Form 1040NR, Form 1120 and Form 5472: A US Tax Guide for Nonresident Aliens with a Single-Member LLC
Tax Reporting for Nonresident Alien LLC Members
A limited liability company (LLC) is a popular choice of entity for conducting business or holding rental real estate in the United States. 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 state statutes for LLCs, and specifically how to form an LLC in each state, see LLC University.
If you have a single-member LLC, the LLC is treated as a disregarded entity for tax purposes unless a corporate election is made. That means if you are a nonresident alien individual, you report the business or rental activity of the LLC on Form 1040NR (U.S. Nonresident Alien Income Tax Return). There is only a single level of taxation.
If your LLC owns only personal use property that does not generate revenue, you are not required to file Form 1040NR. 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 with a pro-forma Form 1120. This requirement is explained in detail below.
As a single owner you can elect to treat your LLC as a corporation for tax purposes. If you do, the corporation must file Form 1120 (U.S. Corporation Income Tax Return) to report and pay tax on corporate income. Form 5472 must be included with Form 1120 to report your ownership interest.
When corporate income is distributed to you as a dividend, you are required to file Form 1040NR to report the 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, 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 corporation might not be your best choice.
LLCs With More That One Owner
If your LLC is owned by you and one or more partners, the default classification for 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.
You must file Form 1065 (U.S. Return of Partnership Income) to report the income and expenses of the partnership, then report your share of partnership income and expenses on your Form 1040NR.
Alternatively, 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.
Our Overwhelming Tax System
Now that you have decided to form an LLC, you need to deal with U.S. tax laws. You will soon discover that our Internal Revenue Code is a tangled swamp of unintelligible gobbledygook, with dangerous penalties lurking at every turn. Welcome to America!
It helps when we narrow the scope. Here, I will focus on the tax reporting requirements for a nonresident alien individual conducting business through a single-member LLC who has not elected to treat the LLC as a corporation. With proper guidance, you can navigate the tax rules successfully.
This post will be your guide as we slog through the small area of the U.S. tax quagmire that pertains to you, at least at the shallow end. We will discuss:
- How to determine your U.S. residency status,
- The dual taxing regime that applies to nonresident aliens,
- The role of tax treaties,
- The rules specific to ownership of real estate by nonresidents,
- Tax rules for conducting business in the U.S., and
- The requirement that pertains specifically to nonresident aliens who own single-member LLCs to file Form 5472.
Who Is 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 conjure up negative images (like space creatures), practitioners tend to use the softer term "foreign national," or the less precise term "immigrant" to describe you. On this site, we generally stick with the legal term "alien" in order 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)): 1) the "green card" test, 2) the substantial presence test, and 3) 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 rules discussed here are all applicable to nonresident aliens.
For a full explanation of how the rules work to determine your tax residency status, including a number of examples, visit our US Tax Guide for Aliens. For an interactive questionnaire that will guide you to your correct tax residency status, visit our Residency Guide.
Taxing Regime for Nonresidents
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 nonresidents. You might receive 1) income that is effectively connected with a U.S. trade or business, and/or 2) income that is not effectively connected (IRC Sec. 871).
Income Effectively Connected With a U.S. Trade or Business
Income that is effectively connected is taxed at the same graduated rates that residents use (IRC Sec. 871(b)). It is shown on page one of Form 1040NR.
Income that is effectively connected with a U.S. trade or business includes business and personal service income. So if you earn a wage while working in the United States, you are taxed under the graduated rate structure (just like if you were a resident).
Income Not Effectively Connected With a Trade or Business
Income that is not effectively connected with a U.S. trade or business is generally taxed at a flat rate of 30% on the gross amount (IRC Sec. 871(a)). Deductions are not allowed to reduce this gross income.
Non-effectively connected income is any income that is produced from passive assets (but see the rental real estate election, below). Examples of non-effectively connected income include interest, dividends, rents, and pension and annuity income.
Non-effectively connected income also includes capital gains. However, capital gains on anything other than the sale of real property are exempt for nonresident aliens who do not spend 183 days or more in the United States during a calendar year (IRC Sec. 871(a)(2)).
The Role of Tax Treaties
The United States has tax treaties with over 65 countries. Tax treaties can override statutory provisions of the Internal Revenue Code. A treaty might allow residents (not necessarily citizens) of the treaty country to be taxed at reduced rates on specified items of U.S. sourced income, or be exempt from U.S. tax on other categories of income.
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 in the United States. The term "permanent establishment" is generally defined as a fixed place of business through which the business of an enterprise is wholly or partially carried on.
You can find general treaty information in our US Tax Guide for Aliens. Our guide includes an overview, sources of treaty information, links to the treaties and technical explanations, and some treaty examples. Treaties can be a little tricky though, so be sure to check with us, or another tax professional, before relying on a treaty provision that appears to benefit you.
States and Tax Treaties
Federal treaty exemptions are allowed by most states. However, some states do not honor federal treaty exemptions. 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 because of a 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.
Tax Rules for Nonresidents Holding Real Estate
Income from the rental of real property is generally considered income that is not effectively connected with the conduct of 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 tax of 30% is withheld by the payor, 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, of course, 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 way to go for nonresident aliens. Any net income is taxed at graduated rates beginning at 10 percent.
If you make this election, you are exempt from the tax withholding requirement (Reg. Sec. 1.1441-4(a)). Your income and deductions relating to 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 rate of tax on net long-term capital gains ranges from 0 to 20%, depending 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, stamped as received by the IRS, must be attached to the return as evidence of the amount withheld.
Alternatively, Form 8288-B 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.
Conducting Business In the U.S. by Nonresidents
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 on the basis of 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.
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 US and sold within the US is US source income under IRC Section 861(a)(6). Additionally, under IRC Section 872(a), gross income of a nonresident alien includes US source income, whether or not it is income effectively connected with a US trade or business.
If the US sale of inventory is not treated as US 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 obviously better to take the position that such income is connected with a US 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.
Sourcing rules for the sale of inventory
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)) includes as US source income "Gains, profits, and income derived from the purchase of inventory . . . without the United States . . . and it's sale or exchange within the United States.
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 on the basis of the production activities with respect to 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. source income. If the inventory is produced entirely in a foreign country, the income is foreign source income.
Income from the sale or exchange of inventory produced in both 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 are directly used by the taxpayer 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.
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.
The Supreme Court Decision in Wayfair
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 when the Court reversed itself in South Dakota v. Wayfair, Inc. (2018), 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 to 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 adopted the Streamlined Sales and Use Tax Agreement, requiring certain standardization in the rate structure to reduce administrative and compliance costs for remote sellers.
Obviously, the Wayfair decision has created mouth watering 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.
A quick google search for "sales tax software for online retailers" brings up several packages that will track your sales, determine your filing requirements, compute the tax, and produce sales tax forms to file. For example, here is a comparison of ten packages.
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 United States 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 not a 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. (Wait a minute - what?) Yes, 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" (just because the U.S. government is especially nosy about foreigners doing business here).
The term "foreign person" includes a nonresident alien individual (defined above) and generally any entity that is not formed in the United States. It also includes an 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 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.
The reporting requirements of Section 6038A change nothing with respect to 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 for the purpose of satisfying the requirements of IRC Section 6038A, which are explain below. (And, if you screw this up, they charge you $25,000, so keep reading and don't doze off.)
Reporting requirements of Section 6038A
In general, this section requires you to 1) 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 it's taxable year, if that person had any transaction with the LLC; 2) describe the manner in which such related party is related to the LLC; and 3) provide a description of the transactions (deemed "reportable transactions" in the instructions to Form 5472) 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. (In U.S. tax law, words have different meanings depending on what page you're on.)
What or Who Is a "Related Party"?
First, you are a related party, whether your ownership is direct or through another disregarded entity, as discussed in the previous section. Now who else is? Let me answer that this way. Let's say you would like to avoid these pesky reporting requirements, but still sneakily engage in transactions with your LLC indirectly, through family members or entities you control. Try to think of ways to do that.
How about having a family member, such as your spouse, parents (or their ancestors), children (or their descendants), brothers or sisters (whether by whole or half blood) perform the transactions? Do you think they will let you do that? Nope - all these people are related parties (IRC Section 267(b)). What if, rather than your spouse, you talk your spouse's brother into performing the transaction? Nope - family members of your spouse are also treated as related parties through the attribution rules (IRC Section 318(a)(1)).
How about a corporation, of which you own over 50 percent, either directly or indirectly? Or the trustee of a trust you are the owner or beneficiary of? Or a partnership you own over 50 percent of, either directly or indirectly, or your partner in the partnership? Nope, nope, nope and nope. All of these entities and people are related parties, so reporting of any transactions between them and the LLC is required (IRC Sections 267(b) and 707(b).)
Even if you can arrange to control a transaction between the LLC and a party that does not fit within the statutory rules, the IRS has the nuclear option - IRC Section 482. Under IRC Section 482 (and extended indirectly through Section 6038A(c)(2)(C)) the IRS is allowed to deem anyone a related party who you have actual or perceived influence over (Reg Section 1.482-1(i)(4)).
The best way to look at this is to consider any individual or entity that is even remotely connected to you to be a related party to your LLC, and talk to us about the activities of that person. We will determine whether there are transactions that must be reported on Form 5472.
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.
Remember that a single-member LLC is disregarded for all purposes of the Internal Revenue Code except for IRC Section 6038A. That means any income received by the LLC is deemed to be received directly by the owner, and any expense paid by the LLC is deemed to be paid directly by the owner. Although Section 6038A does not specifically say that any amount received or paid by the LLC is a "reportable transaction" for the LLC single owner, to assume so is a conservative approach.
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."
So there you have it. Just about anything you or another related party can possibly 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 not reported.
This information is required on Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade of Business). Although a single member LLC has no separate income tax return filing requirements, this form is required to be attached to a pro forma Form 1120 by the due date of Form 1120, 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. The due date can be extended to October 15 using Form 7004.
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 really good reason for not doing so (IRC Section 6038A(d)).
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 nonresident taxpayers who have undisclosed U.S. LLCs.
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).
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 reading this after the due date, 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.