– The United States taxes its citizens, resident corporations, and tax residents on a worldwide income basis.
– U.S. taxpayers with cross-border business operations face complicated international tax rules and reporting requirements.
– Common entity structures for U.S. taxpayers establishing non-U.S. business operations include a foreign branch, which allows for business operation in a foreign country without setting up a legal entity. 1. U.S. tax compliance for a foreign branch is done by filing Form 8858 annually with federal income tax returns, which requires reporting a summary of the income statement and balance sheet.
2. A foreign branch may have less burdensome filing requirements for the U.S. owner compared to other business structures.
3. It is not common for a U.S. taxpayer to operate as a branch office in a foreign country due to legal and operational reasons.
4. A foreign disregarded entity (FDE) allows the U.S. parent company to treat the foreign business as a branch for tax purposes while still enjoying the benefits of having a separate legal entity in the foreign country.
5. Distributions from an FDE to its owner are disregarded for U.S. tax purposes, but the owner may still need to recognize foreign exchange gain or loss on these distributions.
6. The annual U.S. tax compliance for an FDE is the same as that for a foreign branch, requiring the filing of Form 8858 with federal income tax returns. 1. Foreign Disregarded Entities (FDEs) are treated as legal entities locally but as pass-through entities in the U.S., leading to potential tax distortions.
2. Both the U.S. and many foreign countries have anti-hybrid rules to prevent tax deductions for transactions involving hybrid entities.
3. U.S. taxpayers who set up entities in foreign countries may face U.S. income tax under the Controlled Foreign Corporation (CFC) regime, including the Subpart F rules and the Global Intangible Low-Taxed Income inclusion (GILTI) regime.
4. Under the Subpart F regime, certain income of the CFC may be subject to current U.S. taxation at ordinary income tax rates.
5. The GILTI regime pulls most non-Subpart-F CFC earnings into the U.S. tax net, with an elective exception available for CFC income taxed above an effective tax rate of 18.9 percent. – Corporate U.S. shareholders can get a partial tax credit for foreign taxes paid on earnings included under Subpart F and GILTI.
– They are also allowed a deduction (Sec. 250 deduction) which brings the GILTI tax rate down to 10.5 percent (or 13.125 percent starting in 2026).
– Actual distributions from a CFC to its U.S. shareholders are generally tax-free up to the amount of earnings and profits that have previously been taxed under GILTI and Subpart F.
– Individual shareholders can avail themselves of similar benefits as corporate U.S. shareholders by annually electing to be taxed as a domestic corporation with respect to Subpart F and GILTI. – U.S. tax compliance rules and forms for reporting foreign earnings are complex and require detailed information and recordkeeping.
– Forms 5471 and 8992 must be filed to report foreign earnings on a U.S. taxpayer’s annual federal income tax return.
– The 2017 U.S. tax reform created a territorial tax regime, but GILTI has become a minimum tax framework that imposes U.S. tax on most of a CFC’s non-Subpart-F income. – Foreign branch, foreign disregarded entity, and controlled foreign corporation are three different international entity types.
– Foreign branch and foreign disregarded entity are not legal entities, while controlled foreign corporation is a legal entity.
– All three entity types simplify U.S. tax compliance, but controlled foreign corporation may require more time-consuming compliance.
– Foreign branch and foreign disregarded entity allow for easy repatriation, while controlled foreign corporation may have potential tax on distributions.
– All three entity types allow for foreign tax credits, although controlled foreign corporation may require a Sec. 962 election for individual taxpayers.
– Foreign branch and foreign disregarded entity are fully subject to U.S. income tax at ordinary rate, while controlled foreign corporation may have a lower effective tax rate on CFC earnings under GILTI for corporate taxpayers, with a Sec. 962 election for individual taxpayers.
– Careful planning with a qualified advisor is important when setting up a business abroad to ensure the entity structure supports the business goals in a sustainable and tax-efficient manner. 1. Jacinta Lam has eight years of experience in providing international tax consulting and compliance services to businesses and individuals in the U.S.
2. Jacinta started her career at GHJ in 2015 and has also worked at a top-10 firm and a Big Four firm.
3. Andreas Koller has over 20 years of international tax experience in both public accounting and corporate accounting.
4. Throughout his career, Andreas has worked in three countries and served multinational companies in a variety of industries.
https://www.ghjadvisors.com/ghj-insights/operating-a-business-outside-of-the-u-s-which-entity-type-is-best
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