Doing Business in the United States Using a Pass-Through Entity
While foreign corporations often operate in the United States through a domestic corporate subsidiary, other options exist. The most important of these are partnerships and limited liability companies. The difference between these entities and domestic corporations is that these entities allow for pass-through taxation. Domestic corporations are taxpaying entities, meaning they are directly liable for the tax on the income they earn. The tax on the income of a flow-through entity is not paid by the entity, but by its owners.
Partnerships and limited liability companies are generally treated in the same manner under U.S. tax law. They are both pass-through entities. The primary difference is that owners of a partnership are personally liable for the debts of the partnership, while the liability of owners of a limited liability company is limited to the amount of their investment in the company.
Pass-through entities are immensely popular for business and investment activities owned by U.S. persons. This is because when income passes through to owners who are individual U.S. citizens or residents, the dividend level of taxation that occurs with corporations is avoided and capital gains and dividends earned by the entity are taxed at preferential rates that only apply to individuals. This typically results in significant tax savings.
The same advantages are not available to foreign corporations. This is a result of its corporate status, not its foreign status. Domestic corporations will also not benefit from pass-through treatment. Income earned by a foreign corporation through a pass-through entity is taxed the same way as income earned directly by a foreign corporation. The income is subject to corporate income tax on its net U.S. business income at graduated corporate tax rates that range from 15 percent to 35 percent and distributions of U.S. profits to the foreign corporation are subject to branch tax at a rate of 30 percent (or lower treaty rate). As discussed earlier, this is substantially the same treatment as income earned through a domestic corporate subsidiary. Therefore, the structure offers no real tax advantages.
While a limited liability company can receive pass-through treatment for U.S. tax purposes, it is often treated as a U.S. corporation by the foreign corporation’s home country. The result is that both the timing and classification of income earned and distributions made by the entity may differ between the two jurisdictions. While there are complex tax planning structures that take advantage of these differences to reduce tax liabilities, U.S. limited liability companies are often avoided by foreign corporations because of the complexity and risk associated with their different treatment across jurisdictions.
There are some circumstances where investment through a U.S. pass-through entity may be advantageous to foreign investors or businesses. Natural persons (as opposed to corporations or other business entities) that are investing in U.S. activities that are likely to produce substantial capital gains will often prefer pass-through treatment. Foreign corporations that expect their U.S. business operations to generate losses that they wish to deduct in their home country may also prefer pass-through treatment. If we ignore the more exotic tax planning structures, in both cases a U.S. partnership will typically be preferable to a limited liability company because of the conflicting treatment across jurisdictions encountered by limited liability companies.
Partnerships and limited liability companies are generally treated in the same manner under U.S. tax law. They are both pass-through entities. The primary difference is that owners of a partnership are personally liable for the debts of the partnership, while the liability of owners of a limited liability company is limited to the amount of their investment in the company.
Pass-through entities are immensely popular for business and investment activities owned by U.S. persons. This is because when income passes through to owners who are individual U.S. citizens or residents, the dividend level of taxation that occurs with corporations is avoided and capital gains and dividends earned by the entity are taxed at preferential rates that only apply to individuals. This typically results in significant tax savings.
The same advantages are not available to foreign corporations. This is a result of its corporate status, not its foreign status. Domestic corporations will also not benefit from pass-through treatment. Income earned by a foreign corporation through a pass-through entity is taxed the same way as income earned directly by a foreign corporation. The income is subject to corporate income tax on its net U.S. business income at graduated corporate tax rates that range from 15 percent to 35 percent and distributions of U.S. profits to the foreign corporation are subject to branch tax at a rate of 30 percent (or lower treaty rate). As discussed earlier, this is substantially the same treatment as income earned through a domestic corporate subsidiary. Therefore, the structure offers no real tax advantages.
While a limited liability company can receive pass-through treatment for U.S. tax purposes, it is often treated as a U.S. corporation by the foreign corporation’s home country. The result is that both the timing and classification of income earned and distributions made by the entity may differ between the two jurisdictions. While there are complex tax planning structures that take advantage of these differences to reduce tax liabilities, U.S. limited liability companies are often avoided by foreign corporations because of the complexity and risk associated with their different treatment across jurisdictions.
There are some circumstances where investment through a U.S. pass-through entity may be advantageous to foreign investors or businesses. Natural persons (as opposed to corporations or other business entities) that are investing in U.S. activities that are likely to produce substantial capital gains will often prefer pass-through treatment. Foreign corporations that expect their U.S. business operations to generate losses that they wish to deduct in their home country may also prefer pass-through treatment. If we ignore the more exotic tax planning structures, in both cases a U.S. partnership will typically be preferable to a limited liability company because of the conflicting treatment across jurisdictions encountered by limited liability companies.