America is the land of opportunity. However, opportunity can mean additional tax considerations, especially for foreign individuals setting up a business on U.S. soil. It is imperative to structure the business appropriately from the beginning so as not to trigger any unintended U.S. tax consequences down the road. Below is a brief comparison of the most popular entity structures to consider.
S Corporations are a very popular ownership structure because they have no entity-level tax (with a few exceptions) and relatively simple rules to follow. So why not consider an S Corporation? Simply put — it’s not an option for foreign owners. Foreign taxpayers (and U.S. C Corporations) are ineligible shareholders in an S Corporation.
Limited liability companies (LLCs) that are treated as partnerships are often the preferred tax entity in the U.S. because of a few key benefits: no entity-level tax; no restrictions on types of owners; and relative flexibility in profit and loss allocations.
However, LLC partnerships may cause foreign owners to encounter a number of unanticipated U.S. tax consequences. U.S. partnerships that have foreign partners are required to withhold U.S. tax on their distributive share of partnership income. This withholding occurs quarterly and must be made at the highest graduated rate for the particular type of income (currently 35% for corporations and 39.6% for ordinary income earned by individuals). Partnerships must annually file Form 8804 (Annual Return for Partnership Withholding Tax) to report the tax withholding that took place during the year.
In addition, foreign partners are required to file personal U.S. tax returns to report their share of the partnership income or loss. Foreign owners may not want the additional requirement of filing a tax return in the U.S.
The use of a C Corporation structure is often very attractive to foreign business owners. Because C Corporation profits and losses do not flow through to its owners, foreign owners will not need to file U.S. personal income tax returns. Even if the U.S. business is organized as a partnership, it could make sense for foreign persons to own their LLC interest indirectly through a corporate entity. Furthermore, the “double tax” consequence of C corporations may not be a concern for some foreign individuals if their home country treats U.S. dividends in a favorable manner.
The brief entity comparisons in this post paint a simple picture of a much more complicated decision. Whether an LLC or a C Corporation is right will depend on each foreign taxpayer’s individual goals and set of circumstances. But one thing remains constant: it pays to conduct due diligence up front to ensure you are starting your new opportunity knowing all of the tax consequences.
Contact Ray Polantz at rpolantz@cohenco.com or a member of your service team for further discussion.
Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.