U.S. office, sending employees or agents, or having boots on the ground — even temporarily.)
2. You received effectively connected income (ECI), which is U.S.-source income tied to business activity here.
3. You received Fixed, Determinable, Annual, or Periodical income (FDAP income), such as U.S. interest or royalties, and need to claim a refund or apply treaty benefits.
4. You want to deduct U.S. business expenses. Without filing Form 1120-F, the IRS can deny all deductions and tax you on gross income, no matter how much you spent.

Protective filing: a strategic safety net for foreign companies

If your U.S. footprint is still light, filing a protective Form 1120-F is a smart move. Even if you’re unsure whether your activity creates a U.S. “trade or business,” filing a protective return can preserve your ability to deduct expenses and defend your position later. It tells the IRS, “We may not owe tax now, but we reserve the right to claim deductions if it turns out we do.”

Requirements for a Valid Protective Return:

• File it on time (typically within 18 months of the original deadline).
• Clearly mark it as a protective filing.
• Include basic identifying information even if there is no income to report.

Real-World Scenario:

A German software company licenses its product to U.S. clients via online agreements. Occasionally, product managers travel to U.S. trade shows; they aren’t sure if this constitutes a U.S. trade or business. Filing a protective 1120-F ensures that, if the IRS later decides their activities created a taxable presence, they can still deduct travel costs, legal fees, and marketing expenses.

Key filing deadlines (foreign entities, take note!)

• Normal Due Date: The 15^th day of the 4^th month after your tax year ends (e.g., April 15 for calendar year filers).
• No U.S. office? The 15^th day of the 6th month after your tax year ends (e.g., June 15 for calendar year filers).
• Need more time? File Form 7004 to get a 6-month extension by your original due date.
• Protective return late? You might permanently lose the right to deduct business expenses.

U.S. states play by their own rules

Even if your company avoids U.S. federal income tax, individual U.S. states can still tax you. And many don’t honor tax treaties.

Common State-Level Risks for Foreign Companies:

• Economic nexus: Just selling to U.S. customers, even without any employees or offices, can create a state filing obligation.
• Franchise/minimum taxes: States like California impose flat annual taxes (e.g., $800), even if you make no profit.
• Sales thresholds: Many states require you to register for taxes if your U.S. sales exceed a certain amount.

If you’re planning to target specific U.S. states, be proactive and get state-specific tax guidance before your launch. State and local tax consulting services can help identify possible state tax exposures early.

Penalties for missing the 1120-F filing

Skipping this form isn’t harmless. Consequences include:

• IRS denial of all deductions (under IRC §882(c)(2))
• Flat 30% tax on U.S. gross income
• Late-filing penalties, interest, and potential audit risk
• Additional $25,000 penalty if you fail to file Form 5472 for reportable transactions (e.g., with a U.S. disregarded entity or related party)

Before you enter the U.S. market, ask these 5 questions

1. Are any of our German employees or contractors working on U.S. accounts?
2. Do we have U.S. sales, licenses, or customers?
3. Are we using agents, resellers, or partners in the U.S.?
4. Do we plan to open a U.S. office, warehouse, or hire local staff?
5. Should we set up a U.S. subsidiary for liability or tax reasons?

If you answered “yes” to any of the above, it’s time to talk to a U.S. international tax advisor.

The bottom line

Doing business in the U.S. can be a major opportunity for foreign companies, but it comes with unique tax risks. IRS Form 1120-F is a critical part of complying with U.S. tax rules and preserving your company’s rights. Whether or not you think you’re subject to U.S. tax, filing a timely and strategic return, even protectively, can help avoid significant costs and penalties.

If you’re unsure whether your company needs to file, the safest course is to consult a qualified U.S. international tax advisor. Schedule a consultation with Aprio’s International Business Services team to explore whether this filing is required for your business.