Considerations for a US Domestic LLC with Foreign Members by Carolyn Flaherty

Below are some requirements that should be considered when foreign investors are members in a US limited liability company (LLC):

Individual Taxpayer Identification Numbers Required: A foreign individual invested in a U.S. LLC is required to apply for an individual taxpayer identification number (ITIN). The ITIN is required for the Form 1065 filing of the LLC. Form W-7 is used to apply for an IRS ITIN.

LLC withholding Requirements: Under withholding rules, the LLC must calculate its income and remit withholding for the foreign investors on a quarterly basis. The withholding is required regardless of cash flow and even if no actual distributions are made to the foreign members. The payment can be up to 30% of the foreign member’s allocated income and is made on Form 8813. The LLC must also file Form 8804, reporting the total withholding tax required to be withheld and paid, and Form(s) 8805, reporting the payment attributable to each foreign partner on whose behalf the tax was withheld, by the 15th day of the 4th month after the close of the partnership’s tax year.

If prior year losses exist, the withholding can potentially be adjusted, but the procedures for approval are cumbersome. The foreign investor may be entitled to a reduced rate of withholding or an exemption from withholding. A valid Form W-8 must be provided by the foreign member to the LLC to avoid any unnecessary withholding.

If a member’s investment in the partnership is the only activity producing effectively connected income and the IRC section 1446 tax is less than $1,000, the partnership is not required to withhold. However, certification requirements apply.

Form W-8: A partner that is a foreign person should provide the appropriate Form W-8 to the partnership. The partnership may not rely on the certification if it has actual knowledge or has reason to know that any information on the form is incorrect or unreliable. The partnership must keep the certification for as long as it may be relevant to the partnership's withholding requirements.

Foreign Member Filing Requirements: A domestic LLC causes a foreign member to have effectively connected income as a result of the US LLC’s business operations within the United States. Said differently, the member’s ownership interest in the LLC is considered by the Internal Revenue Code to be engagement in a trade or business within the United States.

Therefore, Non-U.S. resident individual members are required to file Form 1040NR to report their respective income of the LLC. They may also be required to file state income tax returns, depending on the laws of the state in which the LLC operates.

Disclosure Requirement: The LLC must file a Form 8886 disclosure statements with the IRS if it has participated in certain transactions such as a sale, exchange, retirement or other taxable dispositions considered reportable transactions under the Internal Revenue Code’s tax shelter provisions. Failure to disclose a reportable transaction can incur a penalty of $10,000 to $50,000.

Foreign Investment Real Property Act: FIRPTA withholding rules were enacted to impose tax payment and reporting liability on the transferee of real property, (and certain others involved in the transaction), to ensure collection of a foreign transferor’s tax on the disposition of U.S. real property. Unless a transaction is exempt from withholding, the transferee must report the transaction and pay the required FIRPTA withholding to the IRS usually within 20 days.

The FRPTA rate is generally 10% of property’s fair market value at the time of the transfer regardless of the amount of gain. A reduced rate withholding certificate can be obtained when the 10% withholding is expected to substantially exceed the actual liability, (the certificate should be requested well in advance of the transaction). The foreign investor will need to file a US tax return to determine the correct amount of income tax on the gain if there was any, and if not to obtain a refund.