A Foreign-owned LLC is an LLC in which a foreign person or entity has interest either directly or indirectly. It could be a single-member LLC which is owned by foreign investor or a multi-member LLC which can be formed as a Partnership firm where one or more partners are foreign person/ entity and it can be an LLC formed as C-Corp where one or more shareholders are foreign person/ entity.
Direct Interest means that foreign entity is holding the shares of the LLC whereas indirect interest means that the foreign entity has property interest in the LLC.
Taxation of an LLC
A single- member LLC
A foreign-owned single-member LLC is always treated as a domestic corporation for the purpose of reporting as per new regulations to Section 1.6038A-1 of the Code of Federal Regulations. Earlier the Disregarded entities with foreign owners had no filing obligations but now they will be required to obtain EIN and file Informational Returns in Form 5472 and Form 1120. A disregarded LLC is known as pass through entity where its owner reports the LLC’s income and deductions on his federal income tax return.
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A multi- member LLC
When an entity is owned by two or more members it is called multi-member LLC. This is one of the most popular business structures in the US. Its members can be an individual, partnership, corporation, another LLC, or foreign person/ entity.
They are popular for their simplicity of operations and protection to the personal assets of their members. It has a pass-through taxation feature as it is not a separate tax entity, all profits and losses flow in the hands of its members.
When a multi-member LLC is formed, it will be taxed by IRS as a Partnership firm by default. It will be subject to file Form 1065, with each partner filing a Schedule- K1.
If you need to elect to be taxed as a corporation, you will need to file Form 8832 (Entity Classification Election).
A foreign-owned LLC is taxed as a C-Corp
Whereas a foreign-owned LLC will have to file Form 8832 (Entity Classification Election) and go through formalities to be treated as a corporation. After it has opted to be treated as a corporation then all the normal corporate tax and reporting laws will be applied to it. It will be subject to corporate tax and state taxes, it will file full fledge Form 1120 along with Form 5472. In addition, it will also be subject to state tax return.
A foreign-owned LLC can never elect to be opted as an S-Corp as that structure is only allowed for residents or citizens of US.
Non-applicability of Foreign LLC taxes:
A Foreign-owned LLC whether single-member/ multi-member will not be subject to US LLC taxes if it is a member of an Affiliated Group that includes at least one US LLC.
A foreign owned LLC opting to be taxed as a C-Corporation will be subject to corporation tax laws and will not be taxed as an LLC.
A C-corporation or an LLC filing as corporation is liable to file Form 1120 every year. Form 1120 is U.S. Corporate Income Tax Return that corporates use to report their income, gains, losses, deductions, and credits.
You must have the below information to file Form 1120:
- Employer Identification Number (EIN)
- Date of Incorporation
- Total assets and income
- Gross receipts
- Cost of goods sold
- Any dividend, interest, royalty
- Capital gains
- Tax deductions
- Business tax credits, if any
Form 1120 can be filed electronically or by mail.
A Corporate with a year-end date of December 31st must file its Form 1120 by April 15th.
If you make a mistake in Form 1120, you must file an amended tax return using Form1120X. You can use Form1120X to correct the Form 1120 you already filed. You can file Form 1120X within 3 years of filing the original Form 1120.
Failure to file form 1120, will result in a Penalty of 5% of the unpaid taxes for each month or part thereof till it is filed, up to maximum penalty of 25%.
Form 5472 is an Information Return that a US Corporation which has 25% or more of foreign-ownership or a Foreign Corporation Engaged in a US Trade or Business must file. Filing requirement of foreign-owned US LLCs has begun in 2017.
A foreign-owned US LLC or Corporation with at least 25% foreign shareholding must file the information return Form 5472 for every year with “Reportable Transactions”.
Due date of filing Form 5472 is April 15th together with Form 1120. If you file extension for your Corporate Return then due date of both the Form will October 15th.
Penalties for Non-Filing of form 5472
For non-filing of Form 5472 or filing substantially incomplete Form 5472 will attract a penalty of $25,000 per year per form. This penalty is applicable in case of non-maintenance of the required records.
Reportable transactions for Form 5472:
All transactions between the LLC and its foreign owner related to exchange of money or property including payments, rental income, sales transactions, remuneration, commission payments, capital contributions, capital reductions, & loans and interest payments. Additionally, you must also report any amounts paid or received in connection with the formation, dissolution, acquisition, and disposition of LLC including contributions and distributions from the LLC.
Features of a C-Corp
C-Corp is a popular structure for foreign investors looking to form a US LLC. Major reason is that C-Corp is not a pass-through entity like Partnership firm or Single Member LLC and hence foreign owners will not have to file US Income tax return.
A C-Corp is always subject to Double-taxation as a C-Corp is a separate entity so it pays corporate income tax. Its after-tax income distributed to its shareholders as dividends is subject to tax in the hands of shareholder in their individual capacity. In this way, double taxation is a concern with a C-Corporations.
There are certain ways of minimizing the consequence of a C-corporations:
- Retained Earnings: The corporate can retain profits in the business
- Salary Distribution: The corporation can avoid distributing profits as dividends and alternatively distribute salary and bonus. Salary and bonus are taxable in the hands of receiver but is a deductible expense for corporates, thus double taxation will be avoided
- Income Splitting: C-Corp owners can take out that much profits in order to leave a sufficient amount of profit in the business. As Tax Slab Rates are used in taxation of C Corp and individuals, C- Corp and Individuals will be able to take benefit of lower Tax Brackets after splitting income. In this way, Lower Taxes will be applied in case of C-Corp as well C-Corp owners.
Advantages and disadvantages of a C-Corp
- Separate legal entity- A corporation has its own legal status, rights, obligations, responsibilities, and liabilities.
- Limited liability of owners- A corporate’s debts and liabilities are its own. Stakeholders of business will look for any recovery to the corporate and not the shareholders.
- Perpetual Existence- Even if one or more shareholder leaves the business or die, the corporate continues to exist until it is liquidated or wound up.
- Free transferability of shares- There is no restriction in sale/ purchase of shares of a corporate.
- Easy access to Investment- A C-Corp easily attracts investors because of its well-established status, credibility and it had no limitation on number of shares it can issue.
- No restrictions on shareholders- There is no restriction on the share-owner of a C- corporate unlike in S-Corp.
- Shareholders are not managers- A C-Corp is managed by Board of Directors by electing managers, shareholders have ownership rights and limited management rights in the form of electing directors or removing Directors.
- Longer application process- It needs extensive paperwork and a lot of documentation to incorporate a corporation. Corporate bylaws, appoint BOD, issue stock certificate etc.
- Complexity of operations – A corporation has legal formalities and complexities to operate. Holding annual and general meetings, maintenance of books of accounts are some of the strict formalities.
- Double taxation- A corporate is subject to corporate-tax on its income and after-tax income distributed as dividends are subject to individual tax in the hands of shareholders. This scenario leads to double-taxation.
- Regulations- A corporation will have to follow both state and federal tax law regulations.
- Expensive- To incorporate a C-Corp you need a start-up capital, filing charges, ongoing fees and taxes. So, its overall a costly affair to start a corporation.
Taxability of a C-Corp:
A C-Corp is a separate taxpaying entity. And it is subject to filing of separate corporate tax return in Form 1120.
A C-Corp is taxed at a Federal Corporate tax rate of 21%. However, if a corporation is making more than 18.3 million, a flat rate of 35% is applied.
A C-Corp is also subject to State/ Franchise taxes, depending upon the state where it is operating.
Restriction of Foreign-owned LLC as S-corporation
A non-resident foreigner cannot have a direct ownership in S-Corporation. This is because non-resident aliens are not subject to U.S. Income tax. An S-Corp entity is a pass-through entity which does not pay any tax at corporate-level. So, tax liability is passed on to its shareholders. Since non-resident shareholders are not subject to U.S. taxes, S-Corp entity will neither be taxed at corporate level nor shareholder-level. A resident alien can own a S-Corp entity. A resident alien is a non-U.S. citizen who either holds a green card or meets substantial presence test for each calendar year.
Reasons to elect as a C-Corp
Reason to opt as a corporation over a partnership firm are:
- Liability Protection
- Access to funds
- Tax benefits- C-corps can involve in income-splitting/ profit-splitting which means they can split profits among shareholders and business. This way they can reduce the tax liability.
- No limitation on number of shareholders
- No restriction on shareholders’ country of origin or corporate status
- Lower maximum tax rate (21%) as compared to maximum personal tax rate applicable to S-Corps (39%), and partnerships (37%)