Taxation on Limited Liability Companies (LLCs)
LLCs are a creation of state law. LLCs are owned (and in some cases managed) by members who aren’t personally liable for the LLC’s debts or obligations.
Under the “Check-the-box” entity classification rules, if an LLC isn’t mandatorily classified as a corporation, it’s an “eligible entity” that may elect to be classified for tax purposes either as a partnership or as a corporation, except that a single-member LLC that doesn’t elect to be a corporation is treated as a disregarded entity and its activities are treated in the same manner as a sole proprietorship, branch or division.
Partnerships are “pass-through entities” -that is, their income is subject to tax only once, at the partner level. They share this characteristic with S-corporation, but not Ccorporations (whose income is taxed twice, once at a corporate and again at the shareholder levels). Partnerships offer several advantages over S-corporations, including no limitation on the identity or number of partners; greater flexibility in allocating the enterprise’s profits, losses and credits and a partner’s basis in his partnership interest includes the partner’s share of partnership liabilities.
In general, no gain or loss is recognized when a partner makes contributions to a partnership’s capital, whether made on formation of the partnership or later.
Partnership Income and Deductions
A partnership is essentially a conduit that passes through to each partner his or her share of income and deduction generated by the partnership. Thus, the partner, not the partnership, are taxed on the partnership’s income. The partnership only files an information return showing each partner’s distributive share of the partnership income, deductions, gains, losses, etc. Each partner includes his/her share of these items on his own return.
Partnership taxable income is computed the same as an individual’s, except that certain items are separately stated, and certain deductions aren’t allowed. Each item passed through to the partners and separately stated on their returns has the same character as if realized or incurred directly by the partnership.
Each partner reports his distributive share of the partnership income, deductions and other items (including guarantee salary and interest payments) for a partnership tax year on his/her individual return for his/her tax year with or within which ends the partnership tax year.
TAX Withholding on Payments to Foreign Taxpayers
Several withholding regimes enforce the imposition of tax and/or reporting requirements on foreign taxpayers. These include withholding at a 30% or lower rate on the gross amount of effectively connected income of foreign partners in a partnership. Nonresident alien individuals, foreign partnerships or corporations, and any other person that it is not a U.S. person are subject to withholding.
A partnership must pay a withholding tax if it has “effectively connected taxable income” for the tax year (whether or not the income is distributed), any part of which is allocable to a foreign partner. Unless the partner can show that the tax should be lower, the partnership must withhold at the highest rate of U.S. (corporate or individual, as applicable) tax to which the foreign partner would be subject on that allocable income.
The partnership must pay the withheld amount in four installments, report the partnership’s total withholding liability for its year to the IRS, and notify each foreign partner of his/her share thereof.
This communication is not intended to be tax advice and should not be treated as such. Readers should contact your tax professional to discuss your specific situation.
Oscar Eduardo Mary is a founding member of RCBM, an international tax and business consulting firm headquartered in Buenos Aires, Argentina and with a branch office in Carrollton, Texas. RCBM assists companies that want to operate in Argentina and / or United States. You may contact him at firstname.lastname@example.org.