Talking about US taxes is always delicate and requires great care for detail. Before starting a business in the US, it is necessary to know a little about the tax obligations in the country. Especially for NRA (non-resident alien) entrepreneurs. At this time, we will explain how single-member LLCs are taxed in the US.
In order to make the topic lighter and clearer for everyone, we will not use that many technical terms. But rather explain the subject in a practical way.
Let’s use as an example the fictitious company GLOBAL, LLC, an LLC with only one member (owner), John Doe, who is not a tax resident of the United States. And his only source of income in the country is through this company.
How are single-member LLCs taxed in the US?
A company registered as an LLC in the US does not have to pay taxes at the corporate level. Also, it is required to distribute its profits or losses to its members (either through Form 1065 or a Schedule C). They, in turn, use the numbers of their income tax returns (model 1040 or 1040NR).
Considering non-resident members, the tax burden varies between 10% and 37%. Click here if you want more information on LLC taxes in the US.
The United States has bilateral agreements and fiscal reciprocity rules with several countries. So, in general, when paying taxes on the profits of your operations in the US, you can use the amount paid as “credit” when making the declaration in your country of residence. Therefore, there would be no double taxation in this regard.
In practice, GLOBAL, LLC, which had $100,000 of profit in the fiscal year, pay no taxes as its profits will be reported to the IRS along with John’s Income Tax Schedule C (Form 1040NR), who receives the profits. and must pay taxes.
In this case, the total tax rate is approximately 20% ($20,000). For this same income, the country where John Doe resides charges 27.5% income tax. Since his country allows credit for foreign income tax, John, who has already paid 20% tax in the United States, will only pay 7.5% tax there.
But for every rule, there can be an exception!
Note: From this point on, the article only applies to individuals whose tax residence is not in the United States and who receive income in the United States only through single-member LLCs.
The IRS considers that individuals should only pay US income taxes if they are “engaged in trade or business in the United States” (ETBUS). Since in the case of a single-member LLC, the taxation is at the personal level, not the corporate level, there is a possibility that this exception would apply to our example: John Doe, of the company GLOBAL, LLC.
Unfortunately, neither the IRS nor the courts specifically list which activities or sources of income apply under this exception. However, to be treated under ETBUS, you must have at least one “dependent agent” in the US, who in turn must do something substantial to promote your business in the US (as opposed to something purely administrative).
For example, if the company GLOBAL, LLC has employees or uses its own operating structure in the country, then it is in fact “engaged in trade or business in the United States” according to the IRS. But if the company does not have employees or a physical presence in the country and conducts all of its activities remotely, it is likely that it will not be considered “engaged in trade or business in the United States” or ETBUS, even if it has income from customers present in the country.
Keep reading to understand the whole context!
How does it work for digital service companies?
Here, the exception to the ETBUS rule applies to services like software development, digital marketing, and online consulting.
Considering the example above, if GLOBAL, LLC has no employees or physical headquarters in the United States and John Doe performs his services remotely, directly from his country of residence, there is no need to pay US income tax.
How does it work for e-commerce businesses?
For sales of physical products, the IRS considers that the tax must be paid in the country of sale and therefore the exemption rule would not apply.
Also, there is a lot of discussion about whether or not there are links between third-party fulfillment services such as Fulfillment by Amazon or Globalfy.
In this case, John Doe would have to pay US taxes on the result of his US operation.
Annual duties and tax payments in the United States
If you believe that your company is not “engaged in trade or business in the United States” and therefore should not pay US taxes, you still need to file Form 5472 with the IRS annually. In addition to performing state renewals (Annual Report and/or Franchise Tax), when applicable.
Continuing with our first example, in which GLOBAL, LLC is not “engaged in trade or business in the United States” by merely rendering services outside the United States, the company must file Form 5472 with the IRS and John Doe, its sole owner, will not have to pay US income taxes.
However, in their country of residence, they still must pay the full percentage of tax (27.5%, based on the example above).
In the end, there was no tax saving on John Doe’s part.
How do I know whether my company is “engaged in trade or business in the United States” or not?
Although a tax specialist can guide you on the subject and reduce the margin of error, unfortunately in most cases it is not possible to guarantee that you will not have to pay taxes.
When choosing to use this IRS exception, it is very important that you keep all the contracts and receipts that can prove and explain your operation, in addition to being aware that, after all, the person responsible for convincing the IRS is you as the owner of the company.
Another very important point in decision-making is that several services are only available to US tax residents, such as Stripe US and Paypal. If your company does not file taxes in the country, you will not be able to submit a W9 form required by them and therefore you will not be able to use their services.
As a company with tax residence outside of the US, you would file the W8 BEN form that applies to foreign nationals.
And what is the benefit of not paying taxes in the United States?
By choosing this, John Doe would be saving the costs of US tax preparation. Nevertheless, as we have seen, the total outlay for the payment of their taxes was the same.
To draw your own conclusions, we suggest you read the official IRS documentation on the subject.
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