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Forms Of Tax-Effective US Company

This section describes US organisational forms which can be used in tax-effective structures, both for US residents and for non-residents. Although US taxes are hard to escape for residents, there are many ways of legally minimising tax; and for non-residents, taxation is entirely avoidable in most investment situations.

A corporation is normally a "C" corporation (taxable under Chapter C of the Tax Code). Certain types of smaller corporation can be taxed under Chapter S of the Tax Code, which allows a 'pass-through' of income for tax purposes. These are known as "S" Corporations.

Limited Liability Companies and partnerships that carry on no business in the US and derive no income from any sources within the US do not need to file a US federal tax return. The US can thus be a conduit for foreign business or foreign investments - the LLC allows the foreign business or foreign investor to use many of the United States' tax treaties. However, an LLC that elects to be treated as a corporation does need to file a return.

Confidentiality remains good in the US, although the Treasury Department is continually trying to breach banking secrecy and professional confidentiality. Unlike Europe, the US has no OECD- inspired "know your client" rules; companies and trusts can be formed discreetly and no record of ownership or directorship is filed with the Government. Non-resident ownership of a US bank account incurs no taxation, although the Treasury Department has been fighting a long-running battle to be able send information on interest payments from such accounts to the individual's home tax authorities. The situation remains unresolved, although the new regime is in operation for Canadians, and pressure from Europe has lessened since Brussels went ahead with its own Savings Tax Directive in July, 2005..

Procedures for the formation of companies, partnerships and trusts vary somewhat between states. As an example, to incorporate in Delaware, a favourite location for companies, or to form a limited liability company, a certificate of incorporation (for a corporation), or a certificate of formation (for a limited liability company) needs to be filed with the Division of Corporations, along with the appropriate fees. The corporation’s by-laws or limited liability company’s membership operating agreement are not needed for the initial formation process when filing these articles of incorporation.

Most states permit the formation of a 'close' ie privately owned corporation, which is eligible to elect “S” Corporation status with the IRS. However, a close corporation cannot have any non-resident aliens as shareholders.

A Limited Liability Company acts in many ways like an “S” Corporation, but can have non-resident shareholders, as can a Limited Partnership. However, a Limited Partnership generally offers less protection of personal assets than does an LLC; neither of them is as robust as a trust in asset protection terms.


Limited Liability Company (LLC)

All 50 states and the District of Columbia have authorized the formation of LLCs. US tax law treats an LLC on a 'pass-through' basis - a single member LLC is simply disregarded for tax purposes, while an LLC with two or more members is treated as a partnership unless it opts to be treated as a corporation. In both cases taxation is applied to the members and not to the LLC.

If the members of an LLC are foreign persons, then they will be taxed on all income which is effectively connected with their conduct of a trade or business in the US. However, the receipt of 'passive' income on its own does not normally amount to the conduct of a US business - passive income includes most interest income, gains from investment in any stock market, and gains from investment in commodities.

Foreign owners of a domestic LLC do not pay income tax on the LLC’s foreign source export income except under certain circumstances. If the foreign person’s LLC does not have a US office or an agent in the US, it is unlikely that foreign source income will be taxed as US income. If there is a US office, then by and large the activities of the US office will not be considered to be a material factor in the realization of income, gain, or loss, unless the US office provides a significant contribution to, by being an essential economic element in, the realization of the income, gain, or loss. An administrative office in the US can pay expenses, deposit income and perform accounting activities. These activities will not cause export income to be taxed by the US taxing authorities.

An office is not considered to have materially participated in a sale merely because one or more of the following activities takes place: (a) the sale is made subject to the final approval of such office, (b) the property sold is held in, and distributed from such office, (c) samples of the property sold are displayed (but not otherwise promoted or sold) in such office, (d) such office is used for purposes of having title to the property pass outside the United States, or (e) such office merely performs clerical functions incident to the sale.

S Corporation

“S” Corporations (which are not available to non-residents) are very popular for small businesses in the US. An S corporation is a regular corporation (normally taxable under subchapter C of the Internal Revenue Code, and thus referred to as a C corporation), or a limited liability company which has elected to be taxed like a corporation, which files form 2553 with the Internal Revenue Service. The result is that the corporation's net income (after business expenses and other permissible deductions) is required to be included in the individual returns of the stockholders of the corporation, in the same percentages as their percentages of ownership of the corporation.

The imposition of a maximum corporate tax bracket in 1988 that was higher than the maximum individual tax bracket made S corporation status very attractive.

A corporation must meet the following qualifications to be eligible for an S election:

  • It must not have more than 35 shareholders;
  • All shareholders must be either individuals, estates or certain types of trusts; a corporation or partnership may not be a shareholder;
  • Nonresident aliens may not be shareholders;
  • The corporation may have only one class of stock;
  • The corporation must be a domestic corporation.

A shareholder's share of net operating loss of an S corporation is limited to the sum of the shareholder's adjusted basis in the stock of the corporation plus his adjusted basis in any debt the corporation may owe him. Disallowed losses and deductions may be carried forward to sebsequent years.

Distributions by an S corporation are treated as a tax-free return of capital to the shareholder, provided the corporation has no accumulated earnings and profits, to the extent of the shareholder's basis in his stock. Such distributions are treated as taxable gain to the extent of the shareholder's basis in his stock. Such distributions are treated as taxable gain to the extent they exceed the shareholder's basis in his stock.

One disadvantage of an S corporation election is that employee status is denied to those shareholders with stock ownership exceeding 2 percent. As a consequence, an S corporation cannot deduct the cost of fringe benefits provided at the corporation's expense (for example, accident and health insurance) for the benefit of these shareholder-employees. Thus, an S corporation cannot provide many fringe benefits on a tax-free basis.

In July, 2005, Internal Revenue Service officials announced that the agency was to launch a comprehensive study of tax reporting compliance amongst America's rising number of S corporations, a form of corporate entity that had grown enormously in popularity over the last twenty years.

According to the IRS, the study would examine 5,000 randomly selected S corporation returns from tax years 2003 and 2004.

Since the mid-1980s, the number of S corporations had risen rapidly, growing from 724,749 in 1985 to 3,154,377 in 2002. Among S corporations with more than $10 million in assets, the growth rate has been even faster. From 1985 to 2002, the number of these larger S corporations grew more than ten-fold, from 2,305 to 26,096.

“The use of S corporations has exploded,” observed IRS Commissioner at the time, Mark W. Everson. “The IRS needs a better understanding of what this means for tax compliance. This research is critical for achieving our strategic goal of ensuring that corporations and high-income individuals are paying their fair share," Everson added.

S corporations are now the most common corporate entity. In 2009, the IRS reported that the number of S corporations increased 5.1 percent to 3.9 million for tax year 2006, so that S corporations represent nearly two-thirds of all U.S. corporations. The number of shareholders in S corporations also increased 5.1 percent to 6.7 million. Total net income (less deficit) increased 7.0 percent to $386.2 billion.

Limited Partnership

In a Limited Partnership, one or more ‘general' partners manage the business while 'limited' partners contribute capital and share in the profits but take no part in running the business. General partners remain personally liable for partnership debts while limited partners incur no liability with respect to partnership obligations beyond their capital contributions.

The Limited Partnership has been very widely used for investment purposes. In the last 30 years, most major financial companies have used the LP form to channel private capital into real estate, oil and gas and mezzanine financing. These LPs are normally structured to be long-term investments (typically 10 to 15 years with extension rights at the partnership's option) and do not make any liquidity provision to cover the eventuality that the investor decides to sell their partnership interest prior to the termination of the LP.

Normally, death, disability, or withdrawal of a general partner dissolves the partnership unless the partnership agreement provides otherwise or all partners agree, in writing, to substitute a general partner. Death or incompetence of a Limited Partner has no effect on the partnership.

The Family Limited Partnership (FLP), which is simply a Limited Partnership used by one family, has become the leading form for asset protection and estate planning in the US. But there are some legal dangers in many states, where a creditor is permitted to “foreclose” on a partnership or LLC interest. A 'foreclosure' is a seizure of the debtor’s interest and that is a very powerful weapon for the plaintiff. Thus, an asset protection structure using an FLP must also protect ownership interests with a trust.

In May, 2005, the US Treasury and the Internal Revenue Service finalized regulations on the tax withholding obligations of US partnerships that include foreign partners.

Foreign individuals were subject to US tax for income from doing business in the US, in addition to income earned in the US through a partnership. To ensure the tax gets collected the IRS requires that partnerships withhold tax on behalf of the foreign partner.

The final rules, first proposed in September 2003, provided guidance on how to determine a foreign partner's share of partnership income and to calculate withholding tax and payment dates. The matters of interest, penalties and extra taxes for failure to comply with the regulations were also addressed.

In addition, the Treasury also issued related proposed and temporary rules covering certain tax and non-tax attributes of a foreign partner for purposes of determining tax withholding obligations.






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