Non-resident aliens (NRAs), basically non-US persons, can own a US-based LLC and sell goods and services in the United States. The big question is: Does a foreign-owned LLC owe tax in the US?
In this in-depth guide to foreign-owned LLC taxation, we cover the US tax situation of NRAs with a US business of selling goods or services. We discuss which businesses trigger US federal income tax liability and which don’t. And we further clarify the potential US tax exposure of doing dropshipping via Amazon.
For simplicity, we will focus here on single-member LLCs with just one foreign owner. First, we explain some general concepts. Then we look at clear situations where the NRA owner has no US tax liability. After that, we will examine the situations that trigger tax liability.
Here’s what we cover:
- How Is A Foreign-Owned Single-Member LLC Taxed?
- IRS Filing Requirements – Form 5472 For Foreign-Owned LLC Tax Return
- Effectively Connected Income And ETOB – Key Concepts For Taxation Of Foreign-Owned LLCs
- When Is A Foreign-Owned LLC Tax-Free In The US?
- Foreign Service Providers Can Be Tax-Free In The US
- Foreign-Owned LLC Businesses That Are NOT Tax-Free
- Is Dropshipping Tax-Free In The US For A Foreign-Owned LLC?
- Reselling Inventory And The Transfer Of Ownership
- Examples Of US Taxation For E-Commerce
- How To File A US Tax Return As NRA LLC Owner
- Determine If Your Foreign-Owned LLC Must Pay US Taxes
Let’s get started.
How Is A Foreign-Owned Single-Member LLC Taxed?
A single-member LLC is a limited liability company that has just one owner. IRS classifies this type of LLC as a “disregarded entity” for tax purposes. This means that, from a tax perspective, the LLC doesn’t exist separately from its owner.
(Still, the LLC must file a form with the IRS. Check out the Form 5472 filing requirements for foreign-owned LLCs. We also talk more about this filing requirement below.)
An LLC with a single foreign owner is commonly referred to as foreign-owned US disregarded entity.
Furthermore, an LLC is a “pass-through entity”. This means that all the income from the LLC flows right through to the LLC owner. If an LLC owes US federal income taxes, that tax liability passes through to its owner. The owner must report the income on their personal tax return.
In many cases, the LLC doesn’t owe US tax. So, the owner doesn’t have to file a US tax return. They must still submit the Form 5472 for the LLC, as mentioned above.
A foreign-owned LLC only needs to pay US taxes if it generates US-sourced income. We will give some examples of LLC generating US-sourced income. We will also explain how the NRA owner files a tax return in the US.
What does NRA mean? – Definition
NRA – Non-Resident Alien – Someone who is not a
- US citizen
- Green card holder
- Resident
- Accidental American (born abroad to an American parent)
nor spends enough time in the US to meet the Substantial Presence Test.
IRS Filing Requirements – Form 5472 For Foreign-Owned LLC Tax Return
Even if the LLC has no US tax liability, the foreign owner of a single-member LLC must still file an annual informational report with the IRS.
They file Form 5472 together with a proforma Form 1120. Proforma 1120 means that it only uses the first page of an actual Form 1120 return and attach Form 5472 to it.
The purpose of Form 5472 is to report all transactions between the foreign owner and the LLC, both directly and indirectly.
Examples of direct transactions are money transfers between the LLC business bank account and the owner’s personal account.
Examples of indirect transactions include paying business expenses on behalf of the LLC, invoicing the LLC from another company the foreigner owns, or sending money to friends and family from the LLC.
Be aware of special rules for transactions between the LLC and members of your family or the LLC and other entities under your name. Seek professional advice to make sure you comply with the IRS rules.
Revenue and sales are irrelevant for Form 1120 plus 5472 – only transactions between the foreign owner and the LLC are reported.
The deadline for filing Form 5472 is April 15th. Remember that failing to file may result in a $25,000 fine.
For more information, check out these FAQs about Form 5472.
Effectively Connected Income And ETOB – Key Concepts For Taxation Of Foreign-Owned LLCs
Whether an LLC owner must pay taxes in the US depends on the type of business activity the LLC performs in the US and several other factors.
It’s important to understand two key terms: ETOB and ECI.
To have a tax liability, an NRA must be “Engaged in a Trade Or Business” (ETOB) in the United States. Any income from engaging in trade or business in the US is “Effectively Connected Income” (ECI).
Only when the income of a US LLC owned by a foreigner is effectively connected to US business or trade will it be subject to federal income tax.
We explain this further with some examples in a moment.
Definitions of ETOB and ECI
ETOB – Engaged in a Trade Or Business in the US: When a business runs operations in the United States, it is ETOB. This is nuanced. We give examples below.
ECI – Effectively Connected Income: When a NRA engaged in trade or business in the US, all income derived from that is ECI.
In addition, there is another form of income that could generate a US tax liability. It is called FDAP – Fixed or Determinable, Annual, or Periodic income. The US taxes it at a flat 30% rate unless a tax treaty specifies a lower rate. FDAP income is passive income such as interest, dividends, rents or royalties. This is outside the scope of this article.
When Is A Foreign-Owned LLC Tax-Free In The US?
Without any activities happening in the United States, the income is foreign-sourced income. The US does not levy federal income tax on foreign-sourced business income. Therefore, it is tax-free in the United States. (The NRA owner might still have to pay tax on the income in their home country.)
However, “any activities in the US” has a broad interpretation by the IRS.
First, to be tax-free in the US, a foreign-owned US-disregarded entity cannot have any actual presence in the US.
So, what does “presence” mean? It means that the LLC cannot have any of the following:
- US employees
- US corporations or “dependent agents“ that work solely for the LLC
- Real offices in the US
- US warehouses
What Is A Dependent Agent? – Definition
Dependent Agent – A person or company who works exclusively or almost exclusively for the company and substantially furthers its business. By contrast, an Independent Agent, like Amazon, works with many others.
But it get’s more complex than having a physical presence.
In the past, many tax practitioners thought that not having a US presence was sufficient to be tax-free. However, recent cases showed that the IRS is going after e-commerce stores that are selling products in the US, even without having a physical presence there. The argument is that the transfer of the product ownership takes place in the United States and therefore the income is US-sourced.
So, in addtion to not having a physical presence, it is also important where the product ownership is transferred.
This sounds complicated – and it is. We explain it in detail in the post and give examples how this effects e-commerce businesses and dropshippers.
Foreign Service Providers Can Be Tax-Free In The US
There are several business services that foreigners can perform through a US LLC and avoid any US federal tax liability. Those services include:
- Web development and design
- Consulting (management, business, lifestyle, financial, accounting, etc.)
- IT services
- Marketing services
- Legal services performed online
If foreigners perform the above-listed activities online and outside the US, then the income that those activities generate will be foreign-sourced income, i.e., not ECI.
Services that are provided while the service provider is in the States are taxable. NRA owners of a US LLC typically don’t have an American work visa. If they travel to the US on a tourist visa, we strongly advise that they do not work while in the US.
Foreign-Owned LLC Businesses That Are NOT Tax-Free
Let’s look at the opposite situation, where a foreign-owned LLC must pay tax in the United States.
Whenever the LLC has an actual presence in the US, it creates an income tax liability for the foreign owner. As discussed earlier, a company has a presence when it has US employees or dependent agents, warehouses, real offices, etc.
Here are some examples:
- The LLC has a marketing manager located in the US, who works only for the LLC, not for other companies. This person works from home or visits customers to increase the LLC business. Therefore, the marketing manager is a dependent agent, which makes the business taxable.
- The business has a physical sales office in the US. That makes it ETOB. On the other hand, having a virtual office (as opposed to a real office) in the States does not create a presence.
- The NRA keeps inventory, e.g. a warehouse or storage space and sells from there to US customers. It does not matter where the warehouse is located. It is US-sourced income because the product ownerhsip changes to the US customer.
So, when product ownership was transferred from a supplier to the foreign-owned LLC, the LLC is basically reselling this inventory. Once the LLC sells it to customers in the United States, the business income becomes US-sourced income.
The only case where inventory is not US-sourced is when the seller produces the goods in a foreign country (instead of purchasing it). In this case, the income is sourced to the place of production. Selling the foreign-produced goods in the US generates foreign source income, which is tax-free in the US. The IRS treats any other sale of inventory to US customers as US source income.
Is Dropshipping Tax-Free In The US For A Foreign-Owned LLC?
Here, the answer is not that simple. It depends on what dropshipping consists of and how the product is moved to the customer.
Many of our foreign clients use platforms such as Shopify, Amazon, etc., to present their web stores. While the seller may theoretically not take ownership and inventory of the products they sell, the platform typically considers the seller as the owner of the product. (Read the fine print of their Terms of Services that you agree to when signing up.)
For Amazon sellers to claim that they don’t own the products they sell poses significant tax risk. This is a grey area that can expose you to US taxes.
Let’s look at a different scenario and say the LLC markets products on their own website instead of Amazon. Any orders are fulfilled directly by the supplier, who manages the transaction. The LLC receives a commission from the supplier for every sale. The LLC’s activities are only on the marketing side of product sales.
In this specific case, dropshipping would not incur US federal income tax liability. It doesn’t matter for the LLC whether the supplier is located within or outside the US. Since there is no transfer of ownership to the LLC, the income generated by selling those products is not ECI.
As you can see, it is crucial whether the LLC takes ownership of the products they sell or not!
It is also important that US-based suppliers work with various parties. If they work solely with the LLC, they become a dependent agent. As explained earlier, having a dependent agent in the US makes the business ETOB in the US.
To summarize, the main potential tax trigger for dropshipping is the ownership transfer. When a foreign-owned US LLC does not take ownership of the products it sells, then the generated income is not effectively connected to the US.
Dropshipping, in those cases, is more of a service-like activity performed outside of the US.
However, when selling through an e-commerce platform, this scenario is unlikely. The seller is typically considered the owner of the product.
Reselling Inventory And The Transfer Of Ownership
As we just explained, a key factor for US taxation is whether the LLC takes ownership of the product or not. But what does “taking ownership” really mean?
It’s quite clear-cut when the LLC buys inventory to resell it. The LLC owns the inventory. When it sells the goods to US customers, the ownership is transferred in the US and therefore subject to US tax.
With dropshipping, the dropshipper pays their supplier when or after the goods have shipped to the end-customer, so the dropshipper never had ownership of the goods. The ownership is directly transferred from the foreign producer to the US customer. This means that the US may not tax the LLC owner on that income.
However, if a dropshipper pays a supplier before the product ships to the customer, you can argue that the dropshipper owns the product, which would trigger tax liability. As you can see, there’s a lot of grey area. The cleanest case is when the supplier manages the transaction directly, not through the LLC.
So, when reselling inventory, the point of the ownership transfer is key – not where the warehouse is.
An experienced US tax advisor can help you determine if your foreign-owned e-commerce LLC is tax-free in the US or not. Schedule a consultation with us.
Examples Of US Taxation For E-Commerce
Let’s look at two different scenarios of selling through Amazon – one triggers US tax, the other doesn’t:
- A non-resident alien (NRA) is holding ownership of the product through their foreign-owned US LLC. For example, an Amazon seller purchases inventory, stores it in Amazon warehouses, and then sells it to US customers. Although Amazon is not a dependent agent, the ownership title transfers in the US. Therefore, he has effectively connected income and must pay US tax on the ECI. – Many Amazon sellers are not aware of this!
- An NRA dropshipper markets a product that goes directly from a supplier outside the US to the US customer. The NRA never owns the product or holds any inventory. He only markets the product on their own website and connects the supplier to the customer. The supplier handles the transaction. So, the LLC has no ECI and therefore no US tax.
Many cases, though, are not always as clear as these two examples.
How To File A US Tax Return As NRA LLC Owner
As we explained above, when the LLC has taxable income, it passes through to the foreign owner, i.e., to the NRA owner. Therefore, the NRA must correctly report and pay those taxes.
The foreign individual owner of the LLC must file the following tax returns:
- An individual tax return for NRAs – Form 1040NR
- An information return for the LLC – Form 5472
So, the 5472 reporting remains in the cases of US income tax liability. Any transactions between the foreign owner and its LLC during the year must go on the 5472 form.
To file a 1040NR return, NRA must first obtain ITIN (individual tax identification number).
The 1040NR will include NRA’s personal information, the exact income amount subject to federal income tax withholding, and the actual taxes NRA must pay.
The deadline for filing 1040NR is April 15.
Determine If Your Foreign-Owned LLC Must Pay US Taxes
As you can see, not all LLCs owned by an NRA are tax-free.
In some cases, it is easy to determine if the LLC owes US tax. As described above, services performed outside the US are typically tax-free in the US.
In other circumstances however, it is not that clear cut. Especially when handling inventory is involved, the business likely triggers US federal taxation.
Federal taxes are also not the only taxes the LLC should consider.
Some states have more rigid tax codes than others and may tax the US LLC directly. Furthermore, sales taxes might apply, but this will probably go hand in hand with the federal income taxes explained above.
Speak to an expert to find out what tax in the US you as a foreign LLC owner might owe. Schedule a consultation.
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