US LLC for Foreigners (Non-Residents) - The Ultimate Guide in 2021

US LLC for Foreigners (Non-Residents) - The Ultimate Guide in 2021

December 4, 2021
10
 Min Read


21%. This is the percentage you could save on taxes on your online business profits, if you form a US LLC  for your online business. If you make a pure profit of $50,000 after a year of hard work, you can sleep easy at night knowing you do not have to pay Uncle Sam (US government) $10,500 in taxes at the end of the year, legally. Whether you want to travel to exotic places like a digital nomad or invest the $10,500 back into your business is up to you. The decision is in your hands.

Setting up a foreign company may sound daunting and complex at first, but not if you read this guide.


In fact:

The strategies in this post have helped dozens of our clients run their online businesses with a US LLC from their home country, generating millions in revenue, tax-free!

Why set up a US LLC as a Foreigner?

Registering an LLC in the US is the first option you should consider before looking at other popular options like Hong Kong, Estonia, Singapore or United Kingdom. If you ignore the US LLC, you are missing a great opportunity as an entrepreneur to create a low-maintenance, tax-free business structure in a first-world jurisdiction.

At the same time, you are missing out on the advantages of doing business as a US company would bring, such as superb banking options, vast payment processing selection, good reputation, access to the US market, solid legal system, to name a few.

If you are still not convinced about the benefits of a US Company, please read The 8 Benefits of a US LLC for Non-Residents

Two types of US Company Structure you should know

From a foreign entrepreneur's perspective, there are two business structures in the US. that you should be aware of: the Corporation and the Limited Liability Company. Before you start a business in the US., it is essential that you know the difference between these two forms.

The almighty Corporation structure

In US. law, a corporation is a legal entity separate from the natural persons who own or manage it. A corporation comes into being when a state issues a certificate of incorporation to the entity, giving it the power to sue and be sued, sign contracts, and other legal documents.

The shareholders of a corporation are generally exempt from liability for the debts of the corporation as long as they perform their duties as directors or officers under the corporation's bylaws, this protection is known as the "limited liability". The corporation is virtually the same as similar company structures you see in other countries, such as the Ltd in United Kingdom, SARL in France and PT in Indonesia.

The current federal corporate income tax rate for a US corporation is 21%, and state corporate income tax rates vary from state to state. You pay the state corporate tax in the state where the corporation is incorporated. After paying the corporate income tax, if you want to distribute the profits after taxation to yourself as a shareholder, you declare dividends, which may or may not be taxable depending on where you live.


Know the Partnership structure

Before we go into the main star of the show, the LLC, let us do a detour to the partnership structure, as this will help you better understand the LLC structure in the next section. A partnership is another type of legal entity that is formed by two or more people, called "partners," who establish and agree to share profits and losses while dividing management of the company. A partnership exists as a legal entity, but it is not a separate tax-paying entity and is not taxed under the law. Instead, it is treated as a pass-through entity where the profit or loss is passed through to the partners and each partner is taxed under the individual income tax.

To recap, as a pass-through entity, partnerships are not taxed as a business, but their owners are taxed on their income from the business.

The Hybrid LLC Structure

Most countries have the equivalents of "Corporation" and "Partnership" in their territories. But most of them lack an equivalent to the US Limited Liability Company (LLC). If you take the word, "limited liability company" literally, it is easy to equate it with a similar "limited company" structure in your own country.

As with football in the US, the LLC in the US is not what you think it is, and requires you to exercise some closer scrutiny.

In the US, the "limited liability company" (LLC) is a legal form similar to a corporation and a partnership. The LLC is a hybrid structure that combines features of partnerships and corporations with the limited liability protections of a corporation and the flexibility and tax efficiency of a partnership. The owners of an LLC are called members. Members of the US LLC can be either individuals or organizations.

From a tax perspective, it is essentially a pass-through entity. This means that an LLC is not taxed in the US like a corporation, but rather the members of the LLC are taxed individually, like a partnership. Also, it is important to note that an LLC can only be formed by one person, unlike partnerships, which require at least two people. LLCs formed by a single person are referred to as single member LLCs.


Tax Advantages of a US LLC for Foreigners

What is the tax advantage for you as a foreigner? As mentioned above, LLCs do not pay corporate income tax. Instead, profits and losses are passed through to the owners, and each owner reports his or her share of the company's profits on his or her personal tax return. This seemingly unremarkable feature of pass-through taxation is a great advantage for foreigners not living in the US.

By forming a US LLC, the Internal Revenue Service (US Tax Authority), see your US LLC as a transparent entity (Disregarded Entity) and does not tax it. Instead, the IRS will basically look through the company and try to determine if you, as the member are taxable.  

From the IRS point of view, if you

  • do not have US citizenship
  • do not hold a US Green Card
  • and you do not meet the US Substantial Presence Test

you are regarded as a Non-Resident Alien. Yes, this term is archaic but you don't get the opportunity to be an Alien every day.

As a Non-Resident Alien, you will only be taxable on US-Source income effectively connected to a US Trade or Business. There is also the tax on FDAP income that applies to passive income, but we will leave that for another day as we are assuming you are starting a US company to build an active business.

To explain it further, first we need to dissect two technical terms, namely “engaging in a US Trade or Business” and “US-Source Income”.  

US Trade or Business

The general consensus is that your LLC is engaged in a trade or business in the US (ETBUS for short) if the following conditions are met:

  1. You have at least one "dependent agent" in the US Dependent agents are employees or exclusive contractors that work for you.  
  2. This dependent agent contributes substantially to furthering your company's business in the United States (e.g., negotiating and concluding contracts), as opposed to merely administrative duties.
  3. you are engaged in “considerable, continuous, and regular” business in the US

Unfortunately, what is considered "substantial, continuous, and regular" is not precisely defined in US law. However, it should not be taken literally, as a look at a document from the Treasury Dept. Office of Tax Policy on the attitude of the US trade and business community toward e-commerce will shed some light on this issue:

Electronic commerce permits a foreign person to engage in extensive transactions with U.S. customers without entering the United States. Although such a person is clearly engaged in a trade or business, questions will arise as to whether he is engaged in a trade or business in the United States or has a permanent establishment in the United States. Therefore, it is necessary to clarify the application of the U.S. trade or business and permanent establishment concepts to persons engaged in electronic commerce. In developing principles to classify these activities, it will be important to consider the extent to which electronic commerce simply represents an extension of current means of doing business, the tax consequences of which are understood. For example, to the extent that the activities of a person engaged in electronic commerce are equivalent to the mere solicitation of orders from U.S. customers, without any other U.S. activity, it may not be appropriate to treat such activities as a U.S. trade or business. It will also be necessary to consider whether it is appropriate or practical to treat foreign persons engaged in electronic commerce with U.S. customers as being engaged in a U.S. trade or business if they are physically located outside the United States.

 

Your US LLC has to be deemed as a business engaging in a Trade or Business in the US  (ETBUS) and the US Source Income (more on this below) that are effectively connected to this US Trade or Business are subject to tax. Being ETBUS is your first line of defense, if you are not ETBUS, you are not subject to US Federal taxes.

US-Source Income vs Foreign Source Income

Other than the ETBUS concept, there is the Source of Income concept that you need to you need to understand.  In taxation, Source of Income is the location (or country) where a specific item of income is deemed to have originated or is deemed to have been generated.

From the US Taxation point of view, a nonresident alien (NRA) is usually only taxed on US-sourced income but not Foreign-Sourced Income. The following are the general rules for determining US source income that apply to most nonresident aliens:

image.png
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Source: Internal Revenue Service

Let's use the table above and use a concrete example: If you provide internet marketing services to a US client through your US LLC and you do not employ any employees/exclusive agents in the US, your income is considered income sourced outside the United States and therefore not subject to tax.

In most cases, the United States does not tax income sourced outside the United States. However, there is a caveat: if your Foreign Source Income is attributed through a physical office of yours in the US, that income is taxable if you are deemed ETBUS, according to IRC §864(c)(4). However, if you hire an agent who is not exclusive and does not negotiate and close sales in the US, even if he/she performs the work through his/her own office, your Foreign Source Income would not be considered Effectively Connected Income to a US trade or business.

US-Source Income doesn’t mean you are taxable

One important point that even confuses the most experienced accountants is that the assessment as " Engaging in Trade or Business in the US" (ETBUS) comes first and the income from US sources that's actually connected to that " US Trade or Business" comes second.

In other words, you have to check if you're ETBUS, and only then check if you have US source income; if both criteria are met, then only you're liable for US Federal taxes. But, if you are not ETBUS, you are not taxable even if you have US source income.

How could Tax Treaties help?

As we see above, once you become ETBUS, you will require you to inspect your Source Income to determine if they are foreign or US sourced. Another way to avoid the trouble of determining if you are ETBUS and have generated US Source Income is to use the Permanent Establishment concept found in tax treaties.

If your country of residence has a double taxation avoidance agreement or so-called tax treaty with the United States, you can take advantage on the Permanent Establishment concept instead of relying solely on the US Trade or Business concept. In international taxation, the concept of "permanent establishment" refers to a company that has a fixed place of business (and other criteria specified in the tax treaty) in another country and is subject to income tax there.

When there is a tax treaty between your country and the United States, IRS allows the definition of Permanent Establishment to take precedence over the definition of the US Trade or Business in the Internal Revenue code. So even if you are engaging in a US trade or business but do not have Permanent Establishment in the United States, you will not be subject to federal taxes on your active business income. To see if your country has a tax treaty with the United States, please refer to this list at the IRS

How to make your Foreign-owned US LLC Tax-Free

We hope we have not lost you already with our boring monologue. If you are still stumped after reading, we can suggest some shortcut hacks to make your US LLC tax-free. Below are some things you need to keep in mind to avoid triggering US federal tax obligations:

  • Do not employ people or have exclusive contractors in the US.
  • Do not have US-persons as members in your LLC.
  • Do not reside in the US for over 120 days per year

Disclaimer: As with all shortcuts, these are general guidelines that will suffice in most cases. For very complicated situation, it is best to consult a US accountant or attorney familiar with international taxation.

LLC vs Corporation and when a LLC is not suitable

As you can see, the US LLC is a very powerful company structure for non-US entrepreneurs and founders. You can use the knowledge of ETBUS, Permanent Establishment, Source Income to structure your US LLC wisely and minimize your tax burden in the United States. On the other hand, if you form a US Corporation instead of an LLC, you will be subject to US federal taxes automatically, so it is really important to consider whether you need a Corporation at all.

Of course, the LLC structure should not be used as a blanket solution for all cases. There are instances where a US LLC may NOT be appropriate for you as a non-US business owner looking to minimize your tax burden:

  1. you are looking to seek angel or VC investments in the United States
  2. you have a US person as one of the members of the LLC
  3. you intend to issue Stock Options to your employees
  4. you have a strong urge to pay taxes even when you don’t need to

Other Articles in this Guide

We are glad you have made it this far, but this is just the beginning of your journey to building your online empire with a US LLC. Please follow the rest of the articles in this guide or contact us at hello@startfleet.io if you have any questions

Need Help Setting up your US Company?  

At StartFleet we help US and non-US founders to set up and manage their companies in the US.

  • LLC and Corporation formation in Wyoming, Delaware, Florida and all other US States
  • Over $500,000 perks from our partners
  • US Business Bank Accounts Opening
  • Expedited EIN Application
  • Stripe/Paypal application consultation
  • Shopify and Amazon FBA setup consultation
  • Customized Website Policies for your website
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