Despite its aggressive stance toward so called secrecy jurisdictions, the USA continues to allow the incorporation of corporate entities which are extensively used by non US clients for their international business interests and are entirely free of tax.
Hypocritical ?…probably. Does it work ? – Yes.
What follows is an analysis and explanation of the tax treatment.
A properly structured Limited Liability Company [LLC] organized in the United States can provide an onshore, tax-free, alternative to a traditional offshore International Business Corporation [IBC].
The members of a US LLC are not liable to United States tax as long as the LLC fulfils 3 simple conditions;
1. The members of the LLC must be non-resident aliens or foreign corporations.
2. The LLC must not employ US resident permanent staff or rely on a dedicated place of business within the United States.
3. The LLC must not undertake business activity that is “effectively connected with trade or business within the United States.”
As long as these conditions remain fulfilled the LLC and its members are not liable to file a US tax return or pay tax in the United States.
The United States Internal Revenue Service [IRS] has a fearsome reputation for its tenacity in the collection of taxes so at first sight it would appear unlikely that a US entity can operate as an effective tax shield. However an examination of the basis of taxation in the US, presents a somewhat different picture.
US tax treatment of an LLC.
An LLC is a hybrid entity. It exhibits the corporate characteristics of limited liability and corporate personality but, like a partnership, it remains transparent in the United States for tax purposes. Where a trade or business is conducted through an LLC, liability for US tax falls upon the members of the LLC and not the LLC itself. Thus in the US an LLC is ignored for tax purposes.
US members’ liability to tax
The United States operates a nationality system of taxation. Its citizens are taxed on their worldwide income regardless of their residence. US citizens are therefore liable to account for and pay taxes on their share of the worldwide income of any US LLC of which they are a member.
Foreign members liability to tax
The Internal Revenue Code (IRC) provides that non-resident aliens [section 871] and foreign corporations [sections 881 and 882] are taxed only on business income that is effectively connected with trade or business within the United States.
Thus an LLC that has non-resident aliens and/or foreign corporations as its members AND whose business income is not effectively connected with trade or business within the United State falls outside the scope of United States tax.
In order to be certain that no US tax liability is incurred it is necessary to ensure that the terms ‘trade or business within the United States’ and ‘effectively connected’ are fully understood.
US trade or business
There is little guidance within the IRC as to what constitutes ‘US trade or business’. Generally, a US trade or business will be found to exist, if there are regular, continuous and considerable business activities within the Unites States. It is clear that passive investment income would not be considered a ‘US trade or business’ but it is recommended that beyond this, activities that could be construed as engaging in commerce within the US be avoided wherever possible.
Foreign source income from outside the US is generally excluded from ‘effectively connected’ income. However if the LLC has an office or fixed place of business within the US, which it relies upon in the ordinary course of its business, an LLC may be included under (S 864(c)(4)). This section would apply to a fixed facility such as a dedicated sales outlet, a factory or a mine but will not apply to the use of the facilities that is ‘relatively sporadic or infrequent’.
Use by the LLC of an agents office will not be treated as an office of the LLC if the agent is ‘a general commission agent, broker, or other agent of independent status acting in the ordinary course of business’ (S1.864-7(d) (3)). Thus an LLC could safely contract with a US business to provide it with accounting and office administrative services.
As long as the 3 simple conditions (1. 100% non US Shareholders, 2. No permanent staff or dedicated office 3. No effectively connected US business) are adhered to a United States LLC offers an excellent, inexpensive alternative to a traditional IBC. A US LLC has the advantages of a tax-free entity but without the ‘taint’ that is often attached to companies incorporated in tax havens.
For more information – Contact Michael Chapman of Middleton Katz Incorporated – Naples Florida.
Telephone +1 239 430 4310