One of the most common questions we get when registering a company in the US is about what kind of entity is more convenient, and there is a big fat “it depends”. Even though there are several types of business entities in the U.S., there are only two recommended when there is a work-based or investor visa involved: LLC – better known as Partnerships, and Corporation – Inc, Corp, Incorporated.
There are a lot of differences between these two; however, tax treatment ranks among the top. LLC – Partnerships are considered pass-through entities and as such a single level of taxation at its owner’s side on distributable net profits. In other words, the Company does not pay taxes, only the owners.
On the other hand, Corporations, have what is known as “double level of taxation”: first on net profits (21%[1] flat rate plus State) at Company level; and then again on the distribution of dividends (if any as passive income) at Shareholder level.
This might be a no-brainer when deciding in selecting the type of entity; however, there are other factors to consider. For instance, since LLCs do not pay taxes, all net profits are automatically transferred to the Company’s Members, and these proceeds are then taxed at individual rate when consolidating all income and losses of that Member. This is important to consider in situations where an individual has participation in multiple partnerships, and/or reports additional sources of income that may bring the Marginal Tax Rate to a higher tax bracket as opposed to a flat Corporate rate of 21%. In these situations, any income from the Partnership – regardless of the amount, may be taxed at a higher tax bracket.
Also, since an LLC does not pay taxes, when in presence of a foreign member (individual or company from outside the U.S.) owning part of the stake of a domestic LLC, the net profit to be distributed to foreign members may be subject to a withholding of up to 35% to cover any potential tax liability of a non-reporting foreign entity and/or individual. As this is payable by the company, the company becomes a withholding agent in charge of covering that potential tax. This is important when considering a structure where a foreign entity is investing in a domestic company and needs to transfer an Executive or Functional Manager to the U.S. – does it ring a bell?
Another factor is that a Member of a Partnership – LLC, under the new provisions of the TCJA cannot be part of payroll as a W-2 recipient of the LLC she/he owns. This is a “condition” for the new Qualified Business Income Deduction applicable to those entrepreneurs with stakes in a pass-through entity. This factor is probably the most important when discussing an Immigration process that would require some sort of proof of payroll and/or Company’s ability to pay beneficiary’s wages down the road. Members that actively work on his/her LLC get paid through “Guaranteed Payments” without the respective withholding of employment taxes such as Social Security and Medicare. Then each member is responsible of making quarterly estimated payments to cover for these taxes.
Therefore, if we are in presence of 1) a foreign partner, 2) the need to proof at some point with a single document salaries and wages paid to an owner, or 3) the owners having multiple sources of income; a Corporation may be worth evaluating.
During the introductory session, I always advise my clients that every situation is unique and, in most instances, immigration planning trumps fiscal structuring and that when everything is settled and in motion, we can play with the business to optimize fiscal impacts.
[1] Based on Tax Cuts and Jobs Act – TCJA of December 2017.
