There are many items to consider when planning a U.S. expansion, including tax requirements, financial considerations, and other important guidelines. Here are some commonly asked questions and answers to help you get started.
1. What entity structure should I use for doing business in the U.S.?
There are several ways a foreign company can conduct business with U.S. customers. Here are some common entity structures to consider based on your circumstances.
U.S. Branch of the Foreign Company
This type of entity structure works well when a foreign company simply ships or delivers products or services directly to U.S. customers from outside the U.S. and there is no activity in the U.S. except those protected by a U.S. tax treaty. Use of a branch is not recommended when a foreign company conducts business directly in the U.S., such as hiring U.S. employees. This could result in permanent establishment (PE) or a taxable presence in the U.S.
U.S. Joint Venture (JV)
A U.S. Joint Venture (JV) can be used to enter or expand to the U.S. with a strategic U.S. or foreign partner for larger scale projects such as a manufacturing or distribution operation. Since a U.S. JV is usually taxed as a flow-through partnership, a foreign company must consider establishing a U.S. legal entity for ownership in the JV to avoid filing U.S. tax returns for the foreign company.
Limited Liability Company (LLC)
A foreign company can establish a Limited Liability Company (LLC) for its U.S. operations. The LLC can be owned by one or more foreign or domestic members, but they will be required to file U.S. returns to report and pay U.S. tax on their share of the LLC’s taxable income. It is recommended that LLCs with foreign members elect to be taxed as a corporation to eliminate the need for U.S. tax filings for the foreign company.
U.S. C Corporation
We saved the best for last! Establishing a U.S. C corporation (C-corp) to conduct business in the U.S. is the most common and recommended legal and tax entity for a foreign company. Businesses can use a corporate structure for early stage U.S. expansion as well as long term growth in the U.S. A C-corp is taxed on net income at the corporate level, eliminating any entity classification elections for tax purposes and removing the U.S. tax filing requirement for the foreign owner.
It’s important to consider the tax and legal implications of each entity structure before choosing one that aligns best with your U.S. expansion goals.
2. How do I choose which state to incorporate my U.S. operations in?
If your business will operate from a physical location, incorporating in that state is recommended. When selecting the state for your physical location, consider the proximity of customers and suppliers, availability of workforce, and state incentives for creating jobs. You should also consider the availability of suitable sites for your type of business, including sufficient power supply and transportation options. If your business does not need a physical location in the early stages of a U.S. expansion, think about long-term location needs.
Some companies expanding to the U.S. may not need a current or long-term physical location, so which of the 50 states should they consider? Many foreign companies opt for a Delaware corporation due to its long-standing pro-business legal system. Others may consider a no-tax state such as Nevada or Wyoming. Regardless of the state in which you incorporate, here are some considerations which extend beyond this initial decision:
- Many businesses will have multi-state tax requirements for income tax and sales tax. This applies regardless of where they are incorporated.
- In addition to the state in which you incorporate, you will also need to register in each state you conduct business in. What constitutes as doing business varies by state, but can include hiring employees residing or working in a state, owning real or personal property in a state, providing services to clients in a state, or reaching a threshold of sales to customers in a state.
- Whether you incorporate or register to do business in a state, you will be required to have a registered agent and registered agent address in that state. If you do not have a physical location in a state, it is common to use a third party as your registered agent.
- States will require an annual filing to remain active in the states you are incorporated or registered to do business in. This filing may require disclosure of corporate officers, some financial information and an annual filing fee, but the requirements vary by state.
- Federal anti-corruption legislation passed in January 2021 that will require disclosure of beneficial ownership when a company is formed or is registered to do business in a state. Currently there are few requirements, if any, among the states.
3. Are there statutory requirements for minimum capital or financial reporting in the U.S.?
The U.S. does not impose any minimum capital requirements when establishing a U.S. trade or business. But, there are limitations on the tax deduction for business interest expense, so a company with a high debt to equity ratio may be impacted.
There is no statutory requirement for private companies to provide financial statements. Financial reporting requirements for a foreign-owned U.S. subsidiary are often determined by the parent company and group auditor needs. Any company with a lending relationship with a financial institution will be required to comply with the financial reporting requirements of the debt covenant.
4. Is operating as a branch in the U.S. easier than setting up a subsidiary?
The short answer is no. It may seem easier to start doing business in the U.S. with your existing foreign corporation, but there are disadvantages. For example, the activity carried out in the U.S. could lead to a permanent establishment (PE) or taxable presence in the U.S. for the foreign corporation.
Operating as a branch generally creates a U.S. tax filing requirement for the foreign corporation for which a federal Employer Identification Number (EIN) is needed. Income derived from a U.S. trade or business is taxed on a net basis at the current federal corporate rate of 21% (subject to change). As a branch, the U.S. income and related expenses must be carved out of the foreign company operations without the benefit of a separate legal entity in the U.S. This task is typically easier in concept than in practice. In addition to corporate income tax, a 30% branch profit tax may also apply unless reduced by a U.S. income tax treaty.
If the branch hires employees in the U.S., the foreign corporation must meet all U.S. employer requirements. This includes a long list of federal and state requirements in addition to withholding and remitting payroll taxes. Handling these employment responsibilities in the U.S. with foreign company resources will usually result in compliance gaps. Additionally, a U.S. bank account will be required for U.S. payroll.
Operating as a branch does not require establishing a U.S. legal entity, but it does require registering in all states in which it is doing business. All considerations mentioned in Question 2 except for the state incorporation will apply to the branch.
Operating as a branch does not provide any legal barrier to liability for the foreign corporation. Using a U.S. corporation to conduct U.S. operations can.
In summary, if the branch activity in the U.S. creates a PE, the foreign corporation must meet almost all the same requirements as a U.S. subsidiary. Doing so as a branch of a foreign corporation is generally more complex, time-consuming, and costly in the long run. Additionally, a branch could be subject to an additional layer of branch profits tax. Therefore, operating as a branch in the U.S. is not recommended due to the ease of establishing a U.S. corporation and the lack of advantages that come from operating as a branch.
5. What tax requirements do I need to meet when I expand to the U.S.?
The U.S. tax structure has multiple layers, including federal and state income tax, which are assessed to and paid by each taxpayer based on their tax structure and operational results.
As discussed, a domestic or foreign owned corporation is currently taxed at 21% (subject to change) federal income tax on net taxable income. There are some differences between book and taxable income including accelerated tax depreciation and limitation on business interest deduction for tax, among others.
The next layer of tax is at the state level. Most states have a net income tax; 10 states have a tax rate of 5% or below, 6 states have a tax rate of 9% or higher, a few states have a gross receipts tax instead of an income tax and a few states have no income tax. Some states have filing thresholds or minimum tax. Many states are moving away from nexus based on physical presence in the state to economic nexus based on a threshold of sales to customers in that state.
The laws for determining whether you are taxable and how tax is calculated are different across all 50 states. For example, the factors such as sales, property and payroll are used differently across each state to allocate income subject to state tax. Determining which state a sale is allocated to also varies by state, especially with the definition of a product and for sales of services.
The bottom line is that state income tax can range from straightforward to complex, depending on what you are selling, how much you are selling, and where you are selling. Many corporations are subject to tax in multiple states. You should look to your tax advisor to guide you in determining your state income tax requirements.
Businesses operating in the U.S. may be required to collect and remit taxes from customers, employees or vendors. These taxes can include sales tax, payroll withholding tax and U.S. income tax on certain transactions with foreign parties. Although these taxes are not assessed to the company required to collect and remit them, there is a cost of compliance to meet these requirements. Additionally, if a company fails to fulfill these withholding requirements, the actual tax plus penalty and interest can become their responsibility upon audit.
6. Do I have to file a tax return before the start of my U.S. operations?
It depends on what steps you have completed in establishing your foreign-owned subsidiary in the U.S.
First, have you established a legal entity such as a U.S corporation? If yes, this step alone does not create a tax filing requirement.
Second, have you applied for and received an Employer Identification Number (EIN) for the new U.S. entity? If yes, the EIN confirmation you receive from the Internal Revenue Service (IRS) will include all initial federal tax filing requirements you must meet based on the information provided in your EIN application. This includes your choice of tax year end and anticipated start of U.S. payroll.
For example, if you establish a legal entity on November 1 and apply for an EIN with a tax year end of December 31 and a U.S. payroll start date the following April, the IRS will expect you to file a tax return for the short period November 1 to December 31 even if you have no other activity. They would also expect you to file the initial quarterly payroll tax returns in July of the following year.
Even if you are required to file a “no activity” federal corporate income tax return, there are some key disclosures required for foreign-owned corporations. Even without operational results to report, these disclosures can have significant penalties if not reported accurately and timely. Requirements include disclosures of all direct and indirect foreign ownership meeting several different percentage thresholds and all reportable transactions with foreign related parties including loans but not equity transactions.
If you are planning to establish a U.S. subsidiary close to the end of the tax year, consider waiting to start until the new year to avoid a short period of no activity federal income tax filing.
As a leader in global expansion consulting, we can help solve your questions regarding U.S. expansion. We work closely with foreign companies of any size who are interested in taking advantage of opportunities in the U.S. market. We are confident in our ability to tailor solutions for your subsidiary to not only meet the needs required by law but also to exceed expectations so your business has room to thrive. Our team is ready and excited to help every step of the way. For additional information, call us at 248.208.8860 or contact us directly. We look forward to speaking with you soon.