Foreign-Owned US LLC: Complete Guide To Taxation

Opening a US LLC as a foreigner has never been popular and more beneficial for non-domestic businesses. A big part of that is the favorable way the US government looks at foreign-owned LLCs, especially when it comes to reporting and taxes. With the right company structure and a type of income, it’s possible to legally avoid paying US taxes.

In this article, we’ll talk about foreign owned LLC taxation in the US. We’ll discuss how to figure out whether you owe US taxes. We’ll talk about US-source income and its importance and go through all the different reporting and tax forms a foreign-owned LLC needs to file. 

Let’s begin.

Foreign-Owned LLC Taxation: How to Know if You Owe US Taxes?

The main thing determining whether you owe taxes in the US is the type of income your LLC generates. There are technically two types of income for taxation purposes— US and foreign-source income. If your company has US-source income, you have to pay US taxes. If your income is foreign-source income, then you don’t have to pay them. Now, the question is — how can you figure out if your company’s income is US-source income or not? 

Foreign-Owned LLC Taxation: Is Your Income US or Foreign-Source?

The first step in determining whether you owe taxes in the US is to evaluate whether your company’s income is US-source income. To do that, you should consider the following main factors:

1. Type of Income 

Apart from US and foreign-source income, the US tax regulations recognize many other types of income. We won’t go into all of them, as that would take a lifetime (quite possibly literally), and will instead focus on the two income types that are always considered US-source income:

Effectively Connected Income (ECI)  

Effectively Connected Income (ECI) is any income derived from a trade or business actively performed in the United States. ECI is always US-source income and is taxable under US law. It can range from 10% to 37% for individuals based on income level. For corporations, it’s fixed at 21%. 

ECI incorporates different types of income, including certain types of:

• Business income — Profits from selling goods or services directly in the US. For example, if a foreign company operates a retail store in the US, it generates ECI from all sales.
• Rental income — Income from renting a real estate property that is physically located in the US. For example, if a foreign-owned LLC owns a residential rental property in the US and collects rent from tenants, that rental income is always ECI and US-source income.
• Interest income — Interest earned from loans given to US businesses, US banks, or other US financial institutions. 
• Service income — Income from services performed while physically in the US is always ECI and US-source income. 

Fixed or Determinable Annual or Periodical (FDAP) Income 

Fixed or Determinable Annual or Periodical (FDAP) income includes certain types of passive income. FDAP is always considered US-source income and is usually taxed at a 30% withholding rate. Some examples of FDAP include:

• Interest income — Interest from loans, savings accounts, bonds, and other interest-bearing instruments that come from the US.
• Dividends income — Most payments made by US corporations to shareholders are considered US-source income and FDAP. 
• Rental income — Renting a property in the US always generates US-source income, which can sometimes be FDAP or ECI (as we’ve mentioned above). The distinction is essential as ECI typically has a lower tax rate than FDAP.
• Pension or annuities — Some US pension plans or annuities can be classified as FDAP income, which makes them taxable under US law. 
• Income from royalties — Payments for using intellectual property (e.g., patents, copyrights, trademarks) in the US are considered FDAP.

2. Physical Location of Income-generating Events and Assets

The physical location can determine whether a particular type of income is US-source income. If the income-generating event occurs in the US or the income-generating asset is physically located in the US, that income is always US-source and taxable under US laws.

For example, providing IT services for a US company but from a foreign country means that the income-generating event (in this case, IT services) is not physically happening in the US. This further means that any income from those services is not considered US-source income by the US government and is, as such, not taxable by the IRS. 

On the other hand, income generated by a rental property in the US is always US-source income because the income-generating asset (i.e., rental property) is physically in the US, and the income-generating event (paying off the rent) happens in the States. 

3. LLCs Ownership Structure

The way a US LLC is structured can play a big role in determining whether the income it generates is US-source or not. 

For example, every single-member US LLC owned by a US citizen or a Green Card holder automatically generates US-source income. This means these entities always have to pay taxes on their profit. On the other hand, foreign-owned single-member LLCs don’t automatically have US-source income and can avoid taxation if their entire income is foreign-source. 

Now, things get a little more complicated with multi-member LLCs. In some cases, if one of the owners is a US citizen or a Green Card holder, all of the LLC’s income could be automatically considered US-source income and taxable under US laws. The best way to avoid this is to contact professionals who know how to create ownership structures that allow you to avoid US taxes legally. 

Need help opening a US LLC? NRI can help! Contact our team to learn how to legally avoid paying US taxes.

4. Substantial Presence Test

Foreign-owned LLCs can legally avoid paying taxes in the US if their income is not US-sourced. But there’s a catch — the Substantial Presence Test or SPT. 

The SPT is a simple calculation that determines whether the IRS considers a foreigner a US resident or nonresident alien solely for tax purposes. If a foreigner is considered a US resident alien, then the income from any LLCs they own can automatically become US-source income, and they will have to pay US taxes.  

The status of a resident alien (and US taxpayer) is given to anyone present on US soil for a minimum of:

• 183 days in the current year
• 183 days during the past 3 years 

It’s important to note that the days for each year are counted differently:

• Current year — 1 day equals 1 day
• The previous year — 1 day equals ⅓ day
• Two years ago — 1 day equals ⅙ day

If the number is less than 183, a foreigner won’t be considered a resident alien and won’t have to pay US taxes on foreign source income(Only on US source income). If it’s equal to or above 183, they will be considered a resident alien and must pay taxes on their worldwide income, not just for their foreign-owned US LLC. All US residents (whether it’s for tax purposes or not) have to pay taxes on their worldwide income. 

5. Business Operation

The way a business operation of a foreign-owned LLC is structured can determine if the income it generates is US-source or not. For instance, if a company has any sort of physical presence in the US, all or some of the generated income will be US-source and taxable under US laws. Some examples of what can constitute physical presence include:

• Employees or dependent agents located in the US
• Warehouses in the US
• Real offices or brick-and-mortar stores in the US

This could also mean that even if a company’s entire income is technically foreign-source, having a single US employee or agent can sometimes convert all or part of that income into US-source income.   

Foreign-Owned Single-Member LLC Filing Requirements

A foreign-owned single-member LLC is a limited liability company with only one owner (a foreign individual or entity). This type of LLC is typically considered a disregarded entity for US tax purposes. This means that the LLC’s income is reported on the owner’s tax returns, and the LLC itself does not pay taxes separately. 

All foreign-owned single-member LLCs must file certain tax forms each year, even if their entire income is foreign-sourced. Having US-source income means you have to pay US taxes. Having foreign-source income means you don’t have to pay taxes, but you still have to fill out various tax forms. 

Owners of a foreign-owned US-disregarded entity should file the following tax forms: 

Form 5472

The 5742 form is an information tax return introduced by the US IRS in the “Final Regulations” action plan on December 13, 2016. Its main purpose is to fulfill obligations outlined in sections 6038A and 6038C of the Internal Revenue Code (IRC). Form 5742 allows the IRS to track the finances of foreign-owned LLCs and prevent tax fraud. Failure to accurately file the 5472 form results in a $25,000 penalty, with the possibility of additional penalties. 

The types of entities that are obligated to file the 5472 form each year include:

• Foreign-owned single-member LLCs
• Foreign corporations that are involved in trade or business in the US
• Companies that are partially foreign-owned and operate in the US

Form 1040 or 1040NR

Foreign-owned single-member LLCs are disregarded entities, meaning that all company taxes are paid through an individual tax form — 1040 or 1040NR. All foreign-owned single-member LLCs with US-source income must file one of these forms each year. Failure to do so will result in penalties reaching up to 50% of unpaid taxes. The 1040NR form is for nonresident aliens with a US-source income. The 1040 form is for all US residents and resident aliens (foreigners who scored over 183 on the Substantial Presence Test)

Beneficial Ownership Information or BOI

Beneficial Ownership Information (BOI) identifies persons who own or control a legal entity in the US (e.g., a Limited Liability Company). BOI should include various details about the owner of a US legal entity, including:

• Name
• Address
• Date of birth
• BOI identification number 

All newly opened businesses in the US must file a BOI with the Financial Crimes Enforcement Network (FinCEN) within a certain time period. The BOI is not a yearly form and only has to be filed when the company is formed or when its owners change. 

Additional Requirements 

Apart from filing the correct tax and/or information returns, all foreign-owned single-member LLCs must have an Employer Identification Number or EIN. The usual process for getting an EIN is to first obtain an Individual Tax Identification Number or ITIN. You need an EIN to file the 5472 form and an ITIN to get an EIN in most cases. We should also mention that there’s a way of getting an EIN without an ITIN by filling out the SS-4 form. 

In addition to that, all foreign-owned single-member LLCs must keep relevant records of all financial transactions. The IRS reserves the right to ask for those records at any time and can issue penalties if such records are not maintained properly. 

All US LLCs must have a registered agent — a person or entity in the US who is responsible for handling communication between the company and the IRS and other government agencies. All foreign-owned single-member LLCs without a registered agent risk being permanently closed or fined.

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Foreign-Owned Multi-Member LLC Filing Requirements

Foreign-owned multi-member LLCs are limited liability companies with more than one owner, at least one of whom is a foreign individual or entity. These entities are not considered corporations and are instead taxed as partnerships. Forms that foreign-owned multi-member LLCs have to file include:

1065 Form

The 1065 form is a Schedule K-1 form that provides an overview of the income, deductions, gains, and losses of a foreign-owned multi-member LLC. It’s technically not a tax form but rather an information form because each of the owners pays all taxes owed by this type of entity via the 1040 or 1040NR forms. 

The 1065 form must be filed each year, regardless of the type of income (US or foreign-source income) a multi-member entity generates. Failure to do so leads to a penalty of $210 per month for each partner (member or owner). For example, if a company has 10 partners, then the penalty would be $2,100 per month or $25,200 per year. Additionally, not filing this form can attract attention from the IRS, which is rarely a good thing. 

Other Forms and Requirements

Similarly to foreign-owned single-member LLCs, multi-member ones must also file various forms and fulfill different requirements, including: 

• Filing BOI
• Filing 1040 or 1040NR (if the income is US-source income)
• Obtaining EIN and ITIN

Foreign-Owned LLC Taxation: Reporting and Taxes Cheat Sheet 

Foreign-Owned LLC Taxation: Reporting and Tax Examples

US taxes can be complicated. Before we let you go, we want to ensure you have a tight grasp of the main concepts. And, the best way to do that, in our opinion, is through some real-life examples. 

Here are some examples of foreign-owned LLC taxation:

Example 1: Foreign-Owned US Disregarded Entity (Tax-free LLC) 

For this example, let’s say the disregarded entity is a single-member LLC owned by Hasann Aaban from Pakistan. Hasann is an IT expert who provides various IT services for clients around the world, including those from the US. Because the income-generating event happens in Pakistan, all income that Hasann’s LLC generates will be considered foreign-source income and will not be taxable under US law. As long as that’s the case, the only tax form he needs to file each year is Form 5472.

Example 2: Foreign-Owned Multi-Member LLC

John Simmons and Oliver Hyde are Canadian business partners who own an LLC in the US. They chose to structure their company as a multi-member LLC because that allows them to pay company taxes through individual tax forms (1040 or 1040NR). Their business is investing in short-term rental properties in the US. Because those properties are all physically located in the US, all of the income their multi-member LLC generates will be US-source income. This means that they will have to pay taxes in the US. First, they’ll have to file a 1065 informational form. After that, both of them will have to file either the 1040 or 1040NR tax forms to actually pay their taxes.