If you’re a non-resident interested in setting up a business entity in the U.S., you probably have a lot of questions. For example: Where to start? The process of starting a U.S.-based business as a foreigner can seem daunting, but there are ways to make it easier—in terms of your stress levels, yes, but also in terms of your tax burden and your business’s bottom line.
In this guide, we’ll review some basic aspects of the U.S. tax system that you should be aware of before setting up a business entity in the U.S. We’ll also discuss why it’s important to consider the different types of business entities that may be available to you, as well as the different U.S. states you may be able to set up your business in. Both decisions can have major tax and accounting implications.
Speaking of accounting, one of the first steps we recommend is setting up a U.S. bank account for your global startup. This helps you adhere to legal requirements for compliance and personal liability purposes, but it has other benefits that can pay off down the line, too. Levro offers a U.S.-based multi-currency account that’s great for fast-growing global startups looking to establish a business presence in the U.S.
Key aspects of the US tax system for businesses
If you’re accustomed to a different country’s tax system, you may find some aspects of the U.S. tax system confusing.
For example, the U.S. federal government imposes a tax on the profit of U.S. resident C-corporations, but not all U.S. states levy the same corporate income tax. And many U.S. businesses aren’t subject to corporate income tax or other entity-level taxes at all, because they’re set up as “pass-through” entities.
Let’s further define these terms and review some other general points about how U.S. taxes work.
Corporate income tax
The corporate income tax is the third-largest source of federal revenue in the U.S., accounting for more than $230 billion in 2019. It applies to corporate profits less certain allowable deductions, such as the cost of goods sold, employee compensation, depreciation, and advertising.
The Tax Cuts and Jobs Act (TCJA) of 2017 lowered the top corporate tax rate to 21% for U.S. resident C-corporations. It also instituted several other changes that effectively reduced corporate income and other taxes owed by most multinational corporations with income generated from U.S. and foreign sources.
With that said, it’s important to note that US-based corporations generally face the same corporate tax obligations on U.S. business activities regardless of whether they’re owned by foreign companies or U.S. residents.
Taxes on business profits at the individual level
Certain corporations in the U.S. are taxed separately from their owners and shareholders. This can lead to “double taxation,” because the corporation must pay taxes on its profits first, and then its shareholders must pay taxes on any dividends distributed at the individual level. Though there are some deductions and other ways to make this double-taxation issue less of a burden, it can still be a tough pill to swallow.
Of course, there is a way for U.S. businesses to avoid paying corporate income tax and other entity-level taxes. If this sounds intriguing, you may consider setting up your U.S. business entity as a “pass-through” entity.
In the U.S., a “pass-through” entity is a business in which profits and losses from the business are passed through to the personal income of its members. This means that no taxes are paid at the entity-level, but that individual members of the business must account for income taxes on their individual tax returns.
There are several different types of pass-through business entities in the U.S., but not all of them are available or applicable to non-U.S. residents. In the next section, we’ll discuss a form of pass-through entity called a Limited Liability Company (LLC), which is popular among non-U.S. startups and entrepreneurs due to its tax setup and relatively low compliance burden.
Let’s not get ahead of ourselves, though. Before you set up any business entity in the U.S., you’ll need to apply for an Employer Identification Number, or EIN.
Why your business needs an EIN (and how to get one)
Generally speaking, every business in the U.S. needs an Employer Identification Number (EIN). Otherwise known as a Federal Tax Identification Number, this nine-digit number is used to identify your business for tax purposes.
Fortunately, it’s not very difficult to apply for an EIN. The IRS allows businesses to apply for an EIN online via an interview-style application. Your application will need to include the name and Taxpayer Identification Number (SSN, ITIN, or EIN) of your business’s responsible party. This can be a true principal officer, general partner, grantor, owner, or trustor
Aside from applying for an EIN, one of your primary concerns should be understanding the pros and cons of the different types of business entities. In the following section, we’ll review a few of these and discuss their major tax implications.
Tax implications of different business structures
Choosing your business’s structure may involve a number of factors—tax implications being one. Many international startups setting up a business entity in the U.S. will likely be deciding between an LLC and a C-corporation.
These business entity types are quite different in terms of their tax implications, but they are also similar in some ways. For example, both offer limited liability protection, which protects the business owners from being personally liable for any debts and obligations belonging to the business.
A third type of business entity you may have heard about is called an S-corporation, but we won’t discuss that here because it’s generally not an option for non-U.S. residents.
LLC tax and accounting implications
An LLC is a “pass-through” entity for tax purposes. We covered this in the section above, but it means that the business’s tax obligations are passed through to the personal income of the LLC’s members.
This can be a particular benefit if the member(s) of an LLC are non-U.S. residents and tax residents of countries with territorial tax systems (i.e. tax systems that only tax income originating within their own borders). A US-based LLC must meet strict residence and other criteria in order to avoid paying US income taxes entirely, and in many cases it may not be feasible. Our friends at Globalization Guide put together a primer on how it can work.
In terms of ongoing paperwork, one thing to note when deciding between an LLC and a C-corp is that compliance and record-keeping are generally easier with an LLC. You’ll also have some more flexibility in choosing a management structure. For example, you can choose to set up an LLC that’s managed by its members, a group of managers, or another individual designated to act as the manager.
C-corp tax and accounting implications
Right off the bat, it’s important to note that “C-corp” is really a tax classification and not a distinct business entity type. The legal entity itself would just be called a corporation, which is defined as a legal entity that is created by—but separate and distinct from—its shareholders, officers, or directors.
So, a C-corp is a corporation that is treated as a distinct entity from its owners for tax purposes. This can result in the aforementioned issue of double taxation, which happens because:
- A corporation must pay corporate income tax on its earnings
- The corporation’s shareholders must pay taxes on any dividends distributed to them individually
This results in the dividends being taxed once at the corporate level, then again at the individual level. Of course, there are other benefits that may outweigh this double-taxation piece—especially for international businesses with a wide global presence. C-corps generally make it easier to raise venture capital and they may offer better international legal protections than LLCs, due to their relative international ubiquity.
So it isn’t simply an issue of avoiding corporate income tax. Global startups that want to offer equity compensation to employees, attract venture capital investors in the U.S., and save their foreign owners from U.S. tax scrutiny may well opt to form a C-corp instead of an LLC.
Tax implications of starting a business in different states
Choosing where to form your business entity is another decision that can have significant tax implications. There are different pros and cons to forming a business in different states, and some states provide a friendlier environment than others.
If your business activities in the U.S. aren’t limited or highly concentrated within a single city, state, or geography, you may consider registering your country in a particularly tax-friendly state such as Delaware.
While several other states also offer favorable tax environments, Delaware remains the most popular for global startups that need to set up a U.S. business entity. The state doesn’t collect corporate income tax from companies that don’t conduct business within its boundaries, and it doesn’t tax stock if the owner lives out of state.
Other states, such as Wyoming and Nevada, also offer a tax-friendly business environment that you may want to consider. But if the majority of your business activities are based in a single city or market (the San Francisco Bay Area, for example) you may be compelled to set up your business in a state like California, where the business tax burdens are generally greater
If your LLC or corporation does business in multiple states, you may need to file for foreign qualification in several or all of those states. You’ll need to check with each local state office to figure out the specific fees and requirements, which may include paying additional taxes and annual report fees.
Tax filing and accounting requirements for businesses in the US
Income taxes in the U.S. are self-assessed by those required to pay them, which means that businesses and individuals must file annual tax returns at the federal level as well as at any applicable state levels. In many cases, businesses are required to make estimated payments in quarterly installments throughout the year to avoid penalty fines and interest charges.
The specific forms your business will need to file may depend on the type of business you set up, as well as other details about your business. For example, you may need to file IRS Form 5472 if your corporation is either:
- A 25% foreign-owned U.S. corporation (meaning it has at least one direct or indirect 25% foreign shareholder at any time during the tax year), or
- A foreign corporation engaged in trade or business within the U.S.
We recommend consulting with an experienced tax advisor to determine the specific forms you’ll need to file.
Other tax implications to consider
There are a number of other tax implications to think about when setting up a business entity in the U.S.—so many, in fact, that we can’t cover them all at length here. With that said, here are a couple of additional tips that may come in handy as you get your business off the ground in the U.S.
Transfer pricing regulations
Transfer pricing refers to a process by which a company sets a price for goods or services sold from one of its divisions, subsidiaries, or affiliates to another. Multinational companies may attempt to use transfer pricing for cross-border transactions in an attempt to reduce their taxable profits.
Your business may run into penalties or trouble with U.S. tax authorities if you attempt to abuse this practice. You can read our guide to transfer pricing for a full breakdown of what international businesses need to consider.
Applying for a U.S. bank account
From an accounting and compliance point of view, opening a U.S. bank account should be a priority for any company that hopes to conduct business in the U.S. For one, corporations and LLCs operating within the U.S. are required to maintain separate accounts for their business’s finances and their owners’ individual finances.
Practically speaking, a U.S. bank account can also save you from accounting headaches throughout the year—and especially come tax time. If you’re looking for a banking solution that’s internationally oriented and capable of handling multiple currencies, consider Levro.
How a US bank account can help with taxes and accounting
Levro’s U.S.-based bank accounts are designed to make multi-currency banking fast and easy. Our fully integrated platform allows business customers to buy, sell, and hold more than 30 global currencies without worrying about FBAR compliance. Levro also offers multi-currency accounting with expense reports that can easily be imported into Quickbooks or Xero.
You can apply for a Levro account today, even if you don’t yet have an EIN. (You may be asked to provide your EIN verification before you can open an account.) To learn how Levro can help you get set up in the U.S. and save you stress come tax time, send an email to firstname.lastname@example.org today.