08 Feb Disregarded No Longer – The Resurgence Of The LLC
Whether you are an entrepreneur looking to open an American company, investor in US real estate, or the owner of a virtual store on Amazon, forming a Limited Liability Company (LLC) may be the right solution for you, as such an entity is easy to form and is flexible in its use.
An LLC can be formed within a day and the costs of its annual upkeep can be as low as a $300 franchise fee and an agent’s fee. It is treated as a transparent flow through entity for US tax purposes (unless you make an election to treat as a closed corporation) but offers the protection of a limited liability company for legal purposes. Israel, on the other hand, views an LLC as a corporation, but allows you to elect to treat it as transparent.
An LLC can have many owners and is then treated as a partnership. It can also be owned by one person. In this case, it is called a single member LLC (SMLLC). Even though it is disregarded for tax purposes, the SMLLC maintains the corporate veil of protection for legal purposes. It also has in the past provided the benefit of anonymity for its owners.
The fact that a SMLLC is disregarded for tax purposes means that the entity itself does not have a tax filing obligation. For these reasons a SMLLC is a very popular vehicle used by individuals for their business and investment holding purposes. An American who owns an LLC reports the income from the company on his 1040 form, typically on schedule C or E.
Favored outside the US
Non-US citizens frequently use the SMLLC to hold their investments in US real estate. They report their income on their form 1040NR and are afforded the legal protection of a corporation due to their holding the investment through the LLC. In this manner, they also benefit from reduced tax rates afforded to individuals on their long-term capital gains, where applicable.
Those who sell products via Amazon, and do not hold American nationality, are required by Amazon to open their accounts through an LLC. Until recently, non-US citizens selling their products through Amazon, even through an LLC, had no US income tax filing obligation if they did not keep inventory or personnel in the US (sales tax needs to be determined on a per state basis).
All this changed on December 13, 2016 when the IRS issued final regulations under section 6038A and 7701 that come into effect for the past year 2017 and forwards. The new regulations treat domestic (US) disregarded entities (including a SMLLC) wholly owned by a foreign person as a US corporation solely for the purposes of section 6038A.
Due to these new regulations non-US citizens who wholly own LLC’s must now file to report their “reportable transactions” on an annual basis. The IRS has clarified that they must now file page 1 of the US corporate tax return (Form 1120) and include with it the Form 5472 to report their reportable transaction with this entity.
Reportable transaction can include any movement of funds between the individual and the disregarded entity. Therefore, even if the movement of funds is not caused by an event that obligates the individual to pay US income tax, they must start filing this form to report the transaction.
This means that non-US citizens who own LLCs to hold their US real estate, sell on Amazon or for any other reason need to consider if they now need to start filing Form 5472 to report their transactions. They must now do so even if they do not have a US income tax filing obligation. They are also required to report these transactions in addition to reporting the income when relevant on their Form 1040NR.
As these new regulations come into effect, it is important that non-US individuals review their holdings in SMLLCs and make sure that they start filing in accordance with new reporting obligations. Those who do not comply risk a penalty of $10,000.
The writer is a partner at Philip Stein & Associates and head of the Individual and Partnership Tax Department