The Ultimate LLC Tax Guide for Nonresident Aliens
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If you are nonresident of the United States and you have formed a limited liability company (LLC) in the United States, special tax reporting requirements apply to you. To the untrained eye of a foreigner, the United States Tax Code is a tangled swamp of strange and exotic words and phrases, with hidden penalties lurking at every step. To understand its meaning, it is necessary to examine small portions of it at a time.
This article will focus on the tax reporting requirements for a nonresident alien individual who owns a single-member limited liability company (SMLLC), formed in the United States, and for which an election has not been made to treat as a corporation. With proper guidance, you can learn to navigate these tax rules successfully.
We will discuss:
- The Rules for Determining the U.S. Tax Residency Status of a Foreign National
- The Dual Taxing Regime That Applies to Nonresident Alien Individuals
- The Default Tax Entity Classifications for Single-Member and Multi-Member LLCs, and the Options to Elect Different Classifications
- The Role of Tax Treaties in Determining Your U.S. Tax Liability
- The Basic Tax Rules for Conducting Business in the U.S. by a Nonresident Alien Individual
- The Rules Specific to Ownership of Real Estate By Nonresident Alien Individuals
- The Special Reporting Requirements Involving Form 5472 for a Nonresident Alien Individual Who Owns a SMLLC
- A New Non-Tax Reporting Requirement for Most Entities Beginning in 2024: The Beneficial Ownership Information (BOI) Report
Are You a Nonresident Alien?
If you are an individual who is not a U.S. citizen, you are defined in the Internal Revenue Code as an "alien" (IRC Sec. 7701(b)). Because this term might have negative connotations, practitioners tend to use the softer term "foreign national," or the less precise term "immigrant" to describe you. However, we generally use the legal term "alien" to describe the tax differences between a resident alien and a nonresident alien.
There are two kinds of aliens (for tax purposes, that is); resident aliens and nonresident aliens. If you are not a resident alien, you are a nonresident alien. There are three tests in the Internal Revenue Code to determine residency status (IRC Sec. 7701(b)(1)):
- The "Green Card" Test
- The Substantial Presence Test
- The First-Year Choice (or election) Test
If you satisfy any one of these tests, you are a resident of the U.S. for tax purposes, at least for part of the calendar year. The tax rules discussed here are applicable to a nonresident alien who owns an LLC.
For a full explanation of how the rules work to determine your tax residency status, visit our US Tax Guide for Aliens. For an interactive questionnaire that will guide you to your correct tax residency status, take our Learn Your US Residency Status test.
Dual Taxing Regime for Non-U.S. Residents
Although resident aliens are generally subject to the same tax rules as U.S. citizens, nonresident aliens are treated quite differently under the Tax Code. Unlike residents who report their worldwide income, nonresident aliens report only income received from sources within the United States, or connected with a U.S. trade or business.
Additionally, there are two separate taxing regimes for aliens. You might receive:
- Income that is effectively connected with a U.S. trade or business, and/or
- Income that is not effectively connected with a U.S. trade or business (IRC Sec. 871).
Effectively Connected Income for Nonresident Aliens
Income that is effectively connected with a U.S. trade or business includes business and personal service income and is taxed at the same graduated rates that residents use (IRC Sec. 871(b)). So, if you earn a wage while working in the United States, you are taxed under the graduated rate structure (just as if you were a resident). This is shown on page one of Form 1040NR.
Non-Effectively Connected Income for Nonresident Aliens
Non-effectively connected income is any income produced from passive assets (see the rental real estate election, below). Examples of non-effectively connected income include interest, dividends, rents, and pension and annuity income. Additionally, non-effectively connected income also includes capital gains. Generally, capital gains on anything other than the sale of real property are exempt from taxation for nonresident aliens (IRC Sec. 871(a)(2)). Non-effectively connected income is taxed at a flat rate of 30% on the gross amount (IRC Sec. 871(a)), unless a lower treaty rate applies. Deductions are not allowed for non-effectively connected income.
What is a Limited Liability Company (LLC)?
The LLC is a popular choice of entity for conducting business or holding real estate in the United States for U.S. residents and non-U.S. residents alike. It is a business structure you can form in any one of the fifty states. An LLC is designed to protect the personal assets of its owners, similar to a corporation, but you have flexibility in how your business or rental activities are reported for tax purposes. It can also be used to hold personal use assets, such as a vacation residence.
For information on the best states for forming an LLC, and specifically how to form an LLC in each state, see LLC University. Additionally, here are some great tips on starting an LLC from the Chamber of Commerce: How to Start an LLC.
Types of LLCs
Single-Member LLC
A single-member LLC is treated as a disregarded entity for U.S. tax purposes unless a corporate election is made. That means there is no separate form to file for the LLC to report taxable income. This is done with the owner's tax return. So, if you are a nonresident alien completing taxes for your LLC, you are only required to report the business or rental activity of the LLC on Form 1040NR (U.S. Nonresident Alien Income Tax Return). If your LLC owns only personal use property that does not generate revenue, you are not required to file Form 1040NR.
Form 5472 Filing
However, whether or not you have a Form 1040NR filing requirement, under special reporting requirements beginning in 2017, you are required to file Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade of Business) with a pro forma Form 1120 (U.S. Corporation Income Tax Return). See Form 5472: Special Reporting Requirements for a Single-Member LLC Owned by a Nonresident Alien.
Corporate Election
As a single owner, you can elect to treat your LLC as a corporation for tax purposes. If you do, the LLC must file Form 1120 to report and pay tax on corporate income and, as a nonresident alien, Form 5472 to report your ownership interest. This requires Form 8832 to be filed with the IRS. Here is some information on Form 8832: About Form 8832.
When corporate income is distributed to you as a dividend, you are required to file Form 1040NR to report the dividend income and pay tax again at the individual level. So there are two levels of taxation when a corporate election is made.
As a nonresident alien, you are not allowed to make an S election for your corporation, which is the way a resident owner turns a corporation into a pass-through entity. We won't go into the pros and cons of different entity options here, but a corporate election might not be your best choice to minimize your U.S. tax obligation.
Multi-Member LLC
If your LLC is owned by you and one or more partners, the default classification for U.S. tax purposes is a partnership. A partnership under U.S. tax law is treated as an entity separate from its partners, but it is a pass-through entity and it generally does not pay tax at the partnership level.
The partnership must file Form 1065 (see the rules for Form 1065) showing the income and deductions allocable to the partners. You, as a partner, must file a personal tax return (Form 1040NR for a nonresident partner) reporting the partnership income allocable to you, shown on Form K-1 issued to you by the partnership. The partnership return is due March 15. Form 1040NR is due June 15.
Special Forms for Nonresident Alien Multi-Member LLC Owners
Although the partnership is not a tax-paying entity, it is generally required to withhold federal income tax when it has a nonresident alien partner and the LLC partnership has received US-source income. Three forms are required for reporting and paying over tax withheld on effectively connected income allocable to foreign partners:
- Form 8804 (Annual Return for Partnership Withholding Tax): Used to report the withholding tax liability of the partnership
- Form 8805 (Foreign Partner's Information Statement of Section 1446 Withholding Tax): Used to show the amount of effectively connected taxable income and any withholding tax payments allocable to each foreign partner. This form must be sent to each foreign partner whether or not any withholding tax is paid. A copy of Form 8805 for each foreign partner must also be attached to Form 8804 when it is filed. A copy of Form 8805 must be attached to the foreign partner's U.S. income tax return to take a credit on Form 1040NR.
- Form 8813 (Partnership Withholding Tax Payment Voucher): Used to make payments of estimated tax to the United States treasury. Payments are required to be made on or before the 15th day of the fourth, sixth, ninth, and 12th months of the partnership's tax year
Corporate Election
A multi-member LLC also has the option to be treated as a corporation for tax purposes, which would require it to file a corporate tax return on Form 1120 rather than a partnership return and pay tax at the corporate level. The process of making the election is the same as for a single-member LLC.
The Role of Tax Treaties for Nonresident Alien LLC Owners
A treaty might allow residents (not necessarily citizens) of their home country to be taxed at reduced rates on specified items of U.S.-sourced income, be exempt from U.S. tax on other income categories, and override statutory provisions of the Internal Revenue Code.
The United States has tax treaties with over 65 countries, and, for example, treaties with several countries offer an exemption from taxation of U.S.-sourced business income if your business does not have a permanent establishment (a fixed place of business through which the dealings of an enterprise is wholly or partially carried on) in the United States.
You can find general treaty information in our US Tax Guide for Aliens. Our guide includes an overview, sources of and links to treaty information, technical explanations, and some treaty examples. However, even with our in-depth manual, treaties can be a little tricky, so be sure to check with us, or another tax professional, before relying on a provision that appears to benefit you.
States and Tax Treaties for Nonresident Aliens
Federal treaty exemptions are allowed by most states, but not all. The states that tax treaty exempt income include Alabama, Arkansas, California, Connecticut, Hawaii, Kansas, Kentucky, Maryland, Mississippi, Montana, New Jersey, North Dakota, and Pennsylvania. Therefore, even though you have no taxable business income on your federal return due to treaty exemption, you may owe state income tax if doing business in one of the nonconforming states, even if you do not have a permanent establishment.
The State of Sales Tax Collections
Although a tax treaty might exempt your business income from Federal income taxation, the tax treaty might not apply at the state level. Additionally, sales taxes, which are imposed only under the authority of state and local governments, are not subject to the purview of federal income tax treaties. Therefore, even if a state honors a Federal treaty provision regarding income tax on business income, the state still could impose sales taxes on the treaty-exempt income.
How Supreme Court Decision in Wayfair Affects Nonresident LLC Owners
For many years, states were precluded from imposing sales taxes on items sold by sellers who did not have a physical presence in the state. This was the position of the Supreme Court in Quill Corp. v. North Dakota (1992), in which the Court relied on the Dormant Commerce Clause, preventing states from interfering with interstate commerce unless authorized by the United States Congress.
That all changed due to South Dakota v. Wayfair, Inc. (2018), with the Court ruling that states may charge tax on purchases made from out-of-state sellers, even if the seller does not have a physical presence in the taxing state. The Court noted that the physical presence requirement of Quill put retailers with physical presence in the state at a disadvantage to solely online or remote retailers.
Helping to sway the Court, the South Dakota law had several features designed to prevent undue burdens on interstate commerce. For example, it applied a safe harbor for those who transact only limited business in South Dakota. The law said retailers with sales of $100,000 or less, or fewer than 200 instate transactions, were exempt. Additionally, South Dakota is one of more than 20 states to adopt the Streamlined Sales and Use Tax Agreement, which requires certain standardization in the rate structure to reduce administrative and compliance costs for remote sellers.
The Wayfair decision has created opportunities for the rest of the states to enact or revise their own sales tax laws to take advantage of the new standard. If you are an online retailer, you will want to keep up with what the states are up to, or purchase software that will do that for you. Several packages will track your sales, determine your filing requirements, compute the tax, and produce sales tax forms to file.
Nonresident Aliens Conducting Business In the U.S.
The term "trade or business within the United States" is not fully defined in the Code or Treasury regulations, and the IRS will not provide an advanced ruling on whether a taxpayer is engaged in a U.S. trade or business (USTB). Generally, whether or not a person is engaged in a USTB is determined based on the facts and circumstances of each case.
To be engaged in a trade or business, a taxpayer (either directly or through a dependent agent) must be involved in an activity that is considerable, continuous, and regular, and the taxpayer's primary purpose for engaging in the activity must be for income or profit.
Do You Need To Be In the U.S. to be Engaged In a U.S. Trade or Business?
There is nothing that tells us that physical presence is a requisite, so, you could be engaged in a U.S. trade or business without ever stepping foot in the United States. For example, income from the sale of inventory items purchased outside the U.S. and sold within the U.S. is U.S.-sourced income under IRC Section 861(a)(6). Additionally, under IRC Section 872(a), the gross income of a nonresident alien includes U.S. source income, whether or not it is income effectively connected with a U.S. trade or business.
Tax Regulations for Nonresident Alien LLC Owners Regarding the Sale of Inventory
If the U.S. sale of inventory is not treated as U.S. business income, it must be shown as not effectively connected income (NEC). NEC income is taxed at a flat rate of 30% of gross with no offset for deductions. It is better to assume that such income is connected with a U.S. trade or business.
Income from sources within the United States that is considered effectively connected with your trade or business is taxed at graduated rates (IRC Sec. 864(c)(3)). Income from sources without the United States is treated as effectively connected to your U.S. business only if you have an office or other fixed place of business within the United States (IRC Sec. 864(c)(4)).
As mentioned above under The Role of Tax Treaties, an exemption from taxation of U.S.-sourced business income might apply under the U.S. tax treaty with your home country, if your business does not have a permanent establishment in the United States.
Purchased Inventory
According to the Internal Revenue Manual, the source of income realized from the purchase and sale of inventory property will generally be determined by the location of the property at the time title passes. Title passes at the location and time when the seller's rights, title, and interest in the property are transferred to the buyer. The title passage rule derives from the law of sales and generally allows the parties to arrange title passage wherever they choose.
However, Treas. Reg. Sec. 1.861-7(c) provides that, when a sales transaction is arranged in a particular manner for the primary purpose of tax avoidance, "all factors of the transaction, such as the negotiations, the execution of the agreement, the location of the property, and the place of payment will be considered, and the sale will be treated as having been consummated at the place where the substance of the sale occurred."
Keep in mind that the Internal Revenue Code (Section 861(a)(6)) classifies "Gains, profits, and income derived from the purchase of inventory . . . without the United States . . . and its sale or exchange within the United States" as U.S.-sourced income.
Manufactured Inventory
As amended by the 2017 Tax Cuts and Jobs Act, IRC Sec. 863(b) now provides that gains, profits, and income from the sale or exchange of inventory property that is produced in whole or in part within and sold or exchanged without the United States (or vice versa) is allocated and apportioned solely based on the production activities concerning the property.
Title passage and location of sale are no longer factors in determining the source of income from the sale or exchange of inventory property. If the inventory is produced entirely in the United States, the income is U.S.-sourced income. Similarly, the income is foreign-sourced if the inventory is produced entirely in a foreign country.
Mixed-Source Income
Income from the sale or exchange of inventory produced in the United States and a foreign country is mixed-source income. The new law obsoletes the current regulations allocating such income between production and sales activities, and the source rules applicable to the portion of income attributable to sales activities.
However, current treasury regulations are still effective to the extent they describe the source of income attributable to production activities. Under the regulations, production activity means activity that creates, fabricates, manufactures, extracts, processes, cures or ages inventory. With some exceptions, the only production activities that are taken into account are those carried on by the taxpayer.
The income attributable to production activities is sourced according to the location of the production assets. Production assets include only tangible and intangible assets that the taxpayer uses directly to produce inventory. Production assets do not include assets that are not directly used to produce inventory, such as accounts receivable, marketing intangibles, and customer lists. For inventory produced both inside and outside of the U.S., the source of income is determined by the ratio of the average adjusted bases of where production assets are located.
Tax Rules for Nonresident Aliens Holding Real Estate
Income from the rental of real property is generally considered income that is not effectively connected with a U.S. trade or business. As non-effectively connected income, it is taxed at a flat rate of 30% of gross (absent a treaty provision) and no deductions are allowed. You are not required to file a U.S. income tax return if the payor withholds a tax of 30%, and you have no other income to report.
Rental Real Estate Election
You might be thinking that a 30% tax on gross rental income sounds like a lousy deal, and it is. Fortunately, an election is available under IRC Sec. 871(d) to have the net income (after expenses) taxed as income effectively connected with a U.S. trade or business. This is generally a much better option for nonresident aliens with LLCs, as any net income is taxed at graduated rates beginning at 10%.
If you decide to make this election, you are exempt from the tax withholding requirement (Reg. Sec. 1.1441-4(a)). Your income and deductions relating to the rental of real property are reported on Schedule E, which is included with your federal Form 1040NR. If you are a partner in a partnership, the election is made at the individual level rather than by the partnership.
The Sale of Real Property
Gains and losses from the sale or exchange of US real property interests are taxed as if you are engaged in a trade or business in the United States (IRC Sec. 897). You must treat the gain or loss as effectively connected with a trade or business, regardless of how you use the property. The tax rate on net long-term capital gains ranges from 0-20%, depending on the amount of your total taxable income.
Generally, a federal tax withholding of 15% of the sales price is required from anyone who purchases real estate from a nonresident alien (IRC Sec. 1445). This withholding is claimed as a credit on your non-resident tax return. Form 8288-A (Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests), stamped as received by the IRS, must be attached to the return as evidence of the amount withheld.
Alternatively, Form 8288-B (Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests) can be filed with the IRS to obtain a withholding certificate to reduce or eliminate the withholding. This can be filed by the closing date to prevent the closing agent from sending the withheld tax to the IRS until after the IRS makes its determination, or after the closing date to request a refund from the IRS.
Form 5472: Special Reporting Requirements for a Single-Member LLC Owned by a Nonresident Alien
As we have discussed above, for income tax purposes, a single-member LLC formed in the U.S. by a nonresident alien is classified as a disregarded entity. That means all of the activities of the LLC are reported on your Form 1040NR (Schedule C if a business or Schedule E if rental property), and there is no separate corporate form to file.
However, for one section of the Internal Revenue Code, if a foreign person has direct or indirect sole ownership of the LLC (that's you), it is treated as a separate entity and classified as a U.S. corporation. This is only for Section 6038A of the Code, which specifies special reporting requirements for a U.S. corporation that is owned more than 25% by a "foreign person". The term "foreign person" includes a nonresident alien individual and generally any entity that is not formed in the United States. Additionally, it also includes any individual who is a citizen of any possession of the United States, but not a citizen or resident of the United States (IRC Section 6038A(c)(3)).
You can have indirect sole ownership of an LLC if your LLC is owned entirely through one or more other disregarded entities owned by you, regardless of whether the disregarded entity was formed within or outside the United States (Reg. Sec. 301.7701-2(c)(2)(vi)). So, for example, if you form an LLC as the sole owner, and that LLC forms another LLC as the sole owner, both LLCs are subject to the reporting requirements of Section 6038A, because they are both either directly or indirectly owned by you.
Reporting Requirements of Section 6038A
The reporting requirements of Section 6038A change nothing concerning how you report the activities of your LLC for income tax purposes. The LLC is still disregarded when it comes time to report its income and expenses on your Form 1040NR. The classification as a separate corporation only applies to satisfy the requirements of IRC Section 6038A.
In general, this section requires you to:
- Furnish the name, principal place of business, nature of business, and country of residence for each person that is a related party to the reporting LLC during its taxable year, if that person had any transaction with the LLC
- Describe how such a related party is related to the LLC
- Provide a description of the transactions (deemed "reportable transactions" in the instructions to Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business)) between each related party and the LLC (IRC Sec. 6038A(b)).
The two critical terms to understand here are "related party" and "transaction" (or "reportable transaction") which have very specific definitions under IRC Section 6038A.
What Is a Reportable Transaction?
Any monetary transactions between a related party and your LLC listed in Part IV of Form 5472 must be reported. Those are primarily taxable income, deductible expenses, purchases of inventory, and loans between the related party and the LLC.
If you don't know the exact amount, an estimate will do, but it must be disclosed in Part IV if you are using estimates. Part V of Form 5472 requires the additional reporting for a foreign-owned disregarded entity (your LLC), as defined by Regulation Section 1.482-1(i)(7).
Regulation Section 1.482-1(i)(7) says these activities are transactions that must be reported: " . . . any sale, assignment, lease, license, loan, advance, contribution, or any other transfer of any interest in or a right to use any property (whether tangible or intangible, real or personal) or money, however such transaction is effected, and whether or not the terms of such transaction are formally documented. A transaction also includes the performance of any services for the benefit of, or on behalf of, another taxpayer."
Simply put, just about anything you or another related party can cook up with the LLC is a transaction that must be reported on Form 5274. Assume this includes all categories of items, both received and paid, by, for, or on behalf of the LLC. This approach will eliminate any arguments by the IRS that a reportable transaction was omitted.
Form 5472 Filing Procedures
Although a single-member nonresident LLC has no separate income tax return filing requirements, Form 5472 is required to be attached to a pro forma Form 1120 by the Form 1120 due date, even if there are no business activities requiring the filing of an income tax return.
"Foreign-Owned U.S. DE" should be written across the top of Form 1120. To file, the forms can be faxed to the IRS, with a cover letter, to 1.855.887.7737.
The due date for a calendar year corporation is April 15 of the following year, however, the due date can be extended to October 15 using Form 7004 (Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns).
In addition to filing Form 5472, you must maintain records to determine the correct treatment of transactions with related parties. Failure to file Form 5472/1120 by the due date, or to maintain proper records, incurs a penalty of $25,000, unless you have a valid reason for not doing so (IRC Section 6038A(d)).
Filing Late
The protections afforded taxpayers who file late FBARs or delinquent international information returns (see Options Available For U.S. Taxpayers with Undisclosed Foreign Financial Assets) are not available to nonresident aliens who file Form 5472/1120 late. These procedures are for U.S. taxpayers who have undisclosed foreign accounts, rather than nonresidents with undisclosed LLCs and unpaid taxes.
However, IRC Sec. 6038A(d)(3) provides that the penalty for late filing or maintaining records will not apply if "reasonable cause" existed at the time of the requirements.
What is Reasonable Cause?
According to the IRS:
The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances. Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light of the experience and knowledge of the taxpayer. Isolated computational or transcriptional errors generally are not inconsistent with reasonable cause and good faith. Reliance upon an information return or on the advice of a professional (such as an attorney or accountant) does not necessarily demonstrate reasonable cause and good faith. Similarly, reasonable cause and good faith is not necessarily indicated by reliance on facts that, unknown to the taxpayer, are incorrect.
Treas. Reg. Sec. 1.6038A-4(b)(2)(iii).
More importantly:
The District Director shall apply the reasonable cause exception liberally in the case of a small corporation that had no knowledge of the requirements imposed by section 6038A; has limited presence in and contact with the United States; and promptly and fully complies with all requests by the District Director to file Form 5472, and to furnish books, records, or other materials relevant to the reportable transaction. A small corporation is a corporation whose gross receipts for a taxable year are $20,000,000 or less.
Treas. Reg. Sec. 1.6038A-4(b)(2)(ii).
Therefore, if you are a nonresident alien LLC owner reading this after the tax deadline, and have been overtaken with a sense of panic, there's still hope! You should file a late return as soon as possible, and get our help to write a reasonable cause statement to attach. We have been very successful in helping clients avoid the $25,000 late filing penalty.
For any further clarification or questions, please be sure to visit our FAQ page or schedule a free 30-minute confidential meeting with us to discuss your situation.
The Corporate Transparency Act (CTA) Beneficial Ownership Information (BOI) Report
The Corporate Transparency Act (CTA), enacted in 2021, was passed to enhance transparency in entity structures and ownership to combat money laundering, tax fraud, and other illegal activity. Beginning in 2024, many companies, including yours, will be required to report information to the U.S. government about who ultimately owns and controls them.
To understand what companies are exempt from the reporting requirements, see FinCEN's Small Entity Compliance Guide. However, your company is definitely not on the list of exempt companies. For some FAQs about the requirements, see FinCEN's BOI FAQs page. Alternatively, you can visit their regular BOI page for complete information.
If you have a reporting company created before January 1, 2024, you will have until January 1, 2025, to file the initial beneficial ownership information report. If your company is formed in 2024, you will have 90 days from the date of formation to submit a report. For more information, read this news release.
Assisting you with your compliance with the Corporate Transparency Act (“CTA”), including beneficial ownership information (“BOI”) reporting, is not within the scope of our services currently. For now, the best solution we have found is CT Corporation.
This service is owned by our professional tax software provider Wolters Kluwer, which is a very reputable firm. This is a self-service process, for which they charge $199.