Forms and Filing for Foreign-Owned U.S Multi-Member LLC | Exploring a Case of an Australian-Owned U.S. Partnership

Forms and Filing for Foreign-Owned U.S Multi-Member LLC | Exploring a Case of an Australian-Owned U.S. Partnership

Wondering which forms you will need to file for a foreign-owned U.S Multiple-Member LLC? I have recently received this question and will provide an in-depth explanation of the many complexities involved. I will then offer some guidance as to how to determine proper filing.

Here is the question we will be answering today: “I am a member of a U.S. Multiple member LLC, in which all members are non-resident aliens residing in Australia. The partnership does not have any offices, employees or exclusive contractors, or exclusive agents in the U.S. All operations are carried out from our home country in Australia. Since the LLC is organized in the U.S., the entity is treated as a domestic partnership that files form 1065. The partnership made the following transactions in the tax year 2020:

  1. The Australian partners provided Software development and consulting services directly from Australia to various U.S. customers.
  2. The partnership savings account at JPMorgan Chase earned $500 USD interest.
  3. The partnership purchased publicly traded stocks when we opened a brokerage account with Wells Fargo. A total amount of $500 USD was distributed to the partnership as dividends from these publicly traded stocks.
  4. The partnership also traded some stocks within the brokerage account referenced above, so brokerage reports some capital gains.
  5. The partnership generated royalty income from Amazon, Apple, Google, and Envato.

So…

  1. Is the partnership required to file form 1065?
  2. Should the partners file form 1040NR?
  3. Is this foreign owned U.S multi-member LLC required to file form 5472?
  4. Is the partnership subject to section 1446 withholding?”

These questions arise at the intersection of two areas of tax law – Partnership Taxation and U.S Income Sourcing Rules. These sourcing rules are generally contained in code sections 861 to 865, whether domestic or foreign source.

Let’s explore some of the basic principles of Partnership Taxation.

Treas. Reg. § 301.7701–3(b)(1) defines an LLC with more than one member as a partnership unless the members choose to designate it for tax purposes as a corporation. A partnership’s income and expenses pass through to the individual partners, who must pay a tax on their proportionate shares of net gain or may claim a deduction for their shares of net loss.

IRC Section 701 provides that a partnership is not liable for Federal income taxes, instead, persons carrying on business as partners are liable in their separate or individual capacities for the income taxes arising from partnership operations.

In United States v. Basye, 410 U.S. 441 (1973), the Supreme Court held that for taxation purposes, partnerships are conduits through which the taxpaying obligation passes to the individual partners.

In Miller v. Comm’r of Internal Revenue, 52 T.C. 752, the court held that foreign partners’ distributive share of a U.S. Domestic Partnership is excludable only to the extent that it represents his share of the firm’s income from sources outside the United States.

A partnership must file an information return (Form 1065) each year reporting items of income, deduction, and credit – where these items of income, deduction, and credit are allocated among the partners who bear the tax consequences for them. The allocation to each partner is reported on a Schedule K-1 to the partnership’s Form 1065 return, and the partner must report his distributive share of these partnership items on his personal tax return.

Now let’s review U.S. Income Sourcing Rules, as generally contained in code sections 861 to 865.

The source of income is essential in determining whether that income is subject to U.S. taxation if earned by non-resident aliens or foreign corporations. It is also crucial for U.S.persons when figuring out their foreign earned income exclusion or foreign tax credit. This article deals specifically with foreign persons, and the discussion of U.S. persons’ taxation is out of scope.

The United States taxes foreign persons (i.e., nonresident aliens and foreign corporations) on two types of income: (1) U.S. source investment income (FDAP) and (2) income effectively connected with a U.S. trade or business. Foreign persons prefer foreign source income since foreign income earned by a non-resident alien generally avoids U.S. income taxes – barring some exceptions. Partnership income retains its character whenever it flows through to the individuals’ personal tax return. If 100% of the partnership income is a foreign source, 100% of the partners’ distribution is a foreign source.

Now, let’s address the various sources of income earned by this partnership by analyzing each of the points provided in the question above.

  1. The Australian partners provided Software development and consulting services directly from Australia to various U.S. customers.

    I.R.C. § 875 specifies that where a partnership is found to be engaged in a U.S. trade or business, the foreign partner will also bear the consequences of such attribution, meaning the foreign partner will also be treated as if he is engaged in a U.S. trade or business.

    Section 875 determines the taxable status of a nonresident partner in a partnership engaged in business in the United States (“USTB”). Section 871 determines the manner in which a nonresident partner in a partnership shall be taxed, and section 872 limits the income to be taxed.

    Since you indicated that the partnership does not have an office, employee, an exclusive agent, or a partner residing or conducting business in the United States, it is fair to conclude that this partnership may not have a U.S. trade or business (“USTB”);therefore the income referenced above cannot be effectively connected to USTB.

    Section 862(a)(3) provides that the source of compensation for personal services is the country where the services are performed – regardless of where the payor resides, the residence of the service recipient, time and place of payment, and the place of contracting.

    In summary, this partnership’s service income from sources outside the United States would be from services performed by its members and employees abroad. As explained earlier, foreign source income earned by a non-resident Alien will not be subject to U.S. taxes even though there is a U.S.LLC set up for this operation.

    The gross foreign earned income, and related foreign expenses of the partnership for all partners must be separately stated. Foreign income and expenses are generally reported in Box 16 of schedule K-1 Form 1065.

    The individual partners will not be required to file a Form 1040NR under these circumstances since the service income is a foreign source and not taxable to the non-resident partner.

    PLEASE NOTE that for tax year 2021 and beyond, additional Schedules namely K-2 (similar concept to Schedule K, see page 4), and K-3(similar concept to Schedule K-1) for Forms 1065 are required to be filed by partnerships with items of international tax relevance (generally foreign activities or foreign partners).

    The schedules are designed to provide greater clarity for partners on how to compute their U.S. income tax liability with respect to items of international tax relevance, including claiming deductions and credits.

    These schedules also replaces, supplements, and clarifies the reporting of certain amounts reported on Schedule K-1 (Form 1065), Part III, line 16. Click here for more information on these additional schedules.

  2. The Partnership savings account at JPMorgan Chase earned $500 USD interest.

    Generally, source of interest income is determined by the residence of the payor. Therefore, interest received from U.S. residents or corporations is U.S.source income. There is, however, an exception.

    Non-resident aliens who receive interest income from deposits with a U.S. bank, savings & loan institution, credit union, or insurance company, or who receive portfolio interest are exempt from taxation on such interest income as long as such interest income is not effectively connected with a U.S. trade or business.

    Since the partnership is not engaged in USTB, the interest received from the savings deposit will not be taxable to the non-resident Partners. The partnership will report the interest income in Box 5 of schedule K-1 Form 1065. The individual partners will not be required to file a Form 1040NR under these circumstances since the interest income is not taxable.

  3. The Partnership purchased publicly traded stocks when we opened a brokerage account with Wells Fargo. A total amount of $500 USD was distributed to the partnership as dividends from these publicly traded stocks.

    IRC § 861(a)(2) provides that dividends from domestic corporations are U.S. source income. Since all the partners are from Australia, Article 10(2)/P6 of the U.S Australia treaty provides a 15% withholding rate for dividends paid by U.S. corporations. If withholding is not done at source – at the brokerage level, it is the duty of the partnership to withhold the taxes and remit directly to the IRS. See IRC sections 1441, 1442,and 1443.The partnership will also be required to report such withholding on Forms 1042 and 1042-S.

    A partnership with such a withholding obligation should register for an EFTPS account where the withheld taxes will be remitted and obtain a Taxpayer Identification Number (ITIN) from each foreign partner to make it easy for the IRS to reconcile these income and tax payments against each foreign partner’s account.

    The Partnership must retain a completed W8-BEN from each foreign partner – which certifies the country of tax residency and to establish their qualification for a reduced rate of withholding on such dividends.

    The partnership will also be required to file form 1065 and report such dividends on each partner’s Schedule K-1 box 6a and 6b if applicable. The individual partners will not be required to file a Form 1040NR since the tax due on the dividend was properly withheld at the U.S. source.

  4. The partnership also traded some stocks within the brokerage account referenced above, so the brokerage reports some capital gains

    Stocks are intangible personal property, so disposition or sale of stock is generally taxed based on the residence of the person receiving the payment – see IRC 865.Foreign persons can exclude U.S. source capital gains that are not effectively connected to USTB.

    Under I.R.C. § 871(a)(2), a nonresident alien is taxable on U.S. source capital gain only if he is present in the United States for 183 days or more during the taxable year. Since the partnership is not engaged in USTB, and none of the foreign partners have been present in the United States for 183 days or more during the year, the capital gain from the stock sale will not be taxable to the non-resident Partners.

    Depending on the type of capital gain (short or long term), the partnership will report the capital gain in either Box 8 or 9a of Schedule K-1 Form 1065. The individual partners will not be required to file a Form 1040NR under these circumstances since the capital gain is not taxable.

  5. The partnership generated royalty income from Amazon, Apple, Google, and Envato.

    The source of royalty is determined by where the property is used. Royalties paid for the use of or for the privilege of using patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and other like property in the U.S. are U.S. source income.

    When a U.S. resident downloads or views your content within the U.S, the royalties received by the partnership will be deemed as U.S. source income.

    Since all the partners are from Australia, Article 12(2)/P8 of the U.S. Australia treaty provides a 5% withholding rate on the U.S.-sourced royalty income. If withholding is not done at source at the vendor or the platform level, it is the duty of the partnership to withhold the taxes and remit directly to the IRS. See IRC sections 1441, 1442,and 1443.The partnership will also be required to report such withholding on Forms 1042 and 1042-S.

    A partnership with such a withholding obligation should register for an EFTPS account where the withheld taxes will be remitted and obtain a Taxpayer Identification Number (ITIN) from each foreign partner to make it easy for the IRS to reconcile these income and tax payments against each foreign partner’s account.

    The Partnership must retain a completed W8-BEN from each foreign partner – which certifies the country of tax residency and to establish their qualification for a reduced rate of withholding on such royalties.

    The partnership will also be required to file Form 1065 and report such royalties on each partner’s Schedule K-1 box 7.The individual partners will not be required to file a Form 1040NR since the tax due on the royalty was properly withheld at the U.S. source.

    Throughout this analysis, we have answered questions 1 (Is the partnership required to file form 1065?), and 2 (Should the partners file form 1040NR?) based on the specific facts presented. We will now address questions3 (Is this foreign owned multi-member U.S. LLC required to file form 5472?) and 4 (Is the partnership subject to section 1446 withholding?).

  6. Withholding Tax on Foreign Partners’ Share of Effectively Connected Income – IRC Section 1446

    A partnership (foreign or domestic) with income effectively connected with a U.S. trade or business (or income treated as effectively connected) must pay a withholding tax on the effectively connected taxable income that is allocable to its foreign partners. The current withholding tax rate for effectively connected income allocable to Individual foreign partners is 37% and 21% for corporate foreign partners.

    If your U.S. partnership is determined to be engaged in a U.S. trade or business effectively connected with the U.S. trade or business, it will be required to withhold on effectively connected taxable income allocable to its foreign partners under I.R.C. § 1446.

    It is the duty of the partnership to withhold the taxes and remit directly to the IRS. The partnership will also be required to report such withholding on Forms 8804, 8805, and 8813.

    A partnership with such a withholding obligation should register for an EFTPS account where the withheld taxes will be remitted and obtain a Taxpayer Identification Number (ITIN) from each foreign partner to make it easy for the IRS to reconcile these income and tax payments against each foreign partner’s account.

    The facts in your case does not support the determination that this partnership is engaged in USTB. In the absence of USTB, the partnership will not be subject to IRC 1446 withholding with respect to the distributive share of income to the foreign partners.

  7. Is this foreign owned multi-member U.S. LLC required to file form 5472?

    Form 5472 is used to provide the 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.

    A “Reporting Corporation” is either:

    1. A 25% foreign-owned U.S. corporation (including a foreign-owned U.S. Single Member LLC)
    2. A foreign corporation engaged in a trade or business within the United States.

    Per IRC 301.7701-2(a), if an entity with two members, including a multi-member limited liability company (“LLC”), seeks to be treated as a corporation, it must check the appropriate box on its IRS Form 8832.If it does not check this box, the entity is treated and taxed as a partnership.

    The reporting of 5472 only applies to foreign owned U.S. Corporations and foreign owned single U.S. member LLCs. It does not apply to multiple member LLCs because the multiple-member LLC is not a reporting corporation within the meaning of the law.

    I hope the analysis provided here sheds light on the form and tax obligations you face as a foreign-owned LLC with multiple partners. Please, exercise caution. The explanation offered is oversimplified, and it should be noted that partnership taxation has always been a complicated field, full of traps and pitfalls, and becomes increasingly so each year. Your tax consequences will always depend on specific facts and circumstances. The issue is even more complex when the following factors are present.

    1. Having a U.S. Citizen or resident as a partner
    2. Owning a U.S. office, warehouse, or any other permanent structure where business is conducted
    3. Partners traveling physically into the U.S. to conduct business
    4. Having U.S. employees and exclusive agents or contractors who are not independent

    It is important to note that the answer and list provided are not exhaustive, and you should always consult your tax attorney or CPA – even when you think your tax obligation is simple. Multi-member foreign owned U.S LLCs need to consult qualified professionals such as O & G Tax and Accounting Services to review unique details and ensure proper filing. If you have a question or need help covering all of your bases, contact us any time!

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***Disclaimer: I am a tax accountant and a CPA licensed in Massachusetts , but I am not your accountant or advocate (Unless you have signed up to my services). This communication is not intended as tax advice, and no tax accountant -client relationship results**

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