The following is an excerpt from the U.S. Small Business Accounting For International Investors Webinar with H&CO. Global CPA Firm
Reviewing the types of Business Entities
This is where I’m going to dive in. I have three scenarios that I want to share with you, which I think are very important and the most common scenarios for international clients or even U.S. people that live here. They use these structures as well. Not all of them, some of them, caveat. Some of these are molded for international clients as well. So individual ownership would basically mean that you as a foreign person, international investor, came to the United States, generated source of income in the U.S., and it had a tax filing requirement. So, you would file an individual income tax return, and you would pay tax according to the tax bracket that I showed you earlier. So depending after the calculation what’s your net income based on your business, or whatever services you performed, or if you sold a property, you would pay tax at the net profit level. What’s the difference? I showed you two examples here, right? The NRA or would incorporate LLC, which is a limited liability company that I mentioned earlier, that is actually a very common type of entity, which is a U.S. company. It’s a legal entity here for us that we incorporate in the United States. It’s very, very common. Why do we recommend this? Because it’s a hybrid entity.
Hybrid Entity Business Structure
Hybrid entity means I have the…I can elect a different type of treatment. That’s all you really need to know about an LLC. So its default classification is a pass-through entity, means that it doesn’t exist for U.S. tax purposes, but it exists for liability purposes, which means there is a separation between the owner and the LLC. So you have more protection. And it’s actually good because you’d open an LLC bank account. It won’t be together with your own personal funds in the United States. Not that there’s anything wrong, but it creates a little bit more separation and for legal matters. But when we talk about tax, what’s going to matter? The LLC doesn’t matter. Who’s going to pay the tax? It’s going to be the individual. So in this structure, the U.S. LLC for a non-resident alien has a basic informational return just to disclose the accounting. But who’s going to pick up the tax and file it? It would be the non-resident alien, from 10% to 37% capital. Whenever you pay tax at the individual level, if you have some sort of asset that was sold and there’s capital gains applicable, and you held the asset or the investment for longer than 12 months related into the business, the capital gains treatments are from 0% to 20%. Okay.
In a negative side, as more as like a con, this structure, people sometimes have the misconception that the LLC would mean that you don’t have to file at the individual level. That is not true. So, the LLC files informational return, and then the NRA also files an informational return. So just so you keep that in mind. That would be the individual ownership type structure. The second most common structure that’s used in the United States by U.S. tax residents and by international investors is a U.S. LLC with more than one shareholder, more than one member. What does that mean? Automatically, the IRS will see this as a partnership. So the default classification, which means you incorporate an LLC, there’s more than one member, it’s going to be a partnership. And this is a great structure for internationals and U.S. taxpayers. Here you also do file at the individual level, and you do file a tax return for the U.S. LLC. So who’s paying the tax? Remember I mentioned, if it’s a pass-through entity and individuals are responsible for the tax, the LLC does not pay tax. It doesn’t owe any money. Who pays? It’s the NRA or the members of the company.
Why is this structure actually a pro? It actually has lesser of a chance of getting audited in comparison with the individual owner. When you’re doing business, imagine the IRS gets thousands and hundreds of thousands of tax returns for U.S. LLCs that are treated as partnerships. And these could be huge corporations that have a very large number of revenues or profits. And these are things that companies are looking for. Not companies. The IRS is looking at, “Who am I going to audit?” Because it’s really random. It’s not something that you can for sure guarantee that you’re not going to. But seeing, if you’re a small business owner and you have a U.S. partnership, that U.S. partnership with smaller profits compared to other major partnerships. So the likelihood of you getting audited is smaller than in comparison of individual ownership, which is in the first structure. So if you have higher income, you would be likelier to perhaps have a little bit more exposition. So if you can get another shareholder, maybe your wife, another friend that’s going to join in on the venture, you could then have a partnership.
Individual Ownership v Partnerships
The great thing about individual ownership and partnerships is that you only pay one level of tax because that is at the individual level in the United States, and then you would have to verify which state would apply. So if you’re doing business in Florida and you pay tax at the individual level, like a partnership or individual ownership, you would only pay tax to the federal government because Florida doesn’t have individual income tax return. That’s why I put zero. Also, if you distribute or withdraw funds from the partnership, there’s no dividend tax, you only pay one level of tax. So you can have income minus expenses, your net profit. That lump sum is going to be taxed in the United States. In a partnership, you would divide that lump sum into three, so it’s prorated. So, if each shareholder owns one-third of the company, and you have $27,000 of net income, each non-resident alien is going to file an individual tax return and is going to report $9,000 of income tax. And those $9,000 would be applied to that individual tax table that I showed you earlier. So you actually end up dividing the responsibility, and you get a lower rate on the tax table. It’s important, these structures, whenever you own directly the LLC, you do have estate tax exposition, like you’re exposed to estate tax this way because you’re a non-resident alien, and you hold shares of a U.S. company. So it’s just something to keep in mind. It’s more favorable in the side of taxes because you get to divide up the obligation, and you get a lower tax rate. But then on the con, you have exposed tax liability. Here in this structure with three members, there would be four tax returns, one for the LLC and three for the individual owners. So sometimes it can become a little bit more expensive.
Personal v Business Taxes
Patrick: Alexandra, quick question. We have someone that’s interested to better understand kind of how taxes are between business and personal. So you have a business, an E-2 visa business in the U.S. Do you pay taxes for your business and personal income, or would it be all in one whole contribution?
Alexandra: Well, in this case, what would we need to know, how is the company treated for tax purposes? Is it a partnership, which is an LLC with more than one member? Is it a disregarded entity, which is the example above this, which is an individual owner, or is it an S corporation? So there are a couple of factors that we would have to take into consideration. And I think maybe once I explain the next slide, which is corporation, they might be able to identify which one their business falls into. If it’s not identified, we can go into it more specifically by email or a call.
So just to continue a little bit to the next step, see if I can answer…get these answered more…clarified for you. So partnership, individual level. Both examples I showed you were individual level. Then we have a U.S. corporation. So as you can see in the title, I put LLC Inc., or Corp. So, by default classification when you open an Inc., and it has Inc. or Corp in the name, it is automatically a U.S. corporation, and it will be treated as a U.S. corporation for tax purposes. I included LLC. I’m not sure if you remember me saying that it is a hybrid entity, and you can elect for a different type of tax treatment instead of it being passed through. So that would mean that as your accountants filled out a specific form, filed it with the IRS, your name won’t change with LLC. It will be now treated as a C corporation. Why is this so interesting? In this structure, as a non-resident alien, you would not have to file an individual income tax return if you own shares of a U.S. C corporation. So the U.S. C corporation is responsible for all the obligations with the IRS, meaning it files its own accounting, files its own tax return, and is required to pay taxes at the company level. So, in accounting terms, we say it’s opaque. So it’s not…the opposite of pass-through. LLC, if you want the pass-through treatment, then the individuals pay tax. So in this feature, you would have the U.S. corporation in which we will pay federal income tax at a flat rate of 21%, and based on your location, depending on what state, we would have to evaluate if you have state income tax requirements.