Do you plan to include a non-U.S. Investor in your Business? If so, you need to plan ahead.
In today’s global economy, it is not uncommon for a U.S. partnership or LLC to include a non-U.S. investor. The benefits are obvious—overseas investors, often friends and family, can be an important source of capital for a new business. However, it is vital to understand the tax consequences before you sign on the dotted line.
First, a quick caveat. This overview will discuss some of the ways U.S. Federal income tax law treats U.S.-based businesses with one or more foreign owners and one or more U.S. owners. We will not discuss the tax treatment of the foreign owners in their home countries. And for purposes of this discussion, we will assume that the business generates income only within the United States.
By way of background, a U.S. business with two or more owners will generally be taxed as one of the following:
- A partnership. By default, a general partnership, limited partnership, or limited liability company (LLC) are taxed as partnerships. A business that is taxed as a partnership does not pay tax on its income. Instead, each partner reports his or share of the partnership’s income on his or her personal return.
- A corporation taxed under Subchapter C of the Internal Revenue Code. By default, a corporation is taxed as a “C Corporation.” A C Corporation does pay tax on its own income. And if the C Corporation makes distributions to its shareholders, they must report the dividends on their own personal tax returns—hence, “double taxation.”
- A corporation taxed under Subchapter S of the Internal Revenue Code. An “S Corporation” does not pay tax on its income. Instead, each shareholder reports his or share of the corporation’s income on his or her personal return, similar to partners in a partnership. Only certain corporations are eligible to make the “S Election.” More on that below.
While many U.S. businesses can choose between a partnership, C-Corporation, or S-Corporation tax structure, a U.S. corporation with a foreign owner is not eligible to make the S Election. By bringing in a foreign investor, the U.S. business is limiting itself to a choice between being taxed as a C Corporation (should it organize as a corporation) or a partnership (should it organize as a general partnership, limited partnership, or limited liability company).
For a business that is suited to C Corporation tax treatment, this is no great loss. But many business owners prefer the “pass-through” tax treatment of an S Corporation or partnership. Before making the decision to bring in a foreign investor, it is vital for these business owners to understand how the decision to include a foreign investor will impact the partnership tax treatment of the business. More on that next time in Part II.
This is just a basic overview and is not legal advice specific to your situation. If you would like to speak with Jonathan about your situation, please email him at firstname.lastname@example.org or call him at 925-217-3255.