1. Choosing the Best Business Structure
2. The Tax Implications for Businesses with Foreign Partners
3. Percentage of Withheld Income for Tax Purposes
4. Importance of Filing Annual Tax Returns
5. Ownership and Formation Requirements
6. Disadvantages
7. Consultant Agreement

Updated July 10, 2020:

To get a U.S. LLC foreign ownership, foreign founders who own startups have to face various international tax issues. There are two kinds of entities that can be formed by companies in the U.S. — LLCs, and corporations. All states in the U.S. have laws that govern the creation of such entities, but for the most part, they are similar.

Choosing the Best Business Structure

U.S. founders can choose which makes the most sense for them, whether an:

  • LLC
  • An S-corp, i.e., a corporation that is taxed under Subchapter S
  • A C-corp, which is taxed under Subchapter C

However, U.S. taxpayers who are non-residents are not qualified to register S-corps. U.S.-based LLCs come with some tax advantages for U.S. taxpayers but are particularly beneficial to foreign entrepreneurs living abroad.

Since there are no “LLC” tax designations at the federal level, LLCs are seen as partnerships, although they can choose to be taxed under Subchapter C. LLCs are referred to as pass-through tax entities and don't undergo direct taxation. Instead, the loss and profits of the business go to the owners/shareholders, who then report them on personal tax returns.

The Tax Implications for Businesses with Foreign Partners

In many ways, LLCs operate as corporations, although the earnings distributed to shareholders are not subject to corporate taxation. As such, LLCs avoid the double taxation that all corporations endure. They offer limited liability protection to their owners since they are separate entities. As such, the personal assets of the owners, such as personal bank accounts and real estate are untouchable by business creditors.

If the LLC is partially or fully owned by a foreign individual, that individual must have an ITIN (U.S. Tax Identification Number). This is a requirement for businesses that engage in business or trade for the purposes of making a profit.

Percentage of Withheld Income for Tax Purposes

U.S. taxation for foreign partners is viewed as unappealing since the partnership has to withhold the U.S. income to be allocated to the foreign partner(s). The maximum withholding rate of 35 percent for corporations and 39.6 percent for individuals is applicable here.

The foreign partner will be considered as being engaged in U.S. business or trade, and as such, the LLC must withhold 35 percent of its profit as tax. This tax must be paid and filed with the IRS on a quarterly basis. U.S. tax laws stipulate that foreigners must pay tax on any earnings received in the U.S.

Importance of Filing Annual Tax Returns

Despite the immigration status of foreigners, the U.S. will allow them to form a company as long as they have a registered ITIN. Although the ITIN application process is not complex, it can be lengthy. After submission of the application, the assignation of the ITIN can take as long as 18 weeks.

To get the portion of their withheld earnings that exceeds the tax due, foreign partners need to file annual tax returns in the U.S. Even if they have no income, they still need to file the tax returns.

Ownership and Formation Requirements

One of the major benefits of LLCs is that the ownership and formation requirements are less rigorous than that of corporations. LLCs are also advantageous in terms of management flexibility. They can either be managed by:

  • The shareholders
  • A structured management team to which the shareholders must agree to

Other requirements that are mandatory for corporations, such as annual board meetings, are not compulsory for LLCs. One of the most common states used by foreigners to incorporate LLCs in the U.S. is Florida because the formation costs, management costs, and taxes are less than those of many other jurisdictions.

Disadvantages

One of the disadvantages of having foreign partners in an LLC is that although the partnership doesn't pay income tax, it must file Form 1065, even if there is no profit. The Form 1065 is reviewed by the IRS to determine whether partners correctly report their income.

Partnerships must also provide to each partner and the IRS a Schedule K-1. This form gives a detailed breakdown of how the business' profits and loss were distributed to each partner. Each partner then reports this information on their personal tax returns.

Consultant Agreement

It should be noted that under a written consultant's agreement, foreign partners can act as consultants. They can perform consulting work from their respective home countries and bill the LLC in the U.S. for their services. This way, some profits can be eliminated, thus reducing taxation and the volume of U.S. earnings that must be reported.

If you need help with U.S. LLC foreign ownership, you can post your job on the UpCounsel marketplace. UpCounsel accepts only the top five percent of lawyers on its site. Lawyers on UpCounsel's marketplace come from schools such as Yale Law or Harvard Law and usually average 14 years of legal experience, including work on behalf of companies like Menlo Ventures, Google, and Airbnb.