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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 to Target Specific S Corporation Areas as Part of New Compliance Campaign

The Internal Revenue Service’s Large Business and International Division has approved five new compliance campaigns in several areas including specific areas related to S corporations. The LB&I Division has been moving toward issue-based examinations and a compliance campaign process in which it decides which compliance issues present enough of a risk to require a response in the form of one or multiple treatment streams to achieve tax compliance objectives. The five new campaigns were identified through data analysis and suggestions from IRS employees. The goal is to improve return selection, identify issues representing a risk of non-compliance, and make the best use of the division’s limited resources.

As part of the S corporation campaign, the IRS noted that S corporations and their shareholders are supposed to properly report the tax consequences of distributions. The service has targeted three issues as part of this campaign:

  • When an S corporation fails to report gain upon the distribution of appreciated property to a shareholder.
  • When an S corporation fails to determine that a distribution, whether in cash or property, is properly taxable as a dividend; and,
  • When a shareholder fails to report non-dividend distributions in excess of their stock basis that are subject to taxation.

For this campaign, the IRS plans to conduct issue-based examinations, suggest changes to tax forms, and conduct stakeholder outreach.

As part of the campaign, any examinations that result from this campaign will probably touch upon other S corporation related issues including the methods S corporations use to determine reasonable compensation and its impact on potential under-reported FICA taxes.

Taxation of Cryptocurrency Mining Activities

There are new rules which the US Congress passed in December 2017 that change the way the IRS treats cryptocurrency. Before the US Congress put forth a clearer ruling in 2017, the classification category of cryptocurrency assets was up for interpretation according to many tax experts. That’s because many cryptocurrency miners and traders treated cryptocurrency similar to real-estate for tax purposes by citing the like-kind exchange rules of IRS Code Section 1031.

Following this ruling a miner could theoretically trade a mined cryptocurrency for another cryptocurrency without having to pay taxes. With 1031 exchanges limited to real estate transactions under the recent tax act this treatment is now out the window. Now anyone with cryptocurrency mining operations in 2018 will have to pay taxes beginning in 2019.

There are a couple of things to consider when paying taxes for cryptocurrency mining. You have two different income streams to consider. The first taxable event occurs whenever a miner mines a new coin. The IRS considers this to be income even if the miner decides to only hold the coins as “inventory”. When you mine the coins, you have income on the day the coin is "created" in your account at that day's exchange value. If you are reporting activity as an individual taxpayer, you can report the income as a hobby or as self-employment. If you report as a hobby, you include the value of the coins as "other income" on line 21 of form 1040. Your ability to deduct any expenses is limited -- expenses are itemized deductions subject to the 2% rule.

If you report as self-employment income (you are doing work with the intent of earning a profit) then you report the income on schedule C. You can fully deduct your expenses. The net profit is subject to income tax and self-employment tax. Similar treatment occurs if you operate as a multi-member LLC except that the transactions are reported on the LLC’s tax return with the individual members having their shares of the net profits or losses reported on individual K-1s.

Your second income stream comes when you actually sell the coins to someone else for dollars or other currency. Then you have a capital gain or a capital loss.

Finally, if you immediately sell the coins for cash, then you only have income from the creation and you don't also have a capital gain or loss.

Now, as far as expenses are concerned, if you are doing this as a business, you can take an expense deduction for computer equipment you buy (as depreciation) and your other expenses (for example electricity and other business expenses). But if you are doing this as a home-based business you need to be able to prove those expenses, such as with a separate electric meter or at least having your computer equipment plugged into a portable electric meter so you can tell how much of your electric bill was used in your business. Unless your expenses are very high, they won't offset the extra self-employment tax, so you will probably pay less tax if you report the income as hobby income and forget about the expenses.

Supreme Court Rules States Have Authority To Require Online Retailers To Collect Sales Taxes

The U.S. Supreme Court, in a 5-4 decision, has held that states can assert nexus for sales and use tax purposes without requiring a seller’s physical presence in the state, thereby granting states greater power to require out-of-state retailers to collect sales tax on sales to in-state residents. The decision in South Dakota v. Wayfair, Inc., et al overturns prior Supreme Court precedent in the 1992 decision Quill Corp. v. North Dakota which had required retailers to have a physical presence in a state beyond merely shipping goods into a state after an order from an in-state resident before a state could require the seller to collect sales taxes from in-state customers. That was before the surge of online sales, and states have been trying since then to find constitutional ways to collect tax revenue from remote sellers into their state.

The Court noted: “When the day-to-day functions of marketing and distribution in the modern economy are considered, it is all the more evident that the physical presence rule is artificial in its entirety”. The Court also rejected arguments that the physical presence test aids interstate commerce by preventing states from imposing burdensome taxes or tax collection obligations on small or startup businesses. The Court concluded that South Dakota’s tax collection plan was designed to avoid burdening small businesses and that there would be other means of protecting these businesses than upholding Quill.

In his dissenting opinion, Chief Justice John Roberts argued that, although he agreed that the enormous growth in internet commerce in the interim years has changed the economy greatly, Congress was the correct branch of government to establish tax rules for this new economy. He also took issue with the majority’s conclusion that the burden on small businesses would be minimal.

Prior to the decision, many states had already begun planning for the possible overturn of Quill.

Congress may now decide to move ahead with legislation on this issue to provide a national standard for online sales and use tax collection, such as the Remote Transactions Parity Act or Marketplace Fairness Act, or a proposal by Rep. Bob Goodlatte, R-Va., that would make the sales tax a business obligation rather than a consumer obligation. Under that proposal, sales tax would be collected based on the tax rate where the company is located but would be remitted to the jurisdiction where the customer is located.

 

C Corp vs S Corp or LLC:
How The Tax Cuts and Jobs Act Impacts This Decision

The Qualified Business Income Deduction section of the Tax Cuts and Jobs Act included a new deduction meant for S corps, LLCs, partnerships and sole proprietorships (commonly referred to as pass-through entities). The deduction is calculated at 20% of the trade/business income of these entities. There are limitations based on owner’s taxable income, W-2 salaries of the business, assets in the business and whether or not the business is a service or non-service entity.

Accordingly, not all pass-through entities will qualify for the 20% deduction.

The Tax Cuts and Jobs Act has also dropped the C corporation tax rate to 21% and a lot of questions have arisen from closely held business owners about converting their limited liability company (LLC) or S corporation (S corp) to a C corporation (C corp) including questions from the owners of entities that don't qualify for the 20% deduction. Does it make sense to switch to or start a C corp? The answer is not that simple. Much depends on your business and the business model you operate under.

While the federal tax rate for C corps has dropped favorably to a flat 21%, there are still limitations to a C corp’s tax structure. C corps are subject to double tax. When a C corp issues dividends on their profits, the shareholders receiving the dividends are then taxed on their personal tax return, while the C corp receives no deductions for these payments. Whereas, if you are structured as an LLC or an S corp, you are taxed on the net taxable income that flows through to the owner’s individual tax return and you can distribute the funds out of your company, without double tax. If the goal of the business is to reinvest the earnings back into the company, C corps are a favorable option to take advantage of the lower tax rates.

As a practical matter, for current operations, closely held C corporations do not normally pay dividends. Owners in these entities are often active in the business and draw a salary. The corporation gets a deduction for the salaries, but owners receiving the salary pay federal tax on that salary at a rate as high as 37%.

Upon exiting a closely held business, the sale of the assets of the business are, normally, the only viable option. Very few buyers will want to buy the ownership interest in a closely held business. If you decide to sell your business as a C corp, income generated from the sale of assets is taxed at the corporate level first and then taxed again when the net cash is distributed out to the shareholders.

Also, consider the timing issues when switching to and from a C corporation. Let’s say your business is currently structured as an S corp. You and your shareholders deem your business is better suited as a C corp and you want to convert your organization. It is fairly easy to switch to a C corp. But there is a “buyer beware” with that enterprise. You must wait five years after the switch to a C corp to switch back to an S corp. Once you switch back to an S corp, you could be subject to double taxation on built-in gains (unrealized appreciation on assets held while the entity is a C corporation) for an additional five years after the switch. At a minimum, you will need to live with the possibility of some degree of double taxation for up to ten years.

So what is the bottom line on all of this?

If you have a business that you plan on keeping fairly small, with fewer than 100 shareholders and located in the U. S, you probably want to be an S corp or an LLC. But if your goal is to reinvest profits back into your business to finance future organic growth then the C corporation is probably a good fit. If you have big plans for growing your company to position it for future sale or to go public, you might want the flexibility to take on investors, raise capital, issue different kinds of stock, and invite foreign investors into your business as a C corp.

As always, it is best to consult your advisors before commencing any changes in business structure.