Understanding Tax Consequences for Foreign Individuals Owning a Corporation in the United States

Foreign individuals seeking to expand their business ventures into the United States often consider setting up a corporation as an effective way to establish presence and enjoy various benefits. However, amidst the excitement of venturing into a new market, one crucial aspect that requires attention is understanding the tax implications that come with owning a corporation in the US. Firstly, let's consider the two different ways corporations register for tax in the United States.

S-Corporation

If all shareholders (holding 25% or more) of a newly established corporation are US residents, you have the option to elect to be taxed as an S-Corp. Under an S-Corp, all profits can flow through to the owners' personal income tax returns annually, taxed at their individual rates. This is possible because US residents are required to file income tax returns yearly, and profits cannot be retained within the corporation. If an owner no longer meets the criteria as a US tax resident, the IRS will reclassify the S-Corp as a C-Corp.

C-Corporation

If a non-US resident (or foreign entity), owns a 25%+ stake in a US corporation, then it must register as a C-Corp. A C-Corp must submit its own annual tax return to the IRS (Form 1120) each year. A C-Corp uses its profits to distribute to shareholders in the form of dividends or salaries. Dividends are subject to corporate tax, whereas salaries can be deducted as a corporate expense. Therefore, it may be advantageous to receive distributions as a salary if your personal tax rate will be lower than the corporate tax rate.

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However, if your corporation has profits in a specific year that you choose not to distribute (retain), they are subject to the corporate tax rate of 21%. You can opt to receive these dividend distributions in a future year, but they will need to be reported on your personal tax return in that year, potentially resulting in double taxation of the same income. Nonetheless, the overall tax rate could still be advantageous if you strategically plan to receive them in a future year with lower tax rates or in a more tax-efficient jurisdiction.

If distributions are taken as dividends, they will be reported on your personal tax return as capital gains (not earned income). US Capital Gains Tax rates have a higher tax-free threshold and lower marginal tax rate compared to earned income, potentially making this approach more beneficial based on the number of dividends in future tax years versus current state/city tax rates.

Now, let's delve into what tax categories foreign individuals need to consider when starting or buying into a US corporation.

Tax Implications for Foreign Individuals Owning a US Corporation

1. Corporate Taxation

Foreign-owned US corporations are subject to corporate income tax on their earnings derived from US sources. The tax rates applicable to these corporations vary based on the profit levels, currently around 21%. It's essential for foreign owners to comply with US tax regulations and file annual tax returns accurately. If a corporation distributes post tax dividends to a foreign owner whom resides in a country which has a tax treaty with the US, then the foreign owner will receive a credit for the foreign tax already paid by the corporation.

2. Branch Profits Tax

In addition to corporate income tax, foreign individuals need to be aware of the Branch Profits Tax. This tax is imposed on the profits deemed to be repatriated back to the foreign owner from the US branch or subsidiary. Understanding the rules governing this tax is crucial to avoid unexpected liabilities. When an Australian entity sets up a US entity to help with 'transfer pricing', it is important to make sure that when goods are sold between company A and company B, that they are transfered at market value.

3. Withholding Tax

Foreign shareholders of a US corporation may be subject to withholding tax on dividends received from their US investments. The applicable withholding tax rate is determined by tax treaties between the US and the foreign investor's home country. Comprehending these treaty provisions can help optimize tax planning strategies.

4. State Taxes

Apart from federal taxes, foreign individuals must consider state taxes, as each state in the US imposes its own tax regulations. Understanding the specific state tax requirements where the US corporation is located is essential to ensure full compliance with all tax obligations. There are 7 states in the US which do not levy income upon individuals whom reside in their states. Additionally, Delaware does not levy a corporate income tax, but it does have franchise taxes that relate to how many shares are issued.

Wrap Up

In conclusion, while owning a corporation in the US offers numerous advantages, foreign individuals must diligently navigate the intricate tax landscape to avoid potential pitfalls. By staying informed about the tax consequences, seeking professional guidance, and maintaining compliance, foreign owners can enhance their business success and financial well-being in the US market.