Talking about taxes in the United States is always delicate, requiring a lot of care, especially when we think about non-resident aliens (NRA).
To make the topic lighter and clearer for everyone, we will not use all the technical terms, but rather we will explain it in a practical way. Our example will be the fictitious company GLOBAL, LLC, with a single-member LLC, John Doe, who is not a tax resident of the United States and the only income in the country comes through it.
As we have explained in other articles, a company taxed as an LLC in the United States does not pay tax at the corporate level, obligatorily distributing its profits or losses to its members (through form 1065, or a Schedule C), who will report the numbers on theirs personal income tax returns (form 1040 or 1040NR).
Considering non-resident members, we will have a tax burden between 10% and 37%, as explained in the article Taxes for Companies in the United States.
As the United States has bilateral agreements with several countries or tax reciprocity rules generally apply when paying US taxes on profits from your US operations, you will be able to use the amount paid as “credits” at the time of preparing the declaration in your country of residence. Therefore, there is no double taxation.
In the example of GLOBAL, LLC which had $100,000 in profit in the fiscal year, the company will not pay taxes and its profits will be reported to the IRS along with John’s Income Tax Schedule C (Form 1040NR), who will receive the profit and pay tax on it.
In this case, the total tax rate was approximately 20% ($20,000). For this same income, the country where John resides charges 27.5% income tax. Since his country allows the credit for income tax paid abroad, 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!
Attention: From this point on, the article can only apply to individuals whose tax residency is not in the United States and who have income in the country only as a member of a single-member LLC.
The IRS considers that individuals only need to pay US income taxes if they are “Engaged in Trade or Business” in the country. Since in the case of a single-member LLC, taxation is on a personal, not a business, level, there is a possibility that this exception would apply to our example, John of GLOBAL, LLC.
Unfortunately, neither the IRS nor the courts specifically list which activities or income sources apply under this exception, however, to qualify for EBTUS, you must have at least one “dependent agent” in the US and that agent does something substantial amount to promote your US business (as opposed to something purely administrative).
For example, if the company GLOBAL, LLC has employees or uses its own operating structure in the country, it is “Engaged in Trade or Business” to the IRS. But if the company does not have any employees or physical presence in the country and carries out all its activities remotely, it may not be “Engaged in Trade or Business”, even if it has revenue from customers present in the country. (Keep reading to understand the whole context)
Application for digital service companies such as software development, online marketing, online consulting and digital products.
Considering the example above, if GLOBAL, LLC does not have employees or physical headquarters in the United States and John develops his services remotely directly from his country of residence, there is no need to pay US income tax.
Application for ecommerce companies, which carry out online sales across the United States
For sale of physical products, the IRS considers that taxes must be paid in the country of sale and therefore the exemption rule would not apply. In addition, 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 way, John would pay US tax on the result of his American operation.
Annual Obligations and Payment of Taxes
If you consider that your company is not “Engaged in Trade or Business” in the United States and, therefore, does not have to pay taxes in the country, you will still have to submit a form 5472 to the IRS annually, in addition to carrying out state renewals. (Annual Report, Franchise Tax), when applicable.
Following our first example, where GLOBAL, LLC is not “Engaged in Trade or Business” for providing services outside the country, the company will submit its Form 5472 to the IRS and John, its sole owner, will not pay any income in the United States and pay the same 27.5% tax in your country of residence as described above.
That is, in the end, there was no tax savings on John’s part.
Who can guarantee me that my company is not “Engaged in Trade or Business” and that, therefore, I will not need to pay income tax in the country?
Although a tax expert can advise you on the matter, reducing margins of error, unfortunately in most cases it is not possible to offer 100% guarantee that the IRS will not consider that your income was not really connected to the fact that your company to be “Engaged in Trade or Business” in the United States.
When choosing to use this IRS exception, it is very important that you keep all contracts and vouchers that can prove and explain your operation, in addition to being aware that at the end of the day, the person responsible for convincing the IRS is you, the owner of the company.
Another very important decision-making point is that several services are only available to US tax residents, such as Stripe US and Paypal. If your company doesn’t deliver taxes in the country, it won’t be able to deliver a W9 form required by them and therefore won’t be able to use their services.
As a company without US tax residency, it would submit the W8 BEN form that applies to foreigners.
And what is the real gain from not paying taxes in the United States?
Using the above, John’s savings boils down to the amounts he would pay for a professional to prepare his US taxes and the monthly cost for accounting and expert support. As we have seen, the total outlay for paying their taxes was the same.
To draw your own conclusions, we suggest reading the IRS’s own publication LB&I International Practice Service Concept Unit.