In Episode 21 of How Tax Works, Matt Foreman discusses why foreign persons almost certainly shouldn’t own LLCs, a surprisingly common issue.

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How Tax Works, hosted by FRB Partner Matthew E. Foreman, Esq., LL.M., delves into the intricacies of taxation, breaking down complex concepts for a clearer understanding of how tax laws impact your financial decisions. Through this, listeners are treated to a comprehensive breakdown of entity structures, from the robust shield of C corporations to the flexibility of partnerships and LLCs. Foreman navigates through the maze of tax considerations, shedding light on entity-level taxation, shareholder responsibilities, and nuanced tax strategies. Foreman shares valuable insights and practical advice, emphasizing the need for informed decision-making and consultation with tax professionals. From qualified small business stock to state and local tax considerations, no stone is left unturned in this illuminating exploration of tax law and entity selection.

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Transcript:

**This transcript has been prepared automatically by AI and may contain inaccuracies**

Matthew Foreman [00:00:00]:
Welcome to the 21st episode of How Tax Works. I’m Matt Foreman. In this episode, I will discuss why foreign persons should not own LLCs. The vast majority of the time. Not always, but the vast, vast, vast majority of the time. How Tax Works is meant for informational and entertainment purposes only. This may be attorney advertising, and it is not legal advice.

Matthew Foreman [00:00:33]:
Please hire your own attorney. How Tax Works is intended to help listeners navigate the intricacies and complexities of tax law, regulations, case law, and guidance to demystify how taxes shape the financial and business choices we all make before we get started. Administrative Just a couple Administrative Things episodes every two weeks. The next episode will discuss Golden Parachutes section 280g 280 cap g of the Internal Revenue Code. If you have any questions, comments, or constructive criticism, you can email me at my FRB email address, which you can find via your favorite search engine. Upcoming Webinars I sort of have a number of upcoming webinars and presentations starting in mid March and kind of running through the summer. I’m not going to list them on this because what happens is they get listed and then it’s irrelevant. And so whatever.

Matthew Foreman [00:01:20]:
So I’m just going to tell you to go to Whatever is the most recent episode on How Tax Works, and there’ll be a list of them and you can sign up. If there’s discount codes, whatever, it’ll all be there, so that’ll be easier going forward. All right, so what are we talking about? Okay, we are talking about why foreign persons should not own LLCs for some context. And this is the really important thing. I see this a lot. I’m not saying a lot. Like every day, I’m saying this a lot. Like at any given time, once a week, I get an email that says that we have a bunch of French investors who own an LLC in the US and sometimes they say, this is what I want to do.

Matthew Foreman [00:02:03]:
We haven’t done it yet. And sometimes they say we did this and we’ve been operating this way for two years. I’m using French, randomly Canadian, Mexican, Indian, whatever. You know, Bangladeshi, I don’t care. My hope is that I hear from them when it’s in the planning stage because I can get them out of situations rather than we’ve already done it and now we have to explain to investors that we formed an LLC in the US and they probably shouldn’t do that. So before we start, let’s get into some definitional terms that are really important, especially in this one. Right? For those who know Me well know that I can be very particular about word choice. But first off, person does not mean individual.

Matthew Foreman [00:02:44]:
It includes individuals. This is, this is section 7701. It includes individuals, partnerships, corporations, trusts, charities, et cetera, at all, whatever, you know. So when I say a foreign person should not own an llc, a foreign corporation probably shouldn’t own an llc, a foreign partnership probably shouldn’t own an llc, so on and so forth, you know, a citizen living abroad or you have certain US visas or otherwise, a US person, you are not a foreign person, you are a U.S. person. So this, I mean maybe you still shouldn’t own a US llc, but not so much for tax reasons. Not the same way if you are a non resident alien, right? Shorten nra. I’ll talk about them a whole bunch, you know, or foreign partnership, foreign corporation, foreign trust, yada yada.

Matthew Foreman [00:03:30]:
Those are the persons, capital P persons that I’m talking about. There’s a great quote by Mitt Romney and it’d be a terrible quote where he said corporations are people too. He got some flack for it. Right or wrong, I don’t really care. But every tax professional should have gone, should have said person, man should have said person. That would have been correct. But. But he didn’t.

Matthew Foreman [00:03:50]:
But that’s kind of what he meant in a way. You know, you can go into a lot of different ways of what he meant. Doesn’t really matter anyway. So what is a llc, right? It’s a limited liability company, limits liability in the us. It permits pass through. You can check the box. Can be an S Corp, can be C Corp for tax, et cetera. Can be a disregarded entity, right? One owner.

Matthew Foreman [00:04:09]:
LLCs don’t really exist elsewhere. There are other countries that have llc. Philippines for example has one. But for the most part LLCs are sort of a quirk of US corporate law. We tend to be much more permissive than other countries. Most countries operate by the rule. If you are a pass through then you get no liability limitations. So in the us, right, Default is either a disregarded entity if one owner or a partnership.

Matthew Foreman [00:04:34]:
You can elect a C Corp or S Corp status. Again, you know this is the US’s quirks, right? Check the box regime used to be four factors. Which one you know they were now doesn’t really exist. But you know, that’s okay. There are some other countries that have extremely limited check the box regimes. I believe Italy has one, there’s a few others. But you know, the US is really aggressive and permissive. Maybe the right word Rather than aggressive.

Matthew Foreman [00:05:03]:
The permissive check the box regime is extremely unique, doesn’t exist elsewhere. And also the fact that we have limited liability entities that have pass through status, pass through ability is really, you know, kind of quirky. The real issue here, and this is what comes up, is you run into a situation called a hybrid entity or a reverse hybrid entity. Okay. And it’s the same thing. Same entity is a hybrid entity and a reverse hybrid entity at the same time. It depends on your perspective, looking at it from the US perspective or the to do my example, the French perspective, right. So one country is going to view it as transparent pass through and the other country is going to view it as non transparent or opaque, some people say.

Matthew Foreman [00:05:49]:
And that’s going to be, you know, a C corporation, Right. I’m kind of ignoring S Corps here. They’re real quirks. But they’re going to be viewed the same way generally as LLCs, taxes, partnerships or disregarded entities. Right. So the hybrid, hybrid entity from the US perspective is transparent in the US and non transparent in a foreign country, so. Such as France. So from French perspective it’ll be reverse hybrid entity because the not you’re viewing it from the non transparent country.

Matthew Foreman [00:06:17]:
That’s really important. That’s a really important thing to think about. Which country’s hybrid, which one’s reverse hybrid. It’s important to understand it. It’s not important to really worry about it. It’s important to know how each one views it. But it’s a nomenclature that I’ve mastered because I’ve dealt with it enough. But if you just say, yeah, it’s a hybrid entity, most people will know it could mean reverse hybrid.

Matthew Foreman [00:06:38]:
And they’ll understand that as long as you can explain the tax consequences and how it’s viewed from either perspective. So people are like, all right, cool, Matt, why does this matter? And there’s many reasons, Many, many, many reasons. There are three reasons I’m going to identify here. If you want to, you know, go super, super, super esoteric and go through a lot of different mechanical issues that you run into. There’s a lot more. But the three main issues that I run into the most, one, foreign tax credit. Two is dealing with what’s called a permanent establishment. And the third is tax rates and withholding.

Matthew Foreman [00:07:13]:
They’re all actually kind of related entities. They deal with a lot of cross border issues. Obviously foreign tax credit, permanent establishment, withholding, backup withholding rates. We’re not talking about like W2 withholding, we’re talking about, you know, 1441 1445, 1446, that whole era, that whole part of the code and dealing with, you know, do I need to withhold how much and how that’s dealt with? It just creates a whole host of issues. So. So let’s start with the foreign tax credit. Right. I’m only going to talk about this from the US Perspective because that’s where I’m licensed and that’s really the only place I know it deeply.

Matthew Foreman [00:07:52]:
Right. However, I am going to reference another country and that country is going to be. It doesn’t really matter. Right. It’s just made up. But I’m explaining to you how most countries view it. There are exceptions to this and I’ll explain how the exceptions work and what they’re looking for. But it’s really important to know that the other country.

Matthew Foreman [00:08:14]:
I’m just going to call the other country. All right. Again, not advice. It is incredibly quirky. It is incredibly fact specific. And so you need to really go get down. And what I do with clients who are dealing with this issue is I end up having a conversation with their foreign tax advisors in order to make sure it’s done right. Much easier when it’s, you know, in England or it’s in Canada.

Matthew Foreman [00:08:37]:
Right. Native English speaking countries. That’s my best language. But I’m always amazed that there are people who can have technical tax discussions in a second or third language. There is. You know, I’m not wearing a hat, but I would take my hat off to them because it is truly impressive. Right. So let’s go through a situation.

Matthew Foreman [00:08:57]:
LLC has two partners. No elections tax in the U.S. is a partnership. Partner A is us, partner B is foreign, earns 100 bucks, $50 allocated to each. Right. U.S. perspective. Individual tax 37%.

Matthew Foreman [00:09:12]:
I’m going to ignore state taxes. State taxes actually exacerbate this. Most states don’t have withholding. Some do under certain circumstances, particularly with regard to real estate. We’re just going to pretend states don’t exist here. We are, right? Partner A pays your tax and partner B gets okay, it’s an issue. Right. Partner B basically pays the US tax.

Matthew Foreman [00:09:32]:
Right. They have $50 of income, so they pay their tax 37%. 1850. Right. And you’re like, all right, well they’ll get 1850 of foreign tax credit, offset the foreign. Any residency based tax. And I’m going to tell you no. A lot of times no partner B’s country likely views the LLC as a corporation, as a C corporation, because it has limited liability.

Matthew Foreman [00:09:54]:
The vast majority of countries if you have limited liability, you’re a C. What we could call a C. Corporation. Most people just call it corporation S Corps really don’t exist. So what happens is the foreign tax credit is only available in this situation in the foreign country to offset corporate taxes. There are no corporate taxes paid. This is individual taxation. So you have a dividend of $50, right? So you have $50.

Matthew Foreman [00:10:24]:
Let’s say you distribute the full 50, right? Because partnership isn’t going to pay the tax for you. It’s not a taxpayer. And so you have 50 minus the US’s tax portion, 18 and a half. So you’re down to 33 and a half. Then, then the foreign country might tax it right as a dividend. A lot of countries are doing dividend tax rates, et cetera, et cetera. But here’s the even worse part, right? I’m going to get into this a little later. But, but you have partnership withholding issues that come up.

Matthew Foreman [00:10:52]:
I am not going to go into those right now. I’m going to talk about it later. But there’s partnership withholding rates that when a partnership makes a distribution, they are legally required to withhold. Okay? So if you ever see partnership operating agreements that say, you know, if the partnership is obligated by law to withhold, it must withhold. This is generally what they’re talking about. Also cover situations where, you know, there’s a lien or a levy from the IRS or other creditor, et cetera, et cetera, that kind of thing. I’m going to talk about, you know, PTETS and local taxes, New York City’s ubt, all the pts, all stuff like that are generally creditable. You have to read the, either the foreign law or a lot of times if there is an income tax treaty, the income tax treaty will specifically say locality taxes.

Matthew Foreman [00:11:37]:
You run into issues, especially with ptets on whether it is a mandatory or optional tax. I appreciate the federal government allows you to deduct it. I don’t think most countries are going to credit it. And most countries might not let you actually deduct it. So there’s foreign tax credit issues and foreign cross border issues of PTETs. I could do a whole issue on PDETs or a whole episode on PTs. Maybe I will, maybe not because I don’t know if I really want to deal with it when it may go away or become less of an issue. Well, who knows how that nightmare is going to go, right? So issue two Permanent establishment, right? A pe, right? People talk about pe.

Matthew Foreman [00:12:11]:
Pe. What, what is a pe, right? And it’s a lot like physical presence nexus in the state income or sales tax context, right? So you have an office, you have a warehouse, you have employees who work there. Under treaties, you must have it for at least 90 or 120 days. You know, at least some of them are more, you know, it depends on the treaty. So it’s easy to have state physical presence nexus without a permanent establishment. Flip side, right? Solicitation only. But you’re there a lot. You might actually have permanent establishment without it.

Matthew Foreman [00:12:46]:
There’s quirky rules. You could have one without the other. Anyway, so. Right. German GmbH, give you an example. All right. Won’t try to pronounce the GmbH. What that stands for.

Matthew Foreman [00:12:54]:
Took Spanish. Not that my pronunciation Spanish is all that great. Anyway, right? So it owns 100% of a US LLC, right? From a US tax, it disregards. So there’s no permanent establishment. You’re still filing a return. Okay. You still have to file. File the US the return for the US llc, from a German perspective, right? It’s a reverse hybrid.

Matthew Foreman [00:13:15]:
Views both the GmbH and the US LLC as non transparent. So the GmbH is taxed as if it’s taxed. The US is going to tax it as a. At corporate rates because it’s owned by a corporation. Disregarded, Right. In Germany, it’s taxed at the corporate rates. But you know, there’s no foreign tax credit because it’s actually on it. So you can lose the foreign tax credit.

Matthew Foreman [00:13:35]:
But let’s talk about the PE here. Permanent establishment. Well, there’s no operations in the US and so there’s no permanent establishment in the us. Great. But the question that I always run into is, right, the disregarded entity. It’s ignored or disregarded, right? So does it actually have permanent establishment in Germany? That. That’s always the underlying question that I have. Right.

Matthew Foreman [00:13:59]:
In that foreign country. Does the US LLC have a permanent establishment in the foreign country because of the fact that that entity is disregarded and it goes up to the top entity? I don’t know. I don’t know. I’d look into what the foreign law says. I’d look into what the treaty says. I would think about it, right? Give another example. Another example, right? Individual resident in Canada owns a US llc. Again, disregarded entity.

Matthew Foreman [00:14:24]:
Canada views it as non transparent. Run into this issue a couple times a year with Canada, obviously, because of proximity, 37% US tax rate because it’s individual. Plus you get the Canadian tax on the distribution, which ignores the US tax system. Already said no foreign tax credit. Right? And because the systems don’t match up. So the US is the quirky one here. Because LLCs are generally inconsistent with the check the box regime and how foreign countries view it. People always say, oh, you know, they should just do what we say.

Matthew Foreman [00:14:57]:
They should do what we say. And I always say, you know, one why, you know, why should a foreign country, we don’t terribly care what other countries and how they tax. Why should other countries care what we do? Right. So that’s an issue, right? You have permanent establishment, they’re going to be not even you’re going to have foreign tax credit issues. You’re going to going to have tax rate matchups, things like that. I’m going to talk about tax rates in a few moments, but first let’s take a quick break and we’ll be back with tax rates and withholding. Okay. Welcome back to How Tax Works.

Matthew Foreman [00:15:34]:
I’ve more or less discussed the rate issues, but it’s less really a function of varying rates and more a function of hybrid entities being subject to different tax types in different countries. Individual in one because it’s a pass through, right. It’s owned by an individual and corporate in the other, which generally prevents the foreign tax credit. If you go back to one of my two examples, the German one, right. Because a German corp MBH use a corp owned a US disregarded entity, the corporate tax applied to both. Right. So that didn’t create a foreign tax credit issue. But you still have questions about the permanent establishment.

Matthew Foreman [00:16:12]:
So a lot going on there. However, even if there were a foreign tax credit, rates can get quirky and so do tax basis. For example, countries generally require that an entity that is transparent in both countries compute taxable income under its rules. That this, you know, whichever country is viewing its rules to determine eligibility for foreign tax credit, or perhaps capacity to take the foreign tax credit is the better word for the foreign tax credit. Right. It’s largely how GILTI works, fdii, fidi, however, they deal with that, right. They’re somewhat interested in the foreign computation. But what they don’t want is a country that has a foreign computation that is just really at loggerheads or has a weird base to erode the US’s ability to pay tax.

Matthew Foreman [00:16:57]:
They don’t want that. So like no, no, you’re gonna, you’re gonna look at how we compute. So you know, again, guilty. It’s on non transparent entities, but conceptually functions very similarly. The truth is that any withholding, you know, could really be a bigger issue. Right. So what is withholding all right. What is withholding? So this is a really important context, right? We’re not talking about wage withholding.

Matthew Foreman [00:17:19]:
It’s really that the real name is what’s called backup withholding. And the premise is that, and I think the premise is entirely correct here, is that it is very, very, very difficult to collect taxes from persons who are outside the jurisdiction, whatever they are. Every country has attempts to collect tax that are unsuccessful, go to litigation, stays unsuccessful. Right. So, you know, remember, this is individuals, partnerships, corps, whatever, Foreign, foreign. So it requires a US person, generally the payor, but can be other things to withhold a certain percent of the payment amount. The default is 30%. There’s other ones that create lower amounts firpta.

Matthew Foreman [00:17:58]:
So if you’re selling real estate, it’s 15%. If a partnership is making a distribution, that’s 15%, there’s some that are 10. There are some that can be higher. There can some be lower? It depends. And the rules can be quirky. There are situations where no actual cash changes hands, but there’s withholding. So you really have to look into it. They can be very.

Matthew Foreman [00:18:17]:
Surprising might be the word. Right. So withholding in the hybrid context. Right. The LLC is a US partnership, but a corporation to the foreign country. The US imposes 30% gross withholding, but the US partnership drops it to 15%. That’s IRC 1446. Would be a good code.

Matthew Foreman [00:18:34]:
Wouldn’t be good if I didn’t drop one code section in here. But what does an LLC operating agreement say? Right, tax distribution at 50%. So you’re going to withhold the distribution amount at the least, maybe higher, when you’re going to remit it to the irs. Right. So withholding could be lower. You know, sometimes with tax treaties, they lower to 10 or 5% depending on ownership, so even lower tax on the distribution. So look, look at the treaty, look at what you’re doing. Think of the transaction, think of what you’re doing and plan out the structures.

Matthew Foreman [00:19:05]:
Right? Which leads me to sort of what I’m going to call the home stretch here. Right. So what do you do? 100% owned by a foreign owner. Right? You think about, you have a foreign corp, it owns an entity here. Look, if you’re an llc, just check the box. Be a C corp. I tell clients, don’t even be a C corp, just be a corp. It’s simpler to form.

Matthew Foreman [00:19:24]:
Really not a huge thing. Oh, I have to have annual meetings. No, you can just, you know, look, have a quick meeting. Doesn’t have to be Here, just have a meeting, write a letter, that’s it. Keeping your records. A 21% tax. There’s a withholding on dividends. Back default is 30% of the dividend amount.

Matthew Foreman [00:19:39]:
Most treaties will drop you to five. Some are still 10. If there’s no treaty, you’re 30. And then there’s a foreign tax credit with be tax withheld. So for a lot of countries, you know, they, they t then tax that dividend tax credit comes with it. So a lot of times 21% US tax, pretty helpful. Some US, some foreign. You know, what a lot of people do is similar to what’s called an UPSEA structure.

Matthew Foreman [00:20:02]:
Goldman Sachs, for example, is the UPSEA structure, which is you have a entity that’s taxed as a partnership, that’s the opco and it’s owned by a bunch of partners. One of the partners is a C Corp. In Goldman’s case it’s, that’s the public company, that’s C Corp. And then above it are all the foreign ones. Obviously you, I anyone who owns gold, not literally saying me, but I’m saying I sort of lazily assume that I own it in some fund in my retirement account. Be surprised if I don’t on some level, right? That’s what they are. So you have an LLC that’s a partnership. All the US persons going right into the LLC needs a C Corp blocker, right? That’s the idea.

Matthew Foreman [00:20:35]:
The blocker is owned a tiny, tiny, tiny amount by a U.S. person. So it keeps your control so the foreign persons don’t have it. Especially when you have foreign investors rather than foreign operators. That situation. And that’s, that’s how you’re going to get, you know, $100 of income, $21 tax. Dividends can be 79, no dividends, 100. With a $21 foreign tax credit going up with a corp owned by a corp.

Matthew Foreman [00:21:02]:
And then any withholding tax, you have a corp, right? It’s a, it’s partnership withholding. So 15% that will only increase the foreign tax, what’s called the creditable amount. So that’s, that’s an important one. So, so you know, another thing that I often see and do, right, you actually loan money to the US subsidiary under certain treaties. You know, has to be a real loan, arm’s length, real terms, interest, real credit agreement, things like that. So it’s, it’s used to pull money back to the foreign owner or parent or you know, finance person financing. Sometimes the shareholders actually doing the financing rather than the company itself, right? So for to be arms against again, interest and payment, those terms must be, must be what you would normally get. Obviously interest can be lower, but must be at least afr and you must be able to actually pay it or permit accrual.

Matthew Foreman [00:21:55]:
You know, sometimes you see ones where, oh, you have to pay and you can’t accrue and they just don’t make payments. What do I do? I’m like, well, you have to modify the note to allow for it. So, you know, be realistic about the note, what’s going to happen. Model out your cash flow, et cetera. You know, watch out for interest deduction limitation 163J and you may have a withholding on the interest payment portion. Just watch out. But that’s something I always, you know, it’s not really here, but it kind of comes up. And so again, you know, look like I do this a lot and sometimes they’re like, oh, I’ll just check the box with taxes.

Matthew Foreman [00:22:27]:
C Corp. I do that. You know, sometimes it’s an issue. Some people like, oh, I’ll just check the box. And then they run into New York, right? And they didn’t make a New York election. So they have a disregarded entity in New York. That’s an issue. So, so, you know, you may want to just be a corp and then there’s no question as to what you’re doing.

Matthew Foreman [00:22:44]:
You know, a lot of countries view entities based on the country’s rules, again, you know, which ignore how the US views them. We do this other countries too. You can actually check the box on foreign entities to make them transparent or non transparent in the us Unless they’re what’s called a per se entity. There’s a list of them. It’s in 301-7701. It’s in dash two or dash three regs. I forget. But what that basically says is a lot of entities, you can make them viewed as transparent or not transparent as long as they’re not a per se corporation.

Matthew Foreman [00:23:16]:
Some countries, you know, actually say like whatever you do in the country of formation. So example in US is fine. We’ll just follow that. A lot of Caribbean countries do that, for example, but not all, you know, most, the vast majority, if you’ve limited liability for any of the owners, it’s non transparent and that’s the default, you know, and that’s it, right? So that’s kind of what you want to do. Look, I’m beating a dead horse here, but foreign persons, right? Individual partnership corporations should not own a US llc. Unless you have a reason, unless you’ve gone through it, you’ve made that decision. This is what I want to do. This is why I’ve modeled it out.

Matthew Foreman [00:23:53]:
But that’s, you know, why would you do that? I’ve talked about some. It’s another episode. What I mostly say is this situation, you know, llc, especially one where you have not checked the box the way I do it is one, that person follows files anyway, and two, that person’s going to come here. You know, we get a lot of visas, E2, EB5, et cetera, et cetera. They’re investment based. Create the entity, bring it here, bring it here. Right. It’s a foreign person when you create it and start it, but it’s really a US person operating.

Matthew Foreman [00:24:22]:
And that’s the key. That’s the key that you look at, who’s operating, when the profit’s going to come, et cetera. If your business only loses money and you walk away, it doesn’t really matter what your tax status is because you’re not going to pay taxes. But that’s the idea. Well, maybe you will on withholding, but you know, that’s the idea that that’s what we’re going for is, is to mitigate taxes to the extent possible. So on that note, this is the end of the 21st episode of How Tax Works. I hope you enjoyed it. Hope you learned something.

Matthew Foreman [00:24:49]:
I’ll be back in two weeks with the 22nd episode and I’m going to be discussing golden parachutes, right. 280 captchi of the Internal Revenue Code. Now for the best song of all time.