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US LLC Taxation: Pass Through Entities for Foreigners VS US Citizens
Global Banking & Finance Review®
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US LLCs offer tax benefits to foreigners and citizens. They operate as pass-through entities, with income reported on personal tax returns.
According to the US Tax Foundation, over 90% of businesses in the US are pass-through businesses, which declare their income on their owners’ tax returns and are taxed under the individual income tax. In 49 of the 50 states, these enterprises generate the bulk of all business income and employ more than half of the private-sector employment.
A US-based LLC can offer significant tax benefits, particularly to international entrepreneurs operating in the United States. Legalzoom LLC formation is one of the most popular routes used to quickly set up a US LLC. Now LLC taxes can be advantageous even for US taxpayers. A limited liability company (LLC) is a tax-exempt entity. This means that the LLC is not subject to direct taxation. Instead, the company’s gains and losses are passed on to the owners, who record them on their personal tax returns.
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Most businesses in the United States are taxed as pass-through (or flow-through) entities, which are not subject to the corporate income tax or any other entity-level tax, unlike C-corporations. Instead, under the individual income tax, its owners or members include their allocated portions of profits in taxable income. Sole proprietorships, partnerships, limited liability companies, and S-corporations are examples of pass-through firms.
Above, LLC’s are a great example of a pass through entity. LLCs are limited liability companies (LLCs) that are formed under state law. Individuals, companies, other LLCs, and foreign entities may be members of an LLC; there is no limit to the number of members, and most states allow sole ownership. Banking and insurance are two examples of prohibited activities. LLCs can choose to be taxed as a corporation, partnership, or as a “disregarded entity” on their members’ tax returns. The earnings of members of disregarded entities are subject to SECA tax.
One little-known fact is that the United States can be one of the world’s largest tax havens. A non-US citizen or non-resident who establishes a US LLC may be able to make money that is not taxed in the United States.
Of course, there are some guidelines to follow in order to avoid LLC taxes. Foreigners are effectively only taxed in the United States if they are “involved in a trade or company in the United States” (ETOB). Even though your firm makes money in the United States, it is not taxed in the United States if it is not ETOB.
In the United States, however, you are engaged in a trade or business (ETOB) if:
Single-member LLCs with foreign owners were formerly exempt from filing. However, beginning in 2017, all foreigners who hold a US LLC must submit a 5472 US tax return with the IRS for disclosure purposes, even if they owe no taxes in the United States. Foreign owners should also be mindful of the tax consequences of LLCs in their respective fiscal residence jurisdictions. The income from the US LLC could still be taxed in your home country.
For Americans, LLCs are not a tax haven. Still, forming an LLC is a simple way to formalize business activities and build partnerships. An LLC is not treated as a separate tax entity by the IRS. Instead, all of the LLC’s earnings are distributed to its members, who must report and pay personal income tax on them. A single LLC owner would report the LLC’s earnings and loss on Schedule C of his or her Form 1040. When there are two or more owners, each reports their share of the earnings on their personal tax return.
Some states in the United States, however, tax LLCs directly. It’s also worth noting that an LLC can choose to be taxed like a corporation. In many circumstances, in addition to income tax, American taxpayers will be compelled to pay self-employment tax. An S Corp is a good alternative for US taxpayers who want to minimise their self-employment tax obligation while simultaneously having the flexibility to contribute more to a retirement plan.
It is undeniable that pass-through companies play a substantial part in the economy of the United States. Pass-through enterprises account for nine out of ten businesses in the United States; they generate more than half of all business income and employ the bulk of the private-sector workers. Despite the fact that pass-through companies are exempt from the federal corporate income tax, they may still be liable to significant federal, state, and municipal taxes.
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The article discusses US LLC taxation for foreigners and US citizens, focusing on pass-through entities.
Pass-through entities are businesses that pass income to owners, who report it on personal tax returns, avoiding corporate tax.
Foreign owners can avoid US taxes if not engaged in US trade or business, under specific conditions.
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