A US-based LLC can have great tax advantages, especially for foreign entrepreneurs abroad. Even for US taxpayers, LLC taxes can be favorable.
An LLC is a pass-through tax entity. What this means is that the LLC is not taxed directly. Instead the profits and losses of the business pass through to its owners, who report them on their personal tax returns.
Tax-free LLC income for foreign owners of a US LLC
A little known fact is that the US can be one of the biggest tax havens in the world. A US LLC opened by a non US citizen or nonresident can allow for earnings that are not taxed in the US.
Of course, certain rules apply to avoid LLC taxes.
Effectively, as a foreigner, you must have no US presence. You are only subject to US tax if you are “engaged in a trade or business in the United States”, which only applies if two things are true:
(1) you have at least one “dependent agent” in the US, which are employees or companies that work for you almost exclusively, and
(2) this dependent agent does something substantial to further your business in the US, as opposed to something purely administrative.
If you don’t have a dependent agent that substantially furthers your business in the US and don’t have an office in the US, you are not subject to US tax. Even if the LLC generates income in the US, the income is not taxed in the US.
Furthermore, if you reside in a country with an applicable tax treaty with the US, then you would not be subject to US tax. Since you reside in your tax home, you can claim you operate a “permanent establishment” (e.g., an office or other fixed place of business) in your home country.
In other words, when you work and pay tax in your home country, the tax treaty will circumvent any of the US rights to tax you since you are working and living in your respective country.
Dependent Agent examples
Let’s explain the “dependent agent” requirement with two examples.
Example 1: Foreign software company without US office or representative
A Mexican software company is performing programming/design work for US clients. It is based in Mexico and has no US office or sales agents. All sales are done over the phone or online.
The company can open an LLC to receive payments in USD in a US bank account. The work is performed in Mexico and the owners are non US citizens/residents, who are not taxed in US. Therefore, the LLC income is not taxed in the US as there are no offices or dependent agents in the US.
Example 2: Foreign “Fulfillment by Amazon” service provider
A foreign entrepreneur sells products into the US market using Amazon’s “Fulfillment by Amazon” service. All marketing and procurement is managed online by the non US citizen, who lives in Colombia. Products are ordered and shipped to Amazon’s warehouses, where Amazon employees package the products and ship to customers in the US.
In this case, Amazon is not a dependent agent but an independent agent that has its own business with millions of other clients. Amazon is not uniquely working for this foreign entrepreneur. Therefore the foreign entrepreneur is not “engaged in a trade or business in the US,” so he or she is not subject to US tax on income from selling products into the US.
LLC tax filing requirements for foreigners
Previously single member LLCs with foreign owners were not required to file. However, starting 2017, all foreigners who own a US LLC must file a 5472 US tax return with the IRS for disclosure purposes even if they do not owe tax in the US.
In addition, foreign owners should be aware of the LLC tax implications in their local fiscal residence jurisdictions. The income from the US LLC may still be taxed in the country of residency.
LLC taxes for US citizens or residents as owners
For Americans there is no tax haven for LLCs. Still, an LLC offers an easy option to formalize business operations and create partnerships.
As mentioned earlier, the IRS does not treat an LLC as a separate tax entity. Instead all its income is passed through to the members of the LLC, who must declare it and pay personal income tax.
A single owner of an LLC would include the profit and loss from the LLC on Schedule C of his or her Form 1040. With two or more partners, each owner reports the allocated portion of the profits on their personal tax return.
However, some US states tax LLCs directly. Also note that an LLC may elect to be taxed as a corporation. In many cases American taxpayers will also be required to pay self-employment tax in addition to income tax.
To limit this self-employment tax liability and also offer the option to contribute more to a retirement plan, US taxpayers should consider an S Corp. We will explore more of these advantages in this comparison of LLC and S Corp. Click here to learn more about our services and pricing.