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What U.S. tax filing obligations would a foreign company have if it is a member of a U.S. entity formed as a limited liability company ("LLC")? Below is a general response. Of course, additional filing obligations can be triggered depending on the facts and circumstances.

A. United States Federal Income Tax Filing Obligations

The United States federal income tax filing obligations of the Foreign company arising from its membership in the LLC depend in the first instance on the classification of the LLC for United States federal income tax purposes and upon the nature of the activities and income of the LLC and the Foreign company with any United States connection.

1. Possible Classifications of the LLC.

The LLC will be treated as fiscally transparent (i.e., as a pass-through entity) for United States federal income tax purposes unless the LLC elects to be treated as a corporation for those purposes. If the LLC does not elect to be treated as a corporation, then for United States federal income tax purposes either (i) the LLC will be disregarded if it has only one member or (ii) the LLC will be treated as a partnership. The number of members is determined under United States federal income tax rules; for example, if an LLC has two members, X and Y, and Y itself is a disregarded entity wholly-owned by X, then the LLC is treated as having only one member for United States income tax purposes. Hence, the possible United States income tax classifications of the LLC are three:

  • Corporation (if the LLC so elects);
  • Disregarded entity (if the LLC has only one member); or
  • Partnership (if the LLC has two or more members).

2. United States Federal Income Tax Filing Obligations If the LLC Is a Corporation.

If the LLC elects to be treated as a corporation for United States federal income tax purposes, then:

a. The LLC itself will have all the United States federal income tax filing, payment and withholding obligations of any United States corporate taxpayer. These obligations are extensive and are not summarized here; the principal obligation is that a U.S. corporation must (x) file a Form 1120 with the United States Internal Revenue Service ("IRS") each year reporting its income from sources throughout the world and setting forth related data (including schedules reporting information about (1) direct and indirect foreign shareholders, such as the Foreign company in this case, (2) foreign activities and income of the LLC, (3) foreign financial assets and bank accounts, and ( 4) transactions with related foreign parties), (y) the LLC must withhold and remit to the IRS taxes on dividends, interest, royalties and other fixed, determinable annual or periodic income and gains paid to foreign persons (including both related persons, such as the Foreign company, as well as unrelated persons) and file related information returns, and (z) file with the United States Treasury Department a separate report regarding foreign bank accounts and foreign assets.

b. If the LLC is a corporation for United States federal income tax purposes, then the Foreign company in its capacity as a shareholder of the LLC generally would not have any United States federal income tax reporting obligations if. and only if. both (x) the Foreign company is not engaged or considered to be engaged in a United States trade or business, (y) the LLC owns no United States real property interests, and (z) all United States federal income tax liabilities of the Foreign company (if any) are fully satisfied by withholding at source (whether the withholding is made by the LLC or third parties).

1 If the Foreign company is engaged in a trade or business in the United States at any time during a taxable year, then the Foreign company is required to file with the IRS a United States federal income tax return on Form 1120-F. This requirement applies even to foreign corporations that are only deemed to be engaged in a United States trade or business (other than by reason of being a beneficiary of an estate or trust), such as being engaged in a United States trade or business through an LLC that is disregarded or by virtue of being a member of a partnership engaged in a United States trade or business. If the LLC is a corporation for United States federal income tax purposes, however, then mere status of the Foreign company as a shareholder in the LLC generally would not result in the Foreign company being treated as engaged in a United States trade or business.
2 If the LLC owned by the Foreign company owns any United States real property interests, it may be a "United States real property holding company" ("USRPHC"). A foreign person who holds shares in a USRPHC is treated as engaged in a United States trade or business with respect thereto and subject to United States federal income tax upon any gain from a sale or other disposition of shares in the USRPHC (and the buyer of such shares has withholding obligations).
3 Withholding obligations on dividends, interest and other fixed, determinable, annual or periodic income and gains is imposed at the rate of 30% of the gross amount paid unless that rate is reduced by an applicable tax treaty.
4 Income tax treaties between foreign entities and the United States differ. For example the income tax treaty between Australia and the United States (x) limits taxation of income from U.S. business activities to circumstances in which the Foreign company has a "permanent establishment" in the United States (as defined in the treaty), (y) reduces withholding taxes on dividends, interest and royalties to rates lower than 30% in certain cases, and ( z) contains many other significant provisions.

If a foreign corporation such as the Foreign company takes the position that it is not required to file a return because its United States federal income tax liability is fully satisfied by withholding based on the provisions of an income tax treaty, then the foreign corporation must file a return to disclose the treaty-based position, although the return need include only the corporation's name, address, and taxpayer identification number (if any), as well as an attached statement disclosing the treaty-based return position.

3. United States Federal Income Tax Filing Obligations If the LLC Is Disregarded.

If the LLC is disregarded for United States federal income tax purposes, then the United States federal income tax withholding obligations of the Foreign company depend on the activities and income of both (x) the Foreign company itself and (y) the LLC (since the activities and income of the LLC are imputed to the Foreign company if the LLC is disregarded). Assuming the Foreign company is a corporation for United States income tax purposes (which is determined under United States federal income tax rules), then the Foreign company would have to file a United States federal income tax return if the Foreign company either is engaged or deemed to be engaged in a United States trade or business as a result of either its own activities or activities of the LLC, or if either the Foreign company or the LLC has dividend, interest, royalty or other fixed, determinable, annual or periodic income or gains from United States sources (as determined pursuant to complicated United States federal income tax rules) that are not fully satisfied by withholding at the statutory rate of 30%. Ownership of any United States real property interest also triggers filing obligations.

4. United States Federal Income Tax Filing Obligations If the LLC Is Treated As a Partnership.

If the LLC is treated as a partnership for United States federal income tax purposes because it has two or more members for those purposes, then the same results apply as in the case in which the LLC is disregarded. In addition, the LLC itself will have filing obligations and will be able to bind the Foreign company to certain liabilities for United States taxes.

B. State and Local Income Tax Filing Obligations. States and localities within the United States usually (but do not always) follow United States federal income tax classification of an LLC or other entity. Many state and local income tax laws are very similar to United States federal income tax laws but have significant differences (so-called "nonconformity"). Also, state and local income tax provisions can only apply to income and gains with some tax "nexus" between the foreign taxpayer and the state or locality making it constitutionally permissible for the state or locality to impose its tax. "Nexus" can arise by virtue of the presence of agents or employees; ownership of property located in the jurisdiction; and business activities within or directed to persons within the jurisdiction.

C. Taxes Other Than Income Taxes. The United States federal government and states and localities within the United States impose many types of taxes other than income taxes that also can trigger tax filing and payment obligations, including excise taxes such as sales and use taxes; transfer taxes applicable to sale of property or recordation of the evidence of transfer; communications, fuels and utilities taxes; and many other special taxes depending on the activities involved.

D. Structuring to Minimize Taxes and Filing Obligations

The United States does not tax the worldwide income of foreign corporations and nonresident alien individuals. As evident even from the brief discussion above, this fact and the complexity of the system give rise to numerous tax planning opportunities and pitfalls. Any non-United States person should plan and tread carefully when setting up a United States entity or engaging in any activity connected with the United States.

 
 
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IRS audits of businesses have dropped in 2016 to just 0.49% of all business tax returns, the lowest level since 2004. IRS audits of large corporations have also dropped. The IRS audited 6,458 large corporations, which are entities with assets exceeding $10 million. Four years ago, the IRS audited over 10,000.

Tax audits of individual by the IRS declined for the fifth straight year in 2016. The IRS audited just 0.7% of tax returns, which represents 1 in every 143 individual tax returns, down from 1 in 90 back in 2000. In 2016, the IRS audited 5.83% of high-income households, which is defined as returns with income over $1 million, down from 9.55% in 2015, which represents the lowest audit rate for that income group since 2008.

The above drop in audit rates are a result of budgets cuts at the IRS, which has lost 30% of its enforcement staffing since 2010. Expect Republicans to continue cutting the agency’s budget as part of broader spending cuts and the continued lowering of IRS audit rates.

The rules for the collection of New York State sales tax as it relates to computer software are quite complex.  In this article we look to explain how sales tax applies to sales of computer software and related services.

Prewritten computer software is taxable as tangible personal property, whether it is sold as part of a package or as a separate component, regardless of how the software is conveyed to the purchaser. Therefore, prewritten computer software is taxable whether sold:

  • on a disk or other physical medium;
  • by electronic transmission; or
  • by remote access.

Prewritten computer software includes any computer software that is not designed and developed to the specifications of a particular purchaser. This includes software created by combining two or more prewritten programs or portions of prewritten programs.

Custom software is not subject to tax provided it is designed and developed to the specifications of a particular purchaser. If the custom software is sold or otherwise transferred to someone other than the person for whom it was originally designed and developed, it becomes subject to tax.

Prewritten software that is modified or enhanced to the specifications of a particular purchaser is subject to tax. However, if the charge for the custom modification or enhancement is reasonable and separately stated on the invoice, then the charge for the modification or enhancement is not subject to tax.

Computer software services

Many services related to computer software are exempt. Examples of these services include:

  • training
  • consulting
  • instruction
  • troubleshooting
  • installing
  • programming
  • systems analysis
  • repairing
  • maintaining
  • servicing

However, when these otherwise exempt services are provided in conjunction with the sale of prewritten software, the charge for the service is exempt from tax only when the charge for the service is reasonable and separately stated on the invoice or billing statement given to the customer.

Sales of software upgrades

Generally, the sale of a revision or upgrade of prewritten software is subject to tax as the sale of prewritten software. If, however, the software upgrade is designed and developed to the specifications of a particular purchaser, its sale to that specific purchaser is exempt as a sale of custom software.

Remotely accessed software

A sale of computer software includes any transfer of title or possession or both, including a license to use.

When a purchaser remotely accesses software over the Internet, the seller has transferred possession of the software because the purchaser gains constructive possession of the software and the right to use or control the software.

Accordingly, the sale to a purchaser in New York of a license to remotely access software is subject to state and local sales tax. The situs of the sale for purposes of determining the proper local tax rate and jurisdiction is the location from which the purchaser uses or directs the use of the software, not the location of the code embodying the software. Therefore, if a purchaser has employees who use the software located both in and outside of New York State, the seller of the software should collect tax based on the portion of the receipt attributable to the users located in New York.

Software maintenance agreements

Separately stated and reasonable charges for maintaining, servicing, or repairing software are exempt from sales tax. However, if a software maintenance agreement provides for the sale of both taxable elements (such as upgrades to prewritten software) and nontaxable elements, the charge for the entire maintenance agreement is subject to tax unless the charges for the nontaxable elements are:

  • reasonable and separately stated in the maintenance agreement, and
  • billed separately on the invoice or other document of sale given to the purchaser.

Exempt sales for production or research and development

Prewritten computer software used or consumed directly and predominantly in the production of tangible personal property for sale, or directly and predominantly in research and development, is exempt from tax. The purchaser must provide the seller with a properly completed Form ST-121, New York State and Local Sales and Use Tax Exempt Use Certificate. See Tax Bulletins Exempt Use Certificate (TB-ST-235) and Research and Development (TB-ST-773).

Exempt sales to corporations and partnerships

Custom software is exempt from tax when resold or transferred directly or indirectly by the purchaser of the software to either:

  • a corporation that is a member of an affiliated group of corporations that includes the original purchaser of the custom software; or
  • a partnership in which the original purchaser of the custom software and other members of the affiliated group have at least a 50% interest in capital or profits.

However, the exemption does not apply if the sale or transfer of the custom software is part of a plan having as its principal purpose the avoidance or evasion of tax, or if the sale is prewritten software that is available to be sold to customers in the ordinary course of business.

 

As more companies in the manufacturing industry are becoming involved in foreign transactions, particularly exporting, they need to be aware that they can reduce their U. S. tax liability using an Interest-Charge Domestic International Sales Corporation, more commonly known as an IC-DISC.  The IC-DISC is a federal tax export incentive entity structuring available for U. S. companies that export goods and services to foreign countries.  An IC-DISC creates the opportunity to tax a portion of export related to profits at lower tax rates, and to potentially defer export related income to future years. 

The IC-DISC allows certain U. S. exporters to reduce their overall tax liability through a commission mechanism.  The exporter manufacturing company pays a tax deductible commission, based on qualified export sales, to a newly created corporation that makes an IRS election to be an IC-DISC.  By design, IC-DISCs are exempt from federal tax, and therefore do not pay tax on the commission received.  The IC-DISC then distributes the commission income to the shareholder as a qualified dividend subject to tax at reduced capital gains tax rates.

The IC-DISC entity can be created by the shareholders of the exporter manufacturing company as a brother-sister configuration, typically used when the exporter manufacturing company is a regular corporation for tax purposes.  Or, the IC-DISC can be established by the exporter manufacturing company as a parent-subsidiary configuration when the parent exporter manufacturing company is a pass-through type tax entity.

In either case, the benefit received from utilizing an IC-DISC structuring is dependent on the tax structuring and the effective tax rates of the taxpayers involved in the commission transactions.  The IC-DISC is not required to distribute its accumulated earnings, allowing for the dividend income to be deferred into future years. 

Export sales must meet the following requirements in order to qualify for the IC-DISC benefit:

  1.  Export property must be manufactured in the U. S.
  2.  Export property must be sold for direct use outside the U. S.
  3.  Less than 50 percent of the export property’s sale price must be attributable to imported

In addition to export sales of manufactured property, the following transactions may also qualify for IC-DISC treatment:

  1.  Leasing U. S. manufactured property for use outside of the U. S.
  2.  Export sales of property that is extracted, produced, or grown in the U. S., including crops and 
  3.  Engineering and architectural services provided for construction projects located outside the U. S.

 

 

The Research and Development Tax Credit Program, or RTCP, was introduced into the Internal Revenue Code to encourage businesses to invest in significant research and development efforts with the high expectation that such an advantageous tax incentive program would help stimulate economic growth and investment throughout the United States and prevent further jobs from being outsourced to other countries.

In December 2015 the Protecting Americans from Tax Hikes Act of 2015, or PATH Act, made the RTCP a permanent tax incentive within the Code and considerably restructured the program to allow eligible “small businesses” (i.e., $50 million or less in gross receipts) to claim the RTC against the Alternative Minimum Tax for tax years beginning on January 1, 2016.

Businesses with average annual gross receipts of less than $50 million for the three taxable year period preceding the current taxable year are now eligible to offset both their regular income tax and their AMT with RTCs. Before the enactment of the PATH Act, businesses in AMT positions were unable to utilize their RTCs to offset their tax liability. Regardless, it is important to point out that RTCs can generally be either carried back 2 years or carried forward up to 20 years before the RTCs could expire unutilized

In addition, PATH allows eligible “start-up companies”, which is defined in this section of the Code as companies with less than $5 million in gross receipts in the current taxable year and that have no gross receipts for any taxable year prior to the five taxable year period ending with the current taxable year, to claim up to $250,000 of the RTC against the company’s federal payroll tax for tax years beginning on January 1, 2016.