Posted by Stephanie L. Chapman, CPA
Does your company contract with the U.S. government? Are you foreign-owned? If so, it may interest you to learn that the U.S. government follows a policy of Buying American. This means that whatever you sell to the government needs to be sold by a U.S. company. As a result, many foreign companies endure the process of forming and maintaining a U.S. company to satisfy this requirement. The consequences for noncompliance can result in cancellation of the contract and loss of income. Belfint, Lyons & Shuman wants to provide our clients and other prospects with key information about forming a domestic company and the significant tax implications associated with that effort.
The first question to consider is what type of entity you want to form. In the U.S. there are two primary entity types that are available to foreign owners: C-corporations and Partnerships/LLC. Whether you should select the C-corporation or LLC/Partnership entity depends on the following:
C-corporation Tax Considerations
- Profits are distributed via a dividend that is subject to withholding tax.
- The prevailing tax treaty with the business owner’s home country, if any, will dictate the effective withholding tax rate and other tax issues.
- An owner may have an income tax filing requirement for any other income connected to the U.S.
- C-corporations effectively face double taxation. Dividends are not deducted at the corporate level (thereby creating a first level of ‘tax’), and are taxed again when received by the shareholder (second level of ‘tax’). Additional taxes may be due depending on the tax treaty with the business owner’s home country.
LLC/Partnership Tax Considerations
- Although the default tax method is as a partnership, these entities can make an election to be taxed as a corporation. It’s important to note that once a tax type has been selected, the entity is unable to elect another change for a period of five years.
- The amount of income on which an LLC/Partnership is taxed is based on the total amount of company profit, regardless of distributions.
- Withholding may be necessary on company profits attributable to nonresidents and paid to the government. This withholding may be averted under certain circumstances and provided proper documentation is maintained. If any of the withholding is recoverable, the owner must file an individual U.S. tax return and cite tax treaty protection to recover it.
Additional Issues to Consider
Below is a list of items to consider based on our firm’s years of international tax experience. They include:
- Building the Right Team – One of the most important decisions a company makes when beginning the process of forming a U.S. entity is which advisors to use. The reason this is so important is because the entity type you form will have a significant impact on your resulting tax situation. An oversight in choice of entity can result in higher taxes for the newly formed company and its owners. A qualified U.S. tax professional will work with you to ensure you are in the most optimal tax position for you, and will then be part of the relationship with a formation agent to implement the plan you’ve established together. The formation agent relationship is most efficient when the agent has direct access to the state records and ability to offer Registered Agent services in all 50 states. Upon forming the entity, you’ll next need to establish a relationship with a U.S. attorney to draft the legal documents relating to your newly formed entity (for example, Articles of Incorporation, Operating Agreements, Sales or Purchase Agreements)
- Opening a Bank Account – Opening a corporate bank account in the U.S. is not a difficult process, but there are some nuances to consider. First, you do not have to be a U.S. citizen or resident to open a bank account. However, most banks require that you provide specific forms of identification, including an Employer Identification Number (EIN) issued by the IRS, passport with photo, or alien identification number as applicable. In addition, it’s important to note that most banks will require you to be physically present to open a corporate bank account. This can make it difficult for those who don’t regularly travel to the States. For this reason, larger banks are generally more experienced at serving foreign nationals and may be a better alternative than local establishments. Your team of advisors may also be able to provide additional connections.
- Employees – Will the company have domestic employees? If so, you will need to establish a payroll system to ensure payments are made, tax elections are made, and remittance is submitted to state and federal authorities on the appropriate schedule. You should also familiarize yourself with U.S. employment law to ensure you are in compliance with key regulations such as health insurance, workers’ compensation insurance, employee benefits, minimum wages and other important issues. Often, newly formed companies in the U.S. elect not to have employees due to the additional issues they face with regard to regulation compliance. If local employees are a necessity, you must be aware of (and in compliance with) domestic employment law.
- Sales Tax – Maintaining inventory in a state will likely create a nexus issue. Nexus is used in U.S. law to define a company’s presence in a state, and its requirement to collect and submit sales tax. Similar to a VAT, states are individually authorized to legislate and collect sales taxes. Because of the vast potential for taxation, nexus requires special attention when determining operational structure. See our recent blog, Fulfilled by Amazon Businesses are “Prime” for Tax Exposure, for more information.