Dear Tax Talk,
I am a U.S. permanent resident with a green card and am planning to start a company with a partner who is a foreign resident. I have the following questions:
It seems that an LLC can be formed with foreign partners not residing in the USA. Is there any other option for forming a company?
How would my foreign partner's income be treated from a tax standpoint? Will he be paying federal tax, state tax, etc.?
Will he be taxed on his portion of income (e.g., if the company made an income of $100,000 and his share is 50 percent, will he be paying taxes on $50,000)? What if we incurred a loss of $100,000?
I usually don't recommend a limited liability company for an operating business due to self-employment tax disadvantages. However, when a participant is foreign, an LLC or other form of partnership is the best choice of entity. However, to avoid the self-employment tax disadvantages that would apply to you and the withholding tax issues that apply to a foreign partner, I recommend that the owners of the LLC interest be corporations. Your corporation would make an S corporation election.
An S corporation is not subject to self-employment tax on its share of LLC earnings. If the S corporation receives cash flow available for payment to you, then you can decide how to pay it out. Consider that you should receive a reasonable salary for your services, either from the S corporation or the LLC.
Your foreign partner's domestic corporation exists to avoid the quarterly withholding tax that applies to foreign partners. Under the withholding rules, the partnership/LLC must calculate its income quarterly and withhold up to 35 percent of the income allocable to the foreign partner regardless of available cash flow. If prior year losses exist, withholding can be adjusted, but the procedures are cumbersome. While direct ownership has some advantages, the quarterly withholding procedures and estate tax disadvantages may outweigh the benefits.
The foreign partner's corporation would pay federal and state income taxes in lieu of the foreign partner. Losses in one year can be offset against gains in a subsequent year.
You should discuss your business structure with a CPA or attorney to achieve the optimal benefits considering the overall situation. Restructuring after operations commence may produce undesired tax consequences and additional costs.
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