LLC, partnership or corporation? Which structure suits a nonresident alien

It is common to hear that an LLC is always best for a nonresident alien. That is a half-truth. The right structure depends on the type of business, where it is carried out and what you plan to do with the profits. The same LLC that pays no federal tax for one business can be the most expensive option for another.

The key question: is there a U.S. business?

A nonresident alien pays federal income tax on income effectively connected with a U.S. trade or business. If the service is performed from outside the country, with no office, employees or dependent agent here, there is usually no such business and the income is not effectively connected. If the operation takes place in the United States, it is. It is a factual determination, and everything else depends on it.

Single-member LLC

For the IRS it is a disregarded entity: its results belong to the owner. Its great advantage appears when there is no effectively connected income: it pays no federal income tax and only files Form 5472 with a pro forma Form 1120 each year. Florida does not tax that LLC either.

The disadvantages appear when there is effectively connected income. The owner files Form 1040-NR, with an ITIN, and pays tax on net profit at graduated rates that reach 37%. Passive U.S.-source income, such as interest or royalties, is subject to 30% withholding. And the penalty for not filing Form 5472 is $25,000 per year.

Partnership: an LLC with two or more members

It files Form 1065. If it has effectively connected income, the partnership must withhold tax on the share allocable to each foreign partner at the highest rate: 37% for individuals and 21% for corporations. That withholding is paid quarterly, reported on Forms 8804 and 8805 and applies even if the partnership distributes nothing, which can create a cash problem. Each partner then files Form 1040-NR and credits the withholding. If a partner sells their interest, the buyer must withhold 10% of the amount realized.

C corporation

The corporation pays its own tax: 21% federal and 5.5% in Florida on profit above the state exemption. The owner does not file a personal return for the business operations. If profits are reinvested, there is no further tax; and a foreign shareholder's sale of the stock is generally not taxed in the United States, unless the company is primarily a real estate holding company.

The cost appears when dividends are paid: 30% is withheld unless the shareholder's country of residence has a treaty. The United States has treaties with about 65 countries, and for an individual the rate usually drops to 15%, and in some to 10%. The 5% rate is for corporate shareholders owning at least 10%. The 0% rate found in some treaties, such as those with the United Kingdom, Germany, Japan and Mexico, applies only to a company owning 80% or more for a minimum period and meeting the anti-abuse provisions; never to an individual. In Latin America, Mexico, Venezuela and Chile have treaties; residents of countries without one, such as Colombia, Argentina, Peru or Brazil, bear the full 30%. Without a treaty, between the corporation's 21% and the withholding, about 45% of distributed profit ends up as federal tax.

A forgotten risk: inheritance

For a nonresident alien, assets located in the United States, including shares of a U.S. corporation, are exposed to federal estate tax with an exemption of only $60,000. That is why, when the estate is significant, the structure often includes a foreign company on top, which is designed with Padilla Advisory Group.

In short

For a business carried out outside the United States with no effectively connected income, a single-member LLC is a great advantage. For a U.S. operation that reinvests its profits, a C corporation is often more efficient. And a partnership with foreign partners requires planning the withholding from day one. The decision is made before forming the company, not after.