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Foreign Entities Doing Business in the U.S. — Tax Structures and Pitfalls

Once a foreign-based company decides to enter the U.S. market, its first major decision is to determine which type of U.S. entity (branch, single member LLC [SMLLC], partnership, or corporation) will best serve its long-term financial and tax interests.

Foreign-based companies will attempt to refrain from operating in the type of entity that will require them to file U.S. federal income tax returns. A foreign-based company can typically form a U.S. domestic corporation under the laws of one of the 50 states. A domestic corporation is required to report its taxable income every year and pay U.S. tax at marginal tax rates ranging from 15% to 35%. The foreign parent does not have to file any U.S. income tax return if it has no other U.S. taxable presence.

U.S. taxation on a foreign-based company doing business through a branch or SMLLC

The U.S. federal income tax consequences of conducting business through a branch or an SMLLC are the same. The advantage of an SMLLC is that it provides limited liability protection for the foreign company. If it is determined that a foreign entity has a taxable presence in the U.S., it will be required to file a U.S. income tax return and report income that is subject to U.S. income tax. The foreign entity will have to pay tax on its U.S. income at the marginal rates, which also range from 15% to 35%.

U.S. taxation of a foreign-owned partnership

A foreign-based entity can form a U.S. partnership with any other party to conduct business in the U.S. and share the profits and loss from that partnership. The partnership can be formed as a general partnership or as a limited liability company (LLC) with two or more members. An LLC is automatically treated as a partnership for tax purposes unless the LLC makes an election to be treated as a corporation. The tax consequences for partnerships are very similar to the tax consequences of operating in branch form as discussed above. Specifically, the U.S. will attribute the partnership's activities to its partners. If those activities are considered to have a taxable presence in the U.S., then each of those foreign partners will have to file a Form 1120-F (or a Form 1040NR if individual person).  

Pitfalls that businesses should consider when choosing branch/SMLLC and partnership structures

An often missed filing requirement for a foreign-based company is Form 5472 “Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.” This form is used to provide information required under Sections 6038A and 6038C when “reportable transactions” occur during the tax year of a reporting corporation with a foreign or domestic related party. This form carries a $10,000 penalty per year per occurrence for late filing or incomplete filing. 

For example, if the foreign parent also has a wholly owned subsidiary in Canada and has related-party transactions with that company, Form 5472 must be filed with the foreign parent's U.S. income tax return (Form 1120F) to report the reportable transactions it has with the Canadian subsidiary. If the foreign parent has other related-party transactions with other foreign related subsidiaries or affiliates, a separate Form 5472 must be filed for each of the other subsidiaries or affiliates.

A partnership is also required to withhold tax on partnership income allocable to the foreign partner and remit quarterly estimated tax payments to the Internal Revenue Service. 

Although partnerships can sometimes provide great tax savings for certain closely held foreign companies, the information reporting must be strictly followed in order to eliminate penalties related to missing, incomplete, or inaccurate filings of the informational returns such as those mentioned below.

Based on the company structure and operation, other forms may also be required to be filed, including but not limited to the following:

• Form TD 90-22.1 — Report of Foreign Bank and Financial Accounts 
• Form 8858 — Information Return of U.S. Persons with Respect to Foreign Disregarded Entities
• Forms 8804 and 8805 — Returns for Partnership Withholding Tax (Section 1446)
• Forms 1042, 1042-S, & 1042-T — information returns for Foreign Person's U.S. Source Income Subject to Withholding 
• Form 5471 — Information Return of U.S. persons with Respect to Certain Foreign Corporations

If you need help in selecting a tax structure for your U.S. business operation, or have questions regarding the required U.S. informational filings, please contact Amanda Zhong at azhong@BlackmanKallick.com or 312-980-3324 or your Blackman Kallick representative.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.