Taxation of LLC in the US formed by Foreigners

LLC is the most common form of Business Entity formed by foreigners at the time of establishing their business in the US. LLC is a pass-through tax entity in the US which means that it is not taxed directly. Instead, profits and losses of the business have to pass through its owners (they report it in their personal tax returns).

Criteria for setting up an LLC in the US (to avoid federal income tax)

Be 100 percent owned by a non-resident alien

You will be considered a non-resident alien if you are not:

• A US citizen
• A US permanent resident (green card holder)
• You have lived in the US enough to pass ‘substantial presence test’

In this case, any income generated by an LLC owned by you, will be subject to US tax. As a non-resident alien, you will only be taxable on US source income which is ‘effectively connected to a US Trade or a Business (ETBUS)’. You have to check whether you are ETBUS or not, and then you have to check if there is a US income source for you. If both the criteria are met, then you are liable for US Federal tax. But if you have a US source income but you are not an ETBUS, you are not taxable.

There is no direct answer to what makes ETBUS. The IRS will not rule on whether a foreign person is engaged in ETBUS or that ETBUS receives connected income. A foreign person not physically present in the United States who takes orders from within the US only through advertising and sends inventory to the US is not likely to be engaged in a trade or a business in the US.

A business is ETBUS only if:

• You have at least one dependant agent (works exclusively for you) in the US.
• Dependant agent does something substantial to expand your business in the US. (excluding Administrative jobs)

Non-Resident Alien are subject to two tax rates:

1. For effectively connected income
2. For fixed or determinable, annual or periodic (FDAP) income

Effectively connected income (ECI) and personal service income are earned in the US from the operation of a business in the US. Non-residents and US residents have the same graduated rates for taxes. FDAP income is passive income such as interest, rents, and royalties. This income is usually taxed at 30 percent unless there is a tax treaty for a lower rate.

Income that the non-residents receive for performing personal services during the tax year independently, is exempt from the tax only if the residents:

• are present in the US for no more than 89 days during the tax year
• do not have a fixed base for performing the services in the United States

You can benefit from an applicable tax treaty. If you operate in the US through a ‘permanent establishment (an office or a fixed business place)’, only then you are subject to US tax.

Foreigners are only subject to US tax if they are effectively connected to a US Trade or Business Entity. If your business generates income in the US but is not ETBUS, the income will not be taxed in the US. Generally, the following businesses are not taxable:

• Selling digital products
• Web Designs
• Selling physical products if the shipping point is outside of the US
• Personal services performed from abroad

The Federal Income Tax rate can vary depending on the income of corporations. This rate is currently 21 percent. It is not dependent on the revenue but rather on the net profit. The rate is the same for products and services. 21 percent federal tax rate is for the IRS. This percentage can be saved on your online business profits if you form a US LLC as a Foreigner. Each state has a different tax rate.

All goods imported into the United States are subject to custom entry and import duty. However, to sell goods in the US, you need to pay state sales tax according to your respective state. The sales tax rate also varies from state to state.

Sales tax registration is more like getting a unique ID from a state. When you form an LLC in one state and get an ID for that state, you will require a new ID if you are paying your sales tax in some other state. Getting the ID is a one-time process. It is not uncommon for companies to have sales tax in multiple states.

Single-member LLCs in the US are also known as sole proprietorships. If you own a single-member LLC in the US, then you do not have to file a tax return for the LLC. All profits and losses must be reported to the IRS in your personal tax return (filing the form 1040NR). Single-owner US LLCs are treated as disregarded entities by the IRS. Foreign owners of the sole proprietorship may have no income tax filing requirement if they do not have a US-sourced income.

If the LLC is a partnership, normal partnership tax rules will apply to the LLC. To pay the income taxes, you should file Form 1065 which is US Return of Partnership income. Each owner has to show their share of partnership income, credits, and deductions (Schedule K-1). Each LLC member reports this profit and loss information on their individual Form 1040 (Schedule E).

You have to report your taxable income on the basis of a tax year, Calendar Year (12 consecutive months starting from January 1 and ending on December 31), or Fiscal Year (12 consecutive months ending on the last day of any month other than December) can be used as a Tax Year. In the US, the tax year is the same as a calendar year.

If you are running a service-based business or drop-shipping business from a foreign country and do not have a physical residence in the US, then you will NOT have to pay any taxes in the US. You just have to file an informational tax return in Pro-forma 1120 + 5472 through mail or fax under the EIN of the LLC by 15 April of the following year for the disclosure purpose. They might not owe a tax in the US but their income might be taxable in your home country. Meeting notes for LLCs are not required by law.

When a foreign national who does not have the right to get Social Security No. in the US wants to file taxes, ITIN is required. If you go to the US a couple of times a year and work there, earn some money, and want to file some taxes, you have the right to request an ITIN. So, ITIN is issued when you intend to file the taxes. The application for ITIN No. is W7 application and is only filed along with the individual person’s federal income tax return. An ITIN number is also needed when you want to get your money back from a local vendor who is withholding taxes for you.

Four primary filing requirements affect foreign-owned, single-member LLCs.

• Form 5472 or Form 1065 (Disclose information about certain reportable transactions)
• 1040-NR (Income tax Return)
• Form 1120
• FBAR (Report of Foreign Bank and Financial Accounts)

Accounting and Bookkeeping for US LLCs

There is no legal requirement to submit the accounting of your LLC. Yet, simple accounting should be done showing profits and losses from the business. This would also be required to help reach the individual income and offer for tax. You merely have to show your profit and loss account which also shows incoming and outgoing payments. This can be accomplished by having simple account statements and screenshots of payments and receipts. When you operate your LLC as a single member LLC, you will have no tax obligations. You won’t have to deal with tax officers and audits.

LLC formation cost: a one-time fee to the state to get your LLC formed.