US Business Structures and the Effect on Expats Taxes

US Business Structures and the Effect on Expats Taxes
June 26, 2013

Many American expats want to establish their businesses as US entities. Whether they have clients or employees in the US or want to operate under a structure they’re familiar with. However, there are numerous types of configurations of US businesses, and each one will have a different impact on an American expat’s US taxes.

There are five basic types of US business structures for profit-motivated entrepreneurs:

  • Sole Proprietorship
  • Partnership
  • Limited Liability Company
  • S Corporations
  • C Corporations

This article will provide a brief overview of each and the impact on expats taxes for a US citizen or green card holder living and/or working abroad.

Sole Proprietorship

This is the most basic and common form of business in the US. A sole proprietorship is operated by individuals or married couples in business for themselves. This type of structure enjoys an ease of operation and flexibility in management. The owners, however, are wholly and personally liable for the debts of the business.

The operations of a sole proprietorship are reported on Schedule C of the American expat owner’s US taxes. No separate business return is needed. All of the income is subject to US self-employment tax of 15.3% (for Social Security and Medicare) in additional to normal ordinary tax rates. Sole proprietorship income for American expats is eligible for the Foreign Earned Income Exclusion (FEIE) if the Physical Presence Test or the Bona Fide Residence Test is met. However, this income will continue to be subject to US self-employment taxation if it is not excluded under a totalization agreement with another country.

Partnership

A partnership is composed of two or more people (not married) in business together. The partnership is typically governed by a written partnership agreement, which outlines how each partner will share profits, losses and management responsibilities. Partnership activities are reported to the IRS on a separate business return, Form 1065. Each partner will receive a Schedule K-1 from the partnership’s Form 1065 with income and expense information to be reported on his or her personal US returns. Ordinary, actively earned income for activities performed abroad is eligible for the FEIE but is also subject to self-employment tax.

Limited Liability Company (LLC)

An LLC is also a very popular form of business structure in the US. It can be operated by one person or multiple persons. LLCs are popular because owners are provided with limited liability though they do have some additional filing requirements beyond a sole proprietorship. LLCs are typically operated under a written agreement that outlines management, ownership, and profit and loss distribution.

All of the profits of the LLC flow through to the owner(s) and are subject to ordinary tax and self-employment taxes. If the LLC has only one owner, the income can be reported on a Schedule C attached to the owner’s individual tax return just as with a sole proprietorship. If there are multiple owners of the LLC, the business must file its own tax return via Form 1065 just as with a partnership.

LLCs can also elect to be treated as a C corporation via Form 8832.

S Corporation

An S corporation is essentially treated as a partnership for federal income tax purposes, but unlike in a partnership shareholders who provide services to the company are allowed (arguably required) to have a salary. This salary is a deductible expense by the S corporation, but the company must withhold and pay payroll taxes on the salary. The individual earning the salary will not be subject to self-employment taxes on his or her individual tax return.

The S corporation’s net income at the end of the year is “passed through” to shareholders as a distribution. This distribution (or dividends) will be subject to self-employment rates at the individual level. S corporations are generally more complicated to establish than smaller entities such as general partnerships or sole proprietorships. Another disadvantage for any American expat is that all shareholders of the S corporation must be US citizens.

S corporations must file a separate business tax return via Form 1120S. As in a partnership, each owner will receive a Form K-1 from the business that outlines the transactions reportable at the individual level.

C Corporation

C corporations are the most complex US business structures. They must have a board of directors, documented annual meetings and fulfill additional reporting beyond annual tax filing requirements. However, the C corporation is considered an entity completely separate from its owners and therefore provides its owners with the greatest liability protection. The corporation’s income does not pass through to the owners but is subject to its own taxation. Any dividends distributed are taxed at the individual level.

C corporations must file a separate business tax return via Form 1120. Because income is not passed through to the owners, no Schedule K-1 will be provided. However, owners who received dividend distributions from the company will receive a Form 1099-DIV reporting the dividend amounts, which will be taxed at dividend rates on the individual’s return.

More Information on Expats Taxes

The IRS also has more information about each business structure on their website. Important information for American expats to remember: Ordinary foreign earned income can be excluded under the Foreign Earned Income Exclusion, but dividends can not. Dividends are eligible for the Foreign Tax Credit, though.

Need Help Filing International Business Taxes?

For information on US Persons and Foreign Corporations, you can read our FAQs. If you would like assistance on your payroll taxes, please contact us.

Who doesn’t love a tax break? Use our handy calculator to learn what you can save using the FEIE.

Use our simple excel calculator to get an estimate of how the foreign earned income exclusion will save you money. It will make your day!

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