What is an LLC?
An LLC combines the elements of a corporation, partnership, and sole proprietorship. Like a corporation, an LLC afford its owners personal liability protection since LLCs are separate entities from their owners. Therefore, LLCs owners are usually not responsible for the LLC’s debts or lawsuits. The personal assets of the owners (such as their personal residences, and personal bank accounts) are not reachable by business creditors.
Yet, it differs from a corporation in that a corporation is a legal entity, a person in the eyes of the tax law – it has to file its own returns. An LLC is not, it is either a sole proprietorship or a partnership which is the reason why LLC’s are popular. An LLC allows for pass-through taxation, thereby avoiding the “double tax” of a corporation. An LLC does not have to pay income taxes itself, instead the owners on their personal income list the profits and losses of the LLC.
Advantages of an LLC:
An advantage of an LLC is that the formation and ownership requirements are less stringent than a corporation’s. The LLC also offers an advantage in management flexibility. The LLC can be “member-managed,” meaning that it would be managed directly by the shareholders. Or the owners of the LLC can agree to have the business “manager-managed,” meaning that the management can be structured and delegated from the owners to managers.
Additionally, other requirements of a Corporation, such as a mandatory annual board meeting and board of directors, are not required and more relaxed for the LLC. There is also no limit to the number of owners that an LLC can have, it could have one owner or hundreds.
The state of Florida is one of the most common states used to incorporate and in Florida the taxes, management costs, and formations costs are usually less than in many other jurisdictions. Since Florida, and Miami in particular, attract foreigners to invest and live, there are advantages and disadvantages of incorporating an LLC with foreign members.
Do you have a foreign partner? Are you starting an LLC?
A foreign partner includes a foreign corporation, foreign trust, foreign estate, and any other person that is not a US individual. When an LLC has foreign partners and has income that is effectively connected with a U.S. trade or business, the LLC must pay a withholding tax. The U.S. Internal Revenue Code of 1986, Section 864(b), generally provides that the performance of personal services by a foreign person within the United States is considered to constitute trade or business. To determine whether income is effectively connected with the conduct of trade or business within the United States, the courts look at the following:
1. whether the income, gain, or loss is derived from assets used in or held for use in the conduct of such trade or business or
2. whether the activities of such trade or business were a material factor in the realization of the income, gain, or loss.
If the foreign partner of the LLC is deemed to be engaged in a US trade or business, the LLC must pay a withholding tax regardless of the amount of the foreign partners’ ultimate US tax liability. The withholding tax is on the effectively connected taxable income that is allocable to its foreign partners. The tax rate is 37% for non-corporate foreign partners and 21% for corporate foreign partners. This must be filed on a quarterly basis to the IRS using Form 8813, Partnership Withholding Tax Payment Voucher.
United States Tax laws require that foreigners pay taxes on any earnings made in the United States and that they file annual US tax returns to get the portion of withholding that exceeds their tax due. Even if there is no income, the foreign partners will need to file US tax returns.
A significant issue to mention is that the LLC cannot chose to be taxed as an S- corp. since foreign citizens may not be partners or owners in an S-corporation in accordance with US law. It may, however, choose to be taxed as a C-corporation (the standard, default, familiar corporation we all know about).
Did you know that an LLC does not pay income taxes?
Even though an LLC itself does not pay income taxes, it must file Form 1065 when it has foreign partners. Form 1065 gives the IRS a glimpse of the company’s financial status for the year. The form provides information on the income, gains, losses, deductions, creditors, and other information from the operation of a partnership.
The partnership must also provide a Schedule K-1 to the IRS and to each partner, which breaks down each partner’s share of the business’s profits and losses. In turn, each partner reports his/her profit and loss information on their individual tax return.