A U.S. Tax Primer for Nonresident Aliens Conducting Business in the United States Through a Single Member LLC

Doing Business Through a Limited Liability Company (LLC)

A limited liability company (LLC) is a popular choice of entity for conducting business or holding rental real estate in the United States. It is a business structure you can form in any one of the fifty states. It is designed to protect the personal assets of its owners, similar to a corporation, but you have flexibility in how your business or rental activities are reported for tax purposes. If you are a sole owner, you can elect to treat it as a corporation for tax purposes. If you do, the corporation must file Form 1120 (U.S. Corporation Income Tax Return) to report and pay its tax. We won't go into the pros and cons of different entity options here, but a corporation might not be your best choice. If you do not specifically elect corporate status, you get to disregard the LLC for tax purposes. That means if you are a nonresident alien individual with a single-member LLC, you report your business or rental income on Form 1040NR (U.S. Nonresident Alien Income Tax Return), and you don't need to file a separate corporate tax return.

If your LLC is owned by you and one or more partners, the default classification for tax purposes is a partnership. That means you must file Form 1065 (U.S. Return of Partnership Income) to report the income and expenses of the partnership, then report your share of partnership income and expenses on your Form 1040NR. However, a multi-member LLC also has the option to be treated as a corporation for tax purposes, which would require it to file a corporate return rather than a partnership return.

Here, we will focus on the tax reporting requirements for nonresident individuals conducting business through a single-member LLC who have not elected to treat their LLC as a corporation. If you would like to read about how and where to form a single-member LLC, absolutely the best place online is Matt Horwitz's LLCUnivsity.com. There is a ton of information on all aspects of LLCs, and it's all for free!

Our Overwhelming Tax System

Now that you have decided to form an LLC, you need to deal with U.S. tax laws. You will soon discover that our Internal Revenue Code is a tangled swamp of unintelligible gobbledygook, with dangerous penalties lurking at every turn. Welcome to America! Well okay, maybe it's not quite that bad. With proper guidance, you can navigate the tax rules successfully. This piece will be your guide as we slog through the small area of the U.S. tax quagmire that pertains to you, at least at the shallow end. We will discuss:

  1.  The definition of "nonresident alien,"
  2.  The dual taxing regime that applies to nonresident aliens,
  3.  The rules specific to ownership of real estate by nonresidents,
  4.  Conducting business in the U.S. and treaty provisions that might apply to business activities, and
  5. Tax reporting requirements that pertain specifically to a nonresident alien who owns a single-member LLC.

Who Is a Nonresident Alien?

If you are an individual who is not a U.S. citizen, you are defined in the Internal Revenue Code as an "alien" (IRC Sec. 7701(b)). Because this term might conjure up negative images (i.e., space creatures), practitioners tend to use the softer term "foreign national," or the less precise term "immigrant" to describe you. Here I will stick with the legal term "alien" in order to describe the tax differences between a resident and nonresident alien. The term is broad, so even if you're a member of an intergalactic advance team, I'm still talking about you.

There are two kinds of aliens (for tax purposes, that is); resident aliens and nonresident aliens. If you are not a resident alien, you are a nonresident alien. There are three tests in the Internal Revenue Code to determine residency status (IRC Sec. 7701(b)(1)): 1) The "green card" test, 2) The substantial presence test, and 3) The first year election test. If you have passed any one of these tests, you are a resident of the U.S. for tax purposes. That means none of the rules we are about to review pertains to you.

The green card test means you are a lawful permanent resident of the United States, so the nonresident alien rules do not apply to you. You can read more about this test in our US Tax Guide for Foreign Nationals. The first year election test requires you to be living in the U.S. and be classified as a resident the following year. If you would like to learn more about the requirements to meet this test, check this link to our US Tax Guide for Foreign Nationals. The substantial presence test is the one you should be familiar with because it applies to you if you merely visit the United States - and it can be a little tricky.

 

Taxing Regime for Nonresidents

 

 

Tax Rules for Nonresidents Holding Real Estate

 

 

Conducting Business In the U.S. by Nonresidents

 

The Role of Tax Treaties

 

Sourcing rules for the sale of inventory

 

 

 

 

 

 

 

Special Reporting Requirements For A Single-Member LLC Owned By A Nonresident Alien

As we have discussed above, for income tax purposes, a single-member LLC formed in the United States is classified as a disregarded entity. That means all of the activities of the LLC are reported on your Form 1040NR (Schedule C if a business or Schedule E if rental property), and there is not a separate corporate form to file. However, for one section of the Internal Revenue Code, if a foreign person has direct or indirect sole ownership of the LLC (that's you), it is treated as a separate entity and classified as a U.S. corporation. (Wait a minute - what?) Yes, this is only for Section 6038A of the Code, which specifies special reporting requirements for a U.S. corporation that is owned more than 25% by a "foreign person" (just because the U.S. government is especially nosy about foreigners doing business here).

The term "foreign person" includes a nonresident alien individual (defined above) and generally any entity that is not formed in the United States. It also includes an individual who is a citizen of any possession of the United States, but not a citizen or resident of the United States (IRC Section 6038A(c)(3)).

You can have indirect sole ownership of an LLC if your LLC is owned entirely through one or more other disregarded entities owned by you, regardless of whether the disregarded entity was formed within or outside the United States (Reg. Sec. 301.7701-2(c)(2)(vi)). So if you form an LLC as the sole owner, and that LLC forms another LLC as the sole owner, both LLCs are subject to the reporting requirements of Section 6038A, because they are both either directly or indirectly owned by you.

The reporting requirements of Section 6038A change nothing with respect to how you report the activities of your LLC for income tax purposes. The LLC is still disregarded when it comes time to report its income and expenses on your Form 1040NR. The classification as a separate corporation only applies for the purpose of satisfying the requirements of IRC Section 6038A, which are explain below. (And, if you screw this up, they charge you $25,000, so keep reading and don't doze off.)

Reporting requirements of Section 6038A

In general, this section requires you to 1) furnish the name, principal place of business, nature of business, and country of residence for each person that is a related party to the reporting LLC during it's taxable year, if that person had any transaction with the LLC; 2) describe the manner in which such related party is related to the LLC; and 3) provide a description of the transactions between each related party and the LLC (IRC Sec. 6038A(b)).

Filing Procedures

This information is required on Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade of Business). Although a single member LLC has no separate income tax return filing requirements, this form is required to be attached to a pro forma Form 1120 by the due date of Form 1120.

In addition to filing Form 5472, you must maintain records to determine the correct treatment of transactions with related parties. Failure to file Form 5472/1120 by the due date, or to maintain proper records, incurs a penalty of $25,000, unless you have a really good reason for not doing so (IRC Section 6038A(d)).

The two critical terms to understand here are "related party" and "transaction," which have very specific definitions under IRC Section 6038A. (In U.S. tax law, words have different meanings depending on what page you're on.)

What or Who Is a "Related Party"?

First, you are a related party, whether your ownership is direct or through another disregarded entity, as discussed in the previous section. Now who else is? Let me answer that this way. Let's say you would like to avoid these pesky reporting requirements, but still sneakily engage in transactions with your LLC indirectly, through family members or entities you control. Try to think of ways to do that. How about having a family member, such as your spouse, parents (or their ancestors), children (or their descendants), brothers or sisters (whether by whole or half blood) perform the transactions? Do you think they will let you do that? Nope - all these people are related parties (IRC Section 267(b)). What if, rather than your spouse, you talk your spouse's brother into performing the transaction? Nope - family members of your spouse are also treated as related parties through the attribution rules (IRC Section 318(a)(1)).

How about a corporation that you own over 50 percent of, either directly or indirectly? Or the trustee of a trust you are the owner or beneficiary of? Or a partnership you own over 50 percent of, either directly or indirectly, or your partner in the partnership? Nope, nope, nope and nope. All of these entities and people are related parties, so reporting of any transactions between them and the LLC is required (IRC Sections 267(b) and 707(b).) Even if you can  arrange to control a transaction between the LLC and a party that does not fit within the statutory rules, the IRS has the nuclear option - IRC Section 482. Under IRC Section 482 (and extended indirectly through Section 6038A(c)(2)(C)) the IRS is allowed to deem anyone a related party who you have actual or perceived influence over (Reg Section 1.482-1(i)(4)).

The best way to look at this is to consider any individual or entity that is even remotely connected to you to be a related party to your LLC, and talk to us about the activities of that person. We will determine whether there are transactions that must be reported on Form 5472.

What Is a "Transaction"?

Any monetary transactions between a related party and your LLC listed in Part IV of Form 5472 must be reported. Those are primarily taxable income, deductible expenses, purchases of inventory, and loans between the related party and the LLC. If you don't know the exact amount, an estimate will do, but it must be disclosed in Part IV if you are using estimates.

Part V of Form 5472 requires the additional reporting for a foreign-owned disregarded entity (your LLC), as defined by Regulation Section 1.482-1(i)(7).

Regulation Section 1.482-1(i)(7) says these activities are transactions that must be reported: " . . .  any sale, assignment, lease, license, loan, advance, contribution, or any other transfer of any interest in or a right to use any property (whether tangible or intangible, real or personal) or money, however such transaction is effected, and whether or not the terms of such transaction are formally documented. A transaction also includes the performance of any services for the benefit of, or on behalf of, another taxpayer."

So there you have it. Just about anything you or another related party can possibly cook up with the LLC is a transaction that must be reported on Form 5274. Even if there are no business activities requiring the filing of an income tax return, Form 5472, attached to Form 1120, should be completed by the due date [when . . .] [filed by fax . . .]

 

 

 

 

Who is a nonresident alien?

  • What if someone passes the SPT, but uses the tie-breaker rule in a treaty to be classified as a nonresident. Does that mean they are a resident or non-resident for 5472 purposes?
  • Who is a "related party" to the reporting corporation? Must a US related party be reported? (The form asks for this.)
  • Who is "ultimate indirect 25% foreign shareholder"?
  • What is a "reportable transaction?
  • What is an example of non-monetary and less than full consideration transaction between a related party and the reporting corporation?
  • Tax year for the LLC must be the same as foreign owner's US tax year - See TD 9796 - or generally it must be the calendar year if the owner has no filing requirement.
  • There are no exceptions to reporting and record keeping requirements. See TD.
  • A single member LLC is treated as a separate entity for one Code section - 6038A - if:
    • The entity is domestic, and
    • "One foreign person has direct or indirect sole ownership of the entity." (Reg. Sec. 301.7701-2(c)(2)(vi)(A))
    • What does "indirect" mean? For this purpose only, indirect sole ownership means ownership by one person entirely through one or more other entities disregarded as entities separate from their owners or through one or more grantor trusts, regardless of whether any such disregarded entity or grantor trust is domestic or foreign. (Reg. Sec. 301.7701-2(c)(2)(vi)(B).)

 

 

Taxing regime for nonresident aliens

  • Effectively connected income
    • Sale of inventory - when is it considered US source income?
  • not effectively connected income
  • Rental income & real property election
  • What is a U.S. trade or business?
    • Conducting business through a single member LLC
    • Conducting business through a multi-member LLC
  • Treaty provisions
  • Additional filing requirements for single-member LLC owners
    • Form 1120/5472
    • FBARs

 

 

Notes:

Points to make: 

  1. Estate tax considerations
  2. Who is required to file
    1. Entities and attribution rules
  3. FBAR filing requirement of the LLC: According to the FinCen instructions: "The federal tax treatment of an entity does not determine whether the entity has an FBAR filing requirement. For example, an entity that is disregarded for purposes of Title 26 of the United States Code must file an FBAR, if otherwise required to do so."

Therefore, a single member LLC is considered a “US person” for FBAR filing purposes. So if it has a financial interest in foreign accounts totaling more than $10,000 it is required to file the FBAR, even if the LLC is owned by a nonresident. Explore attribution rules - are accounts owned by a nonresident LLC owner attributed to the LLC?

  1. Transactions with disregarded entities: Reg. §1.482-1(i)(7):

“Transaction means any sale, assignment, lease, license, loan, advance, contribution, or any other transfer of any interest in or a right to use any property (whether tangible or intangible, real or personal) or money, however such transaction is effected, and whether or not the terms of such transaction are formally documented. A transaction also includes the performance of any services for the benefit of, or on behalf of, another taxpayer.” 

    1. Therefore, a non-operating LLC might still have a 5472 filing requirement.
    2. Who are related parties for which transactions must be reported. 
  1. Penalties: 
    1. $25,000 for failure to file, filing late, or filing a substantially incomplete form - Sec. 6038A
    2. $25,000 for failure to maintain records under Reg. §1.6038A-3 
    3. $25,000 for continued failure for each 30-day period after IRS notification + 90 days
    4. For late filing, expect an automatic assessment
    5. Possible to request reasonable cause relief
    6. First time abate procedures may work

 

 

1.6038A-1(c) Reporting Corporation--

1.6038A-1(c)(1) In General. — 

For purposes of section 6038A, a reporting corporation is either a domestic corporation that is 25-percent foreign-owned as defined in paragraph (c)(2) of this section, or a foreign corporation that is 25-percent foreign-owned and engaged in trade or business within the United States. After November 4, 1990, a foreign corporation engaged in a trade or business within the United States at any time during a taxable year is a reporting corporation. See section 6038C. A domestic business entity that is wholly owned by one foreign person and that is otherwise classified under § 301.7701-3(b)(1)(ii) of this chapter as disregarded as an entity separate from its owner is treated as an entity separate from its owner and classified as a domestic corporation for purposes of section 6038A. See § 301.7701-2(c)(2)(vi) of this chapter.

 

301.7701-2(c)(2)(vi) Special Rule For Reporting Under Section 6038A—

301.7701-2(c)(2)(vi)(A) In General. — 

An entity that is disregarded as an entity separate from its owner for any purpose under this section is treated as an entity separate from its owner and classified as a corporation for purposes of section 6038A if—

301.7701-2(c)(2)(vi)(A)(1) — 

The entity is a domestic entity; and

301.7701-2(c)(2)(vi)(A)(2) — 

One foreign person has direct or indirect sole ownership of the entity.

Treasury Regulation § 301.7701-3 Classification Of Certain Business Entities.

This regulation was last amended by T.D. 9300, 71 FR 71040-71045 (Dec. 8, 2006).

301.7701-3(a) In General. — 

A business entity that is not classified as a corporation under Section 301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) (an eligible entity) can elect its classification for federal tax purposes as provided in this section. An eligible entity with at least two members can elect to be classified as either an association (and thus a corporation under Section 301.7701-2(b)(2)) or a partnership, and an eligible entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner. Paragraph (b) of this section provides a default classification for an eligible entity that does not make an election. Thus, elections are necessary only when an eligible entity chooses to be classified initially as other than the default classification or when an eligible entity chooses to change its classification. An entity whose classification is determined under the default classification retains that classification (regardless of any changes in the members' liability that occurs at any time during the time that the entity's classification is relevant as defined in paragraph (d) of this section) until the entity makes an election to change that classification under paragraph (c)(1) of this section. Paragraph (c) of this section provides rules for making express elections. Paragraph (d) of this section provides special rules for foreign eligible entities. Paragraph (e) of this section provides special rules for classifying entities resulting from partnership terminations and divisions under section 708(b). Paragraph (f) of this section sets forth the effective date of this section and a special rule relating to prior periods.

301.7701-3(b) Classification Of Eligible Entities That Do Not File An Election--

301.7701-3(b)(1) Domestic Eligible Entities. — 

Except as provided in paragraph (b)(3) of this section, unless the entity elects otherwise, a domestic eligible entity is--

301.7701-3(b)(1)(i) — 

A partnership if it has two or more members; or

301.7701-3(b)(1)(ii) — 

Disregarded as an entity separate from its owner if it has a single owner.

301.7701-2(c) Other Business Entities. — 

For federal tax purposes--

301.7701-2(c)(1) — 

The term partnership means a business entity that is not a corporation under paragraph (b) of this section and that has at least two members.

About Gary W. Carter, PhD, MT, CPA

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