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Guide to taxation of US LLCs presented by PwC

October 2018 Table of contents

This guide is current as of October 2018, and is not updated regularly.

What is an LLC? 3 Federal income 6 State 8 10 Other 11 A guide to the key US tax issues Federal tax issues 14 State and local tax issues 26 US tax treaties 28 How can PwC help? 29 Appendix A: Other taxes 30 Appendix B: Other issues 31 Appendix C: Information reporting 32 Appendix D: Foreign and individual considerations 33 Appendix E: Transfer pricing 38

A guide to the key US tax issues What is an LLC?

A (LLC) is formed and operated under state law and is widely used by taxpayers for both tax and non-tax benefits. LLCs offer flexibility because unincorporated entities, like LLC’s, can choose to be taxed as a disregarded entity (also referred to as a sole proprietor if LLC is owned by an individual), corporation, or as a . An LLC is a hybrid entity that combines several of the advantages of operating as either a partnership or a corporation. In contrast to a (LP), which must have at least one general partner with personal liability, all the members in an LLC have limited liability (a factor that resembles a corporation or limited partners of a limited partnership). Furthermore, an LLC can be formed with only one owner, whereas a partnership requires at least two owners. Note that an ‘owner’ of an LLC can also be referred to as a partner, member, or investor for purposes of this Guide. The LLC structure also provides the flexibility to decentralize the management structure without the participation of all of its members and designate managers to manage the . Additionally, there is also no limit to the number of owners and the type of owners, unlike S . If there is only one member in the LLC, the LLC is treated as a "disregarded entity" for tax purposes, and would report the LLC’s income on their applicable tax return; for example, an individual owner would report the LLC's income or loss on his or her US individual tax return, Form 1040 or 1040NR. Thus, income from the LLC is taxed at the individual tax rates. The default tax status for LLCs with multiple members is a partnership, which is required to report income and loss on IRS Form 1065. Under partnership tax treatment, each member of the LLC, as is the case for all partners of a partnership, annually receives a Form K-1 reporting the member's distributive share of the LLC's income or loss that is then reported on the member's income tax return. An LLC that is treated as a partnership may specially allocate the members' distributive share of income, gain, loss, deduction, or credit via the company operating agreement on a basis other than the ownership percentage of each member as long as certain Treasury Regulations are met. Note IRS Form SS-4 will include entity classification information. For US federal income tax purposes, an LLC can elect to be taxed as a C corporation or (as long as they would otherwise qualify for such tax treatment). Election decisions are typically based on legal and tax considerations.

3 PwC For Federal taxes, there is no “LLC taxation” class. LLCs are taxed like existing . The 4 business types are: disregarded entity Partnership (limited partnership); C-Corporation; and S-Corporation. The LLC Default Tax Classification (meaning unless a different tax election is requested with the IRS) is taxation based on number of members: • An LLC with one owner is called a single-member LLC, and the IRS taxes single-member LLCs like a if the owner is an individual. If the single owner is a C-Corporation, the IRS will tax the LLC at the C-Corporation level on Form 1120. • An LLC with two or more owners is called a multi-member LLC, and the IRS taxes multi-member LLCs like a Partnership. • Sole Proprietorship, disregarded entity and Partnership taxation are “pass-through”, meaning the business profits, losses, credits, and deductions will flow through to the tax return of each member. • An LLC taxed as a Partnership must also file a 1065 partnership return and issue K-1s to the LLC owners. • An LLC can also elect to be taxed as an S-Corporation or a C- Corporation. We’ll discuss these within this Guide.

When foreign (persons) are investing in the US, they should be aware of the potential US tax implications for the foreign entity interacting with the US. While the US tax consequences of the US LLC are described throughout this Guide, there are other tax considerations for a foreign company (person) to manage the US tax risk of the activities of the foreign company. Generally, foreign investors of US LLC’s will have a US tax reporting and tax obligation in the US. Please see Appendix D in this Guide for further discussion.

A guide to the key U.S. tax issues 4 For entity structuring considerations, LLCs can choose how to be taxed – either using the default tax treatment of a disregarded single member entity (where the tax reporting flows directly onto the sole owner’s return) or as a multiple member partnership, or as a C Corporation or S Corporation if a formal election with the IRS is made. No other entity has this flexibility. Below is a summary chart on general comparisons for each entity:

LLC LLC (Disregarded/ Limited (Multi Member) Single Member) C Corporation S Corporation Partnership Liability Generally limited Generally limited to Generally limited to Generally limited to Unlimited for to amounts invested amounts invested amounts invested amounts invested general partners; and loaned. Owners and loaned. Owners and loaned. Owners and loaned. Owners limited partners of LLCs are not of LLCs are not of Corporations are of S Corporations possess limited personally liable for personally liable for not personally liable are not personally legal liability and the LLCs business the LLCs business for the C liable for the S generally risk only debts. debts. Corporation’s Corporation’s their capital business debts. business debts. contributions to their limited partnership. Generally No Generally No Yes. In general, Generally No No (Taxation at both income is taxed to LLC and Owner the C Corporation Level) and shareholders are taxed upon receiving distributions from the corporation. Pass – through of Yes Yes No Yes Yes profits and losses from Entity to Owner Ownership Interests are offered Single member No limitations on Investors generally Interests are offered Limitations to investors owner (can be ownership can only be US to investors (can be (can be foreign foreign corporations citizens or foreign corporations corporations or individuals, residents. Limited to or individuals, or individuals, domestic 100 owners/ domestic domestic corporations, trusts, members. corporations, trusts, corporations, trusts, and ) and partnerships). and partnerships). Federal Tax Rates Generally, income Generally, income Income is taxed to Income is taxed to Income is taxed to is taxed to owners is taxed to owners the corporation at a owners at their owners at their at their marginal at their marginal flat 21% rate and marginal rates. marginal rates. rates. (*Note self- rates. (*Note self- taxed again to employment taxes employment taxes owners upon may also apply) may also apply) distribution. Taxable year Generally, Generally, Any fiscal year or Generally, Generally, calendar year calendar year calendar year. calendar year calendar year Once calendar taxable year has been established, need business purpose to change to fiscal year.

5 PwC Federal income tax

the LLC might still be required to file a federal income tax return. Even Who is subject to US Income Tax? if your LLC has no business activity, it is important to understand your An annual US income tax return is LLC tax filing status and whether it is obligated to file a federal income required for a multi-member LLC. This tax return. applies to both US and foreign persons If the LLC elected to be treated as a corporation, normal corporate who have formed a US LLC. tax rules will apply to the LLC and it should file a Form 1120, An LLC is not considered separate from its US Corporation Income Tax Return (See "Stripe Atlas - PwC partners for tax purposes. Generally, this means Corporate Guide to US Taxes" for further discussion on C the partnership (the default tax-treatment for a Corporation filing requirements). multi-member LLC) itself does not pay any If a qualifying LLC elected to be treated an S Corporation, it should file income taxes; instead, LLC income "passes a Form 1120S, US Income Tax Return and S corporation laws would through" the business to each partner, who then then apply to the LLC. reports his or her share of business profits or losses on the applicable federal tax return. As owners of a pass-through business entity, partners in a partnership may qualify for the 20% pass-through established under the Tax Cuts and Jobs Act.

As an LLC, what do I need to file? LLCs with more than one member generally file a partnership return Form 1065 on an annual basis with the IRS. Included within Form 1065 is Schedule K-1; Schedule K-1 is a tax document issued to report member’s share of the partnership's income, deductions and credits. Single member (disregarded) LLC’s generally do not have a separate federal filing requirement; instead, for example, a single member LLC who’s member is an individual As an Owner/Member of an LLC, what do I need to file? would report LLC income, deductions and If an LLC has only one member and is classified as an entity credits on Schedule C of their individual US disregarded as separate from its owner, then the LLC’s income, tax return (Form 1040 or Form 1040NR). deductions, gains, losses, and credits are reported on the owner's Note in addition to the Forms mentioned income tax return. For example, if the owner of the LLC is an above, there are other informational forms individual, the LLC's income and expenses would be reported on that may be required. For example, Form 5472 schedules within the owner's Form 1040. If the single member of the (Information Return of a 25% Foreign-Owned LLC is a C Corporation, then the LLC’s activity would also be reported US Corporation or a on the owner’s (C Corporation) Form 1120. Engaged in a US or Business), is If the LLC has multiple members, the activity is reported to the required to be filed by a foreign-owned, owners on Form K-1 (the owner/member receives the K-1 from US company. Please consult with your tax the LLC). The member/owner then reports the K-1 activity on professional for more information. their income tax return, similar to the single member LLC For multi-member LLCs that are inactive reporting above. (i.e. a newly formed LLC that might not have started doing business yet or an older LLC might have become inactive without being formally dissolved),

A guide to the key U.S. tax issues 6 Single Member LLC (US) taxed as individual - A US As an Owner/Member, how much tax individual must file their annual tax return (Form 1040) by will I owe? the 15th day of the fourth month following the close of the Your US LLC, for both multi and single member LLCs, calendar year. will not be taxed at the LLC level, but will be taxed at the member level based on the distributive share amounts. The LLC taxed as a C-Corporation - A corporation must file member pays taxes based on if they are an individual, their annual tax return by the 15th day of the fourth month partnership, or corporation. Each member’s is following the close of its tax year. See guide “Stripe subject to graduated higher tax rates ranging from 10% to 37% Atlas - PwC Corporate Guide to US Taxes” for further depending on the amount of taxable income if an individual, or details. at a flat rate of 21% if a corporation. Is the foreign partner engaged in a When do I have to file my taxes? US trade or business? Multi Member LLC (no foreign members) & Beginning tax year 2017, US domestic LLCs Multi Member LLC (at least one foreign member) - A that are wholly owned, directly or indirectly, by one foreign partnership generally must file the annual tax return by the person (foreign person includes a nonresident alien 15th day of the third month following the close of its tax year. A individual, foreign corporation, foreign partnership, foreign taxpayer can obtain a six-month extension to file its tax return, trust, a foreign estate, and any other person that is not a US provided it’s timely and properly files Form 7004. person), are required to obtain a US tax identification number and file an annual return, on Single Member LLC (Foreign) - LLCs Owned (owned 25% Form 5472, reporting transactions between the LLC and its or more) by Foreign Persons Must File IRS Form 5472. A foreign owner. foreign person is defined by the IRS to include: an individual who is not a citizen or resident of the United States, an The LLC is still considered a disregarded entity for US tax individual who is a citizen or resident of a US possession who is purposes, but the information collected from foreign-owned not otherwise a citizen or resident of the United States, any LLCs will be available to the Internal (IRS) partnership, association, company, or corporation that is not as it seeks to satisfy US obligations under its Foreign created or organized in the United States. A reportable Account Tax Compliance Act (FATCA) intergovernmental disregarded entity that has one or more reportable transactions agreements and, potentially, to be considered a Common with a related party during a tax year must file an IRS Form Reporting Standard participating jurisdiction. 5472 along with an IRS Form 1120. Form 5472 must be filed if a reporting corporation, including a foreign-owned single- member LLC, had a reportable transaction with a foreign or domestic related party. Reportable transactions include any amount paid or received in connection with the formation, dissolution, acquisition, and disposition of the entity. A single member LLC (foreign) must attach their Form 5472 to the reportable disregarded entity’s annual pro forma Form 1120 by the 15th day of the fourth month following the close of the tax year. The only information required to be completed on Form 1120 is the name and address of the foreign-owned US disregarded entity and Items B and E on the first page. Item B is the US Employer Identification Number (EIN) of the LLC and Item E indicates if the 1120 is an initial return, final return, or if there has been an address or name change.

A single-member LLC owned by a foreign person is also generally required to report LLC income, deductions and credits on Schedule C of their individual US tax return (Form 1040NR) due by the 15th day of the fourth month following the close of the calendar year (or by the 15th day of the tenth month following the close of the calendar year if the return is on extension).

7 PwC State income tax

What do I need to file? Which states do I need to file? Each state in the US has their own tax system that requires annual filings A state generally may impose its tax on an depending on your activity in the state. These filings are separate from the US entity to the extent a sufficient ‘nexus’ or federal return submitted to the and are taxable connection exists between the submitted to tax authorities of the individual states. The tax rates entity and the state. Each state has their vary across the states but generally result in an additional income own criteria for nexus but, in general, tax of up to 13.3%. Depending on the state, certain states will have owning property, paying rent, or storing both an LLC filing requirement (for both regarded and disregarded LLCs) and inventory in a state are examples of a member level requirement; some states will have no filing requirement and situations that would lead to a filing some only member level requirement. requirement in that state. Other factors, such as the location of employees and sales activity, can also be considered, Federal vs. State taxable income? depending on the state. Generally, an LLC will need to file in the state it is The starting point for determining US state taxable income generally is an incorporated in and will likely need entity’s federal taxable income. However, there are several items that may be to file in any state where treated differently for state taxable income purposes (e.g., depreciation, registered to do business. state taxes paid, interest deductions and charitable contributions). The states will then apportion taxable income according to the company’s relative presence in the state using various factors (e.g., sales, property, payroll, etc.).

When are state taxes due? Most states require the taxpayer to file their annual tax return by the 15th day of the third or fourth month following the close of its tax year. Some states permit a five or six-month extension to file their tax return, provided it’s timely and properly files the extension form for that jurisdiction and deposits the full amount of any tax.

How can an LLC incorporated in one State do business in another? If you're an LLC incorporated in one state and doing business in another state, your Company is considered domestic in the State incorporated and foreign in the state doing business (e.g. an LLC registered in Delaware and doing business in California). If your business will have a physical presence by operating, hiring employees, banking or even holding an asset in the “foreign” state, you will typically need to qualify the business to operate there through a process known as Foreign Qualification. If this is something you are encountering or are planning to move forward with, please consult with your legal advisors.

A guide to the key U.S. tax issues 8 Other state tax issues States generally conform to federal income tax treatment with respect to inclusion of partnership items in state taxable income, guaranteed payments in state taxable income of the partner and treatment of preferred returns. However states do not conform to certain federal tax items like federal US tax treaties with foreign countries. The United States has tax treaties with a number of foreign countries. Under these treaties, residents (not necessarily citizens) of foreign countries are taxed at a reduced rate, or are exempt from US taxes on certain items of income they receive from sources within the United States. Treaties, such as the US/UK treaty, expressly do not apply to state income taxes. Therefore, a state can tax income even if the US federal government is prohibited from imposing taxes on such income under the . As this is a complex area, please consult with your tax professional for more information. • Allocation –state source income is determined at the partnership level, with the partnership income apportioned only using the partnership apportionment factors. The partner receives a K-1 with the state source income amount already determined, and this predetermined amount is sourced directly to the state. The partner is then required, in many cases, to file a state tax return in the states they receive K-1s. • Apportionment – corporate partner includes its share of the partnership’s total income and apportionment factors in its own income and apportionment factors, and computes a combined apportionment factor at the partner level to determine state source income. State allocation and apportionment varies from state to state. State treatment of entity type generally conforms to federal tax treatment with exceptions. Please consult with your tax professional for more information.

9 PwC Transfer pricing Examples of Transfer Pricing considerations If you have multiple entities within your structure that interact with each other (e.g. subsidiaries Foreign parent sells US LLC provides sales under a parent company) and are subject to inventory to a US LLC which support to foreign parent, taxation in different jurisdictions, transfer pricing will be used in production of in the US may be applicable to you. Transfer pricing may the inventory. • Does the US charge the foreign apply not only to cross border transactions • Is the amount charged by the parent for the services they internationally, but also within the US across foreign parent the same amount are providing? states. Transfer pricing is a complicated area of that it would have charged to an • If so, is the rate being charge taxation and therefore it is best to consult with unrelated third party? appropriate under the ‘arm’s your tax professional for more information. • If the IRS determines the purchase length’ standard? Transfer pricing regulations govern how related price was not at ‘arm’s length,’ then • If neither are considered, the IRS entities set prices for the transfers of goods, an adjustment will be required on may consider an adjustment and intangible assets, services, and loans. The IRS (as the purchase price, potentially impute income in the US for the well as several other countries) look to what is resulting in double taxation of the services being provided, and the known as the arm’s length standard to determine foreign parent and US LLC. income would be taxable. the appropriate price. Foreign parent licenses US LLC uses the name brand Generally, the arm’s-length standard is met if the software to be used by the of the foreign parent results of a related party transaction are consistent with the results that would have been US LLC • What royalty payment does realized had unrelated parties engaged in a • What rate does the foreign parent the foreign parent charge similar transaction under similar circumstances. charge the US LLC to use the the US subsidiary for use of Assessing the arm's length nature of transactions software license? the brand name? involves careful analysis of the facts and • If the IRS determines the rate • If the IRS determines the rate circumstances surrounding the transaction. The being charged is too high, when being charged is too high, when analysis considers the functions performed, considering the ‘arm’s length’ considering the ‘arm’s length’ assets employed, and risks assumed by each of standard, the deduction taken in standard, the deduction taken in the parties in the transaction. the US may be adjusted downward, the US may be adjusted downward, resulting in the US LLC having resulting in the US LLC having The IRS may distribute, apportion, or allocate additional taxable income in additional taxable income in gross income, deductions, credits, or allowances the US. the US. between or among the entities involved if it determines it is necessary to accurately reflect income or prevent evasion of taxes. Under certain circumstances, the IRS may impose penalties for incorrect transfer pricing. Preparing documentation of your transfer pricing positions contemporaneous with the filing of your US tax return can help you avoid penalties.

Transfer pricing in practice • A and B are related parties in different tax jurisdictions. Tangible goods / materials

• Tax authorities can be concerned that differences between jurisdictional tax Entity Intangible assets Entity rules and rates create the opportunity for related entities to shift income from A B a higher tax jurisdiction to a lower tax jurisdiction (true for cross-border Country Services Country X Z transactions both internationally and between states). Leases, loans, guarantees • To deal with this concern, transfer pricing regulations govern the price when items or services are transferred between related entities.

Example of how profits can be taxed Entity Sales Cost Profit Makes a t-shirt for $5 Foreign Parent $8 $5 $3 Foreign parent Sells the t-shirt for $8* US Subsidiary $10 $8 $2

US subsidiary In this simplified example, the profit subject to tax in the US ($2) represents its sales less cost of purchasing the T-shirt. The US subsidiary may have other Sells the t-shirt for $10 operating expenses that it can also deduct to further reduce taxable income. Customer *Price must be similar to what the foreign parent would charge to unrelated parties in the US

A guide to the key U.S. tax issues 10 Other taxes

The United States has separate federal, state, and local government(s) with taxes imposed at each of these levels. Taxes are levied on income, payroll, property, sales, withholding, as well as various fees (see detailed descriptions of each below). These taxes are constantly evolving to keep up with new industries, to meet the changing needs of a state, or one of countless other factors. For example, on June 21, 2018, the US Supreme Court in South Dakota v. Wayfair overturned prior Court decisions and ruled that a physical presence is not required for the imposition of sales and use tax. This decision will have far-ranging tax and accounting impacts on companies, including LLC’s. Therefore as a business owner/member, it is important to be aware of the constant changes, and account for them to reduce your potential risk.

Indirect Taxes • An (such as , per unit tax, value added tax (VAT), or goods and services tax (GST)) is a tax collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the consumer). The intermediary later files a tax return and forwards the tax proceeds to government with the return. • There is no VAT nor similar . As a result, indirect tax is generally a state tax issue. • The most common indirect tax is a state's sales and use tax, and franchise tax which is generally based upon capital.

Sales &Use Taxes • Generally, once an entity has nexus to a state with respect to sales and use taxes, that entity must register with the state’s tax department, file sales tax returns, and pay its sales tax liabilities. • Depending on the volume of sales, the company may be required to file returns on an annual, quarterly, or monthly basis. Physical presence is not required for the imposition of sales and use tax by certain states. • Generally, sales tax is imposed on retail sales, leases, rentals, barters, or exchanges of tangible personal property and certain enumerated services unless specifically exempted or excluded from tax. • Sales tax generally is imposed in the jurisdiction in which the ‘sale’ occurs. The definition of ‘sale’ differs from jurisdiction to jurisdiction; however, the definition generally includes both (1) consideration and (2) transfer of title, right to use, or control (possession) in the case of tangible property and completion of the service act in the case of a service.

Delaware Franchise Tax • LLCs have the following requirements: • Any entity that is formed in Delaware (regardless of where you conduct business) must pay an Annual Tax for the privilege of incorporating in Delaware of $300 (as of 2018). • Annual Taxes are due no later than June 1st of each year. Failure to pay the required annual taxes will result in a $200 penalty plus 1.5% interest per month. LLCs that have elected to be treated as C-Corporations have a required Annual Report filing fee of $50 due March 1. Starting in 2018, the minimum tax is $175 for corporations using the Authorized Shares method and $400 for corporations using the Assumed Par Value Capital Method. Maximum Tax is $200,000 for both methods unless it has been identified as a Large Corporate Filer, then their tax will be $250,000. Please refer to the “Stripe Atlas – PwC Corporate Guide to US Taxes” for further information.

11 PwC Other taxes (continued)

Payroll Taxes • A obligation will exist for a US entity if it has employees. • All payments for employment within the US are wages subject to (1) federal income tax withholding, (2) Federal Insurance Contributions Act (FICA) taxes (i.e., social security and Medicare), and (3) the Federal Unemployment (FUTA) tax, unless an exception applies. • The employer must pay and withhold social security taxes equal to 6.2% of wages for the employer and 6.2% for the employee, up to $128,400 of wages in 2018, and Medicare taxes equal to 1.45% for the employer and 1.45% for the employee. An additional 0.9% is also withheld on wages in excess of $200,000. • The employer generally must file quarterly and annual employment tax returns and annual wage statements (Forms W-2) in its name and employer identification number, unless such statements are filed by a properly authorized third party.

Withholding and Self –Employment Taxes • Individual LLC owners and members that are self-employed (i.e. not employees) are not subject to tax withholding, so each member must generally pay estimated taxes and self- employment taxes (Medicare and Social Security) quarterly to the IRS and applicable states. If an LLC owner or member is a Corporation, the Corporation must generally pay estimated taxes but is not subject to self-employment taxes. *Note S Corporations may or may not be subject to withholding taxes; please consult your tax advisor if this applies to you. • An LLC with foreign partners could be responsible for complying with other filing requirements such as Foreign Investment in Real Act of 1980 (FIRPTA), Partnership Withholding, and NRA (Non Resident Alien) Withholding. If you are an alien (i.e. not a US citizen), you are considered a nonresident alien that may have an additional filing requirement unless you meet one of two tests: You are a resident alien of the United States for tax purposes if you meet either the green card test or the substantial presence test for the calendar year (January 1-December 31). A partnership must pay the withholding tax for a foreign partner even if the partnership does not have a US taxpayer identification number (TIN) for that partner. Foreign partners must attach Form 8805 to their US income tax returns to claim a credit for their share of the IRC section 1446 tax withheld by the partnership. To insure proper crediting of the withholding tax when reporting to the IRS, a partnership must provide a US taxpayer identification number for each foreign partner. The partnership should notify any of its foreign partners without a valid TIN of the necessity of obtaining a US taxpayer identification number. An individual's taxpayer identification number is the individual's social security number (SSN) or individual taxpayer identification number (ITIN). An ITIN will always begin with a 9, and the middle two digits will be in the range of 70 to 80. It is also possible that a partner's TIN could be its US employer identification number (EIN).

Further guidance For a more comprehensive discussion of US Taxation, please see the following section, “A guide to the key US tax issues.” Contact us To schedule a discussion with a PwC professional on general US tax issues, please contact [email protected]

A guide to the key U.S. tax issues 12 A guide to the key US tax issues

2018 Federal tax issues

Taxes on Multi-Member LLCs and Single-Member, Disregarded LLCs All US LLCs are subject to federal For LLCs with multiple members, income taxes at the member level. the LLC members are then US LLC members are taxed based allocated a portion of the income on their distributive share of income. to be taxed. The US income For Federal taxes, there is no “LLC Generally, US taxable income is is based on a progressive rate taxation” class. LLCs are taxed like based on the member’s portion of the schedule if the member is an existing businesses. The 4 business LLC’s gross receipts less various individual or a flat rate of 21% types are: Disregarded Entity (also business expenses (e.g., cost of goods if a member is a corporation referred to as single-member LLC sold, salaries and wages). For a single (this applies to both single member or Sole Proprietorship; Partnership member, disregarded LLC, this and multi-member LLCs). (limited partnership); C- would be 100% of the LLC’s activity Corporation; and S-Corporation. reported at the owner’s level. The LLC Default Tax Classification (meaning unless a different tax election is requested with the IRS) 2018 taxable income US individual income tax is taxation based on number of members: Over ($) But not over Pay ($) +% on Of the amount over ($) excess ($) • An LLC with 1 owner is called a single-member LLC, and the IRS 0 9,525 0 10 0 taxes single-member LLCs like a Sole Proprietorship. 9,525 38,700 952.50 12 9,525 • An LLC with 2 or more owners is 38,700 82,500 4,453.50 22 38,700 called a multi-member LLC, and the IRS taxes multi-member 82,500 157,500 14,089.50 24 82,500 LLCs like a Partnership. 157,500 200,000 32,089.50 32 157,500 • Both Disregarded Entity and Partnership taxation are “pass- 200,000 500,000 45,689.50 35 200,000 through”, meaning the business 500,000 150,689.50 37 500,000 profits, losses, credits, and deductions will flow through to the tax return of each member; The computation of a partnership's for example, if the member is an (LLC’s) taxable income is individual, the LLC activity would prescribed in Section 703(a). flow thru onto the member’s When reporting tax items, the Form 1040. partnership must distinguish • An LLC taxed as a Partnership tax items between those that are must also file a 1065 partnership separately stated and those that return and issue K-1s to the LLC are not separately stated to owners. the partners. • An LLC can also elect to be taxed as an S-Corporation or a C- Corporation.

A guide to the key U.S. tax issues 14 Separately stated items For example, individuals can For purposes of determining Separately stated items are items of generally deduct up to $3,000 of their individual NOLs, partners income and deduction that can capital losses in excess of capital may use their allocated portion affect the computation of a partner's gains, whereas this deduction is not of the loss to offset other income, tax liability differently from another available to corporations. Therefore, or include it as part of an NOL partner's liability. The eight capital gains and losses must be that may be carried back or categories of partnership income, separately reported on page 3 of forward to other years on their gain, loss, deduction, and credit that Form 1065, Schedule K, and tax returns. must be separately stated on the Schedule K-1. There are certain limitations on partnership return pursuant to The partner's return retains the tax the deductions for partnerships. Section 703(a)(1) are: character of each of these items to For example, the dollar 1. Short-term capital gains and the partnership. For example, a limitation on expensing Section losses (Section 702(a)(1)); long-term capital gain realized by 179 property applies to the the partnership is a long-term partnership and a separate 2. Long-term capital gains and capital gain on a partner's return, limitation applies to each losses (Section 702(a)(2)); even if that partner has been a individual partner. Furthermore, 3. Gains and losses under Section member of the partnership for less since a partnership is not 1231 (Section 702(a)(3)); than a year. allowed a charitable contributions deduction, each 4. Charitable contributions There are certain classes that must partner is considered as having (Section 702(a)(4)); be separately stated including paid, within the taxable year, a passive activities, tax adjustment, 5. Qualified dividend income taxed distributive share of any and preference items for purposes at capital gain rates under charitable contribution, payment of the alternative minimum tax Section 1(h)(11) and dividends of which was actually made by computation, such as certain eligible for a deduction under the partnership within its taxable depreciation deductions, and Sections 243 through 247 year ending within or with the deductions that partners can claim (Section 702(a)(5); reg. section partner's taxable year. 1.702-1(a)(5)); as itemized deductions, such as medical expenses. In addition, items 6. Certain taxes of foreign countries Non-separately stated items to be taken into account separately or US possessions (Section include items related to activities The non-separately stated items 702(a)(6)); not engaged in for profit. include income and expenses that 7. Taxable income or loss, exclusive are attributable to the businesses or No deductions are allowed at the of the various items otherwise (excluding rental activities) LLC (partnership) level for personal requiring separate computations conducted by the partnership and exemptions, foreign taxes, net (Section 702(a)(8); reg. section have the same tax treatment for all operating loss (NOL) carrybacks or 1.702-1(a)(9)); and the partners. The income and carryovers, capital losses, or the related deductions are reported on 8. Any other item of income, gain, deduction for depletion with page 1 of Form 1065. The loss, deduction, or credit, to the respect to oil and gas wells. partnership's net ordinary income extent required by regulations While a partnership may not take or loss is allocated to (Section 702(a)(7)). advantage of the NOL deduction, the partners. Each partner must report on its own nor foreign taxes, the partnership return its distributive share of each can allocate percentages of the of the separately stated items, loss and foreign taxes to partners aggregating the items with the in the method described in amounts of similar items to the partnership agreement. determine if any limitations apply.

15 PwC Partner's distributive share Nonrecourse debt is when none of Except for certain partnerships Form 1065 is designed to show the partners have personal liability with fiscal year partners, a separately each category of or bear the economic risk of loss. partnership is required to adopt partnership income, gain, loss, Since there is no risk of economic a calendar year to prevent deduction, or credit that could affect loss, the liability generally is shared partners from deferring tax on the computation of each partner’s by all the partners, including limited partnership income through income tax. The partnership files partners, in the same proportion as adopting different taxable years. Form 1065 for informational ownership interests. A partner must include its purposes only, which includes distributive share of partnership Partnership tax elections partnership activity Form K-1; the items on its tax return in the partnership's income is taxed to the Most elections affecting the tax same year as the last day of the partners according to their computation of partnership income partnership's taxable year falls. distributive shares. A partner's and loss must be made by the A partnership does not have the distributive share is reported on partnership. Elections include the option of selecting any taxable Schedule K-1 of Form 1065, which is method of accounting, method of year (calendar or fiscal) for provided to the partner. The partner computing depreciation, and federal income tax purposes. A takes the information on the amortization of certain organization partnership must have the same Schedule K-1 and reports it on his or fees. Once the elections are made, taxable year as the partners who her tax return. Foreign partners they apply to all the partners. have the "majority interest would also be subject to US filing Generally, a partnership may elect taxable year," which is an and reporting of K-1 activity; see any allowable accounting method aggregate interest in partnership Appendix D below for and choose an accounting method profits of more than 50 percent further discussion. that is different from its partners on each "testing day" (defined as The partners, not the partnership, unless specifically excluded. For the first day of the partnership are liable for the tax on their example, the partnership can make taxable year). The alternative is allocable share of partnership an election to deduct and amortize to use the taxable year of all the income even if the income is not organization fees, an election to "principal partners" (defined as distributed to the partners. amortize start-up expenditures, and partners owning 5 percent or Furthermore, partnership income or an election to adjust the basis of more of the profits or capital). If loss is allocable to a partner only for partnership assets upon the transfer the "majority interest taxable the portion of the year that the of a partnership interest or upon year" or the "principal partners" partner is a member of certain distributions from the cannot be determined, the the partnership. partnership. However, if the partnership must adopt the partnership's accounting method calendar year unless otherwise Treatment of liabilities does not clearly reflect income, the provided by regulations. To determine the treatment of IRS has the authority to recompute If the taxable year of a partner is liabilities (e.g., trade accounts and partnership income under a method different from the partnership, accrued expenses), liabilities should that the IRS deems reasonable. the partner’s share of the be distinguished between recourse partnership taxable income is Partnership taxable year and nonrecourse depending on the reported as if it were all received facts of the partnership at issue. A partnership generally is by the partner on the closing Recourse debt is when a partner or required to conform to the date of the partnership year. If related party shares the economic partners' taxable years unless the partnership has more than risk of loss relating to the liability or there is a business purpose for one closing date within a guarantees all or part of a debt; choosing another taxable year. partner’s taxable year, then more generally, the partner's basis is than one partnership period is increased to the extent of the risk. included in the partner’s return.

A guide to the key U.S. tax issues 16 Taxes on corporation income In order to be tax-free, a number c. If the LLC is characterized If an LLC elects to be treated as of requirements need to be as a C-Corp or S-Corp, there a C-Corporation, please refer to satisfied (see the section The are some additional the “Stripe Atlas – PwC Corporate Liquidation below). If these complexities that would Guide to US Taxes” for further requirements are not met, the need to be considered. If information. Liquidation will be taxable. Note this is something you are that in the event the Liquidation encountering or are planning is taxable, it is both taxable at the to move forward with, please What are the tax implications corporate level (i.e., taxable on consult with your tax of converting from a C the final return, as advisors. corporation to an LLC? if the entity had sold all of its Tax implications of a conversion in Generally speaking, a limited assets at their fair market value) greater detail liability company (LLC) is a unique and shareholder level. This may type of entity in that it can be or may not have any actual cash- • Compliance: classified for US federal income tax tax consequence, and will - General federal purposes differently depending on ultimately depend on the tax compliance comments: the ownership of the LLC. For attributes of the liquidating ◦ If the C corporation example, if an LLC only has one corporation – see the section was part of a owner it is characterized as a Impact on tax attributes below). “consolidated group”: “disregarded entity” (i.e., it does not 2. What follows next actually When a company’s legal exist as a separate taxable entity for depends on how the LLC will be entity organization US federal income tax purposes, but characterized for US federal structure is comprised of instead its activity flows up to its income tax purposes (based on more than one US C owner and is taxed on the owners the guidelines outlined above). corporation, these entities tax return). If the LLC has two or a. To the extent the LLC is a typically join in one group more owners, it is characterized as a tax return filing referred to partnership for US federal income “disregarded entity,” there is no further tax consequence of as a “consolidated group” tax purposes. With that said, an LLC (each C corporation is is eligible to make a special election, the conversion. This is because although the LLC referred to as a by filing a simple form with the IRS, “member”). If the entity to be characterized as a corporation legally holds all of the assets and liabilities, the LLC does that is converting was a if it wanted to. Further, once it is a member of a “consolidated corporation, it has the ability to not exist as a separate entity for US federal income tax group” then a statement elect to be a subchapter “S” needs to be attached to the corporation (often referred to as an purposes and therefore it is simply viewed as if the parent consolidated tax return for “S-Corp”), which has its own set of the year the conversion requirements and tax benefits. continues to hold those assets received in the Liquidation. took place explaining that When a C corporation converts to an one of the members of the LLC under state law, there is a tax b. If the LLC is characterized as group liquidated fiction that is deemed to occur. a partnership, following the (i.e., the tax result of Liquidation it is viewed as if the conversion). 1. The first step in the tax fiction all assets and liabilities are is a liquidation of the C then contributed to a newly corporation (will refer to this formed partnership, in here forward as the Liquidation). exchange for partnership The tax treatment of the interests. This transaction is Liquidation depends on a generally tax-free. number of factors, but can either be (1) tax-free, or (2) taxable.

17 PwC ◦ If the C corporation was • Impact on tax attributes (i.e., net As a result, the outside basis is “standalone” C operating losses (NOLs), tax typically higher than inside basis. corporation: If it was a credits, etc.): The impact on tax In any liquidation, whether “standalone” C corporation attributes will differ depending taxable or nontaxable, the (i.e., filed its own separate US on whether or not the outside stock basis in the federal income tax return and Liquidation is taxable or tax-free. liquidating entity is was not a member of a ◦ If tax-free: Generally eliminated/lost. To the extent “consolidated group”), it speaking, all tax attributes outside basis exceeds inside would file a final corporate carryover to the corporate basis, consider the inside vs tax return for the year of the shareholder. Further, the tax outside tax basis. For example: conversion (generally, the basis of all the assets inside - Assume the business is worth year would end on the date of the corporation also carryover $100, the outside basis the the conversion). (i.e., no basis step-up shareholders had in the stock - General state tax comments: is achieved). was $90 and the inside basis Certain states do not respect ◦ If taxable: If the transaction is the corporation had in the disregarded LLCs and tax them taxable, there is a tax assessed assets it held was $80. as C corporations. Additionally, on the final corporate tax ◦ If the shareholders sold other states respect the flow- return of the liquidating the stock of the C through nature of an LLC; entity, as if it sold all of its corporation, gain of $10 however, they may require a assets to the shareholder at would be recognized. separate tax filing even though their fair market value. This is the entity is disregarded for US ◦ If the C corporation was a complicated transaction and converted to an LLC, and federal income tax purposes. calculation and therefore you You should consult with your the members sold the should consult your member units (the equity), tax advisor regarding the state tax advisor. tax consequences of these types gain of $20 would be of transactions. • Outside basis: When a C recognized. corporation is formed, typically Note that if the C corporation was • The Liquidation: Generally the owners contribute cash and speaking, in order to achieve a acquired in a taxable transaction or operating assets to it, so the (and no special tax election was tax-free liquidation, at least the business can run, and in following requirements must be made), the discrepancy between exchange the C corporate inside and outside basis can be large satisfied (not an exhaustive list): issues shares to the (1) the shareholder must have as the shareholders have an outside owners/contributors of the cash basis equal to the purchase price, the requisite control (80% vote and operating assets. Generally and 80% value), (2) the but the corporation’s inside basis in speaking, this contribution is tax the assets remains un-changed (is shareholder must receive free. As such, the shares that the payment with respect to each not stepped up to the fair market owners hold have a basis equal to value/purchase price paid). class of stock it holds, (3) the the basis they had in the assets parent and subsidiary both must they contributed – this basis is • Consult with a tax advisor before be corporations. If any of these referred to as “outside basis.” converting an acquired C requirements are not satisfied, The C corporation now holds corporation to an LLC. the liquidation is taxable both to these assets and operates the • Consult with a tax advisor before the liquidating corporation, and business. The corporation also converting a C corporation with a then to the shareholder. has a basis in these assets – this built-in loss (i.e., the is referred to as “inside basis” as shareholders outside basis is it’s the basis “inside the greater than the fair market corporation.” Over time the value of the C corporation stock) assets are depreciated for US to an LLC. federal income tax purposes, and the inside basis decreases.

A guide to the key U.S. tax issues 18 - Go-forward taxation: Guaranteed payments are What are the tax implications Converting from a C those made by a partnership of converting from an LLC to corporation to an LLC to a partner (member) that a C corporation? generally eliminates the are determined without To the extent the LLC is a double taxation that a C regard to the partnership's “disregarded entity” and it corporation is subject to. income. A partnership treats converts to an entity that is However, to the extent the guaranteed payments for treated as a C corporation for LLC is held by a C services, or for the use of US federal income tax purposes, corporation, no benefit is capital, as if they were made such transaction is generally achieved as the income flows to a person who is not a expected to be viewed as a tax free from the LLC up to the C partner. Specifically , by the members of corporation parent, subject to guaranteed payments that are the LLC, of the assets in the LLC. tax at the corporate level. In compensation for services This generally holds true if (1) the order for double taxation to actually rendered to the liabilities of the LLC do not exceed be avoided, the LLC would partnership are self- the tax basis in its assets, and (2) need to be a disregarded employment earnings, and the LLC members only receive back entity held by an individual or therefore subject to self- shares (membership interest) of the a flow-through entity; employment taxes. In newly formed C corporation. Other however, under this fact addition to income taxes, the unique fact patterns could require pattern it would not be IRS requires you to pay self- additional considerations; thus, possible to obtain a tax-free employment taxes on converting from an LLC to a C liquidation. Generally guaranteed payments and all corporation should be discussed speaking, when exiting the partnership profits allocated with a tax advisor. corporate solution (and to you. Self-employment taxes double taxation) there will be consist of contributions to the a final tax assessed on any Social Security and Medicare built-in gain of assets inside systems, similar to what that liquidating corporation. employees must pay. Thus, - Self-employment taxes: future federal tax liabilities an LLC member that is may increase. an individual is liable for the full amount of self- employment taxes on any guaranteed payments, plus its share of any pass through ordinary income.

19 PwC Other Federal Taxes The tax rates are as varied as Transfer pricing 1. Sales & Use Taxes the goods and activities on which Transfer pricing regulations they are levied. The US does not impose a federal govern how related entities set internal prices for the transfers sales tax, use tax, or value-added tax Payroll Taxes (VAT). For information related to of goods, intangible assets, sales and use taxes that are imposed All payments for employment services, and loans in both by the States, please refer to Section within the United States are wages domestic and international II. State and Local Tax Issues. subject to contexts. The regulations are 1. Federal income tax withholding, designed to prevent tax 2. duties and import tariffs avoidance among related entities All goods imported into the United 2. Federal Insurance Contributions and place a controlled taxpayer States are subject to customs entry Act (FICA) taxes (i.e., social on par with an uncontrolled and are dutiable or -free in security and Medicare), and taxpayer by requiring inter- accordance with their classification. 3. Federal Unemployment (FUTA) company prices to meet the The classification also identifies tax, which are withheld by the arm’s-length standard. eligibility for special programs and employer on behalf of the The arm’s-length standard is free- preferential employee. Exceptions may apply. met if the results of a related duty rates. For employees sent to the United party transaction are consistent When goods are dutiable, ad States by their foreign employer, with results that would have valorem, specific, or compound duty there is a de minimis exception been realized if unrelated rates may be assessed. An ad for amounts less than $3,000 taxpayers had engaged in a valorem rate, the type most often and visits of less than 90 days; similar transaction under similar applied, is a percentage of the value also, certain treaty provisions circumstances. Under the of the merchandise. A specific rate is may eliminate the need to regulations, it is often the case a specified amount per unit of withhold income taxes (but that the arm’s length result can measure (weight or quantity). A generally not the need to report). be determined to fall within a compound rate is a combination of If a company has US employees, it range of comparable transactions both an ad valorem rate and a must pay and withhold social or comparable profits. specific rate. US Customs and security taxes equal to 6.2% of Comparable for a given Border Protection (CBP) requires wages for the employer and 6.2% for transaction are determined that the value of the goods be the employee, up to $128,400 of considering the following properly declared regardless of the wages in 2018, and Medicare taxes variables: dutiable status of the merchandise. equal to 1.45% for the employer and • Nature of the goods or services 1.45% for the employee. There is no Payment of duty becomes due at the being provided cap on wages subject to Medicare time an entry is filed with CBP. The • taxes. The employer also must Relationship between the obligation for payment is on the withhold an additional 0.9-percent parties and function of person or firm in whose name the Medicare tax on wages above the transaction between entry is filed, the importer of record. $200,000. The FUTA tax is between the parties The importer of record has a legal 0.6 and 6.0% (depending on credits • terms obligation to exercise reasonable for state unemployment taxes) on care in all aspects of its • Economic conditions such the first $7,000 of wages paid to importing activity. as geographic markets an employee. If a company is not in 3. Excise taxes A company generally must file compliance with the arm’s- The US government imposes quarterly and annual employment length standard, the IRS may excise taxes on a wide range of tax returns and annual wage adjust taxable income and tax goods and activities, including statements (Forms W-2) in its name payable in the United States. For gasoline and diesel fuel used for and employer identification number additional information on global transportation, air travel, unless such statements are filed by a tax issues, including additional manufacturing of specified goods, properly authorized third party. transfer pricing guidance, please and indoor tanning services. see Appendices E and F.

A guide to the key U.S. tax issues 20 Determining income a. LLC: Partnership Taxation c. LLC Disregarded 1. Gross Receipts LLCs that choose to be taxed as a Entity Taxation Income received in the normal partnership will default to not An LLC with only one member is course of business will be treated as recognize any profits or losses but treated as an entity disregarded and ordinary and taxable income, pass them through to each partner not separate from its owner for eligible to be offset by various tax (member) based on the partner’s federal income tax purposes (but as deductions, as discussed below. ownership percentage. The net a separate entity for purposes of capital gain or loss is reported on employment tax and certain other 2. Capital Gains Schedule K of Form 1065, US taxes). If the single member LLC’s Gains or losses on the sale or Return of Partnership Income. Each owner is an individual, the IRS exchange of capital assets held for partner will receive a K-1 showing treats the business as a sole more than 12 months are treated as the amount of capital gain to include proprietorship for income tax long-term capital gains or losses. as part of income or loss that can be purposes. LLC owners therefore Gains or losses on the sale or deducted on their tax return. The report business income and losses exchange of capital assets held for partner takes the information on the on their personal tax returns. 12 months or less are treated as Schedule K-1 and reports it on their short-term capital gains or losses. applicable entity tax return. Foreign Deductions The excess of net long-term capital partners would also be subject to US 1. Depreciation and amortization gain over net short-term capital loss filing and reporting of K-1 activity; is considered net capital gain. see Appendix D below for further Depreciation deductions are discussion. allowances that may be taken for For LLCs, generally capital losses capital expenditures for tangible are allowed only as an offset to b. LLC: C Corporation Taxation property. These deductions capital gains. Net capital losses and LLCs that elect to be taxed as a C generally flow thru to the LLC net capital gains are reported as corporation are subject to dual members. separately stated items and taxed taxation. If capital gains exceed based on the member’s tax profile capital losses, the net gain is 2. Charitable contributions for partnerships and sole considered ordinary income and Charitable deductions flow thru to proprietorship. For Corporations, added to the LLC’s other income. If the members and are generally capital gains are simply added to the capital losses exceed capital gains, limited based on the member’s corporation's ordinary income along the amount is carried back to the taxable income (with the exception with other income items and taxed previous three years. Any remaining of C Corporations). Deductions for at the corporate tax rates. capital losses can be carried forward contributions that are limited may for up to five years. The LLC pays be carried over to future years, taxes on capital gains at the subject to certain limitations. corporate rate. Profits are paid out 3. Research or experimental in dividends, and the LLC members expenditures will pay taxes on the dividends at their tax rates. Please refer to the Depending on entity classification, “Stripe Atlas – PwC Corporate research or experimental (R&E) Guide to US Taxes” for further expenditures that are paid or information. incurred during the tax year are generally deductible and flow thru to members. Taxpayers also can make a special election to amortize their research expenditures over 120 months.

21 PwC 4. Other common business Credits and incentives Administrative issues expenses deductible for tax 1. Foreign (FTC) 1. Reporting and Withholding • Salaries and Wages Generally, in any year, a US Withholding payments are generally • Repairs and company or individual can choose required to be made by the LLC’s or Maintenance Expenses whether to take as a credit (subject its members. If the payment falls to limitation) or as a deduction into the categories noted below, • Bad debts foreign income and excess profit requiring a withholding, the payor • State, local, and other taxes taxes paid or accrued during the tax withholds the tax from the payment, (excluding federal income tax) year to any foreign country or US which is then reported to the possession. An FTC reduces US recipient on the appropriate form. • Advertising and marketing income tax liability dollar for dollar, Withholding payments are remitted • Interest expense. Limitations while a deduction reduces US to the IRS on various forms exist on the amount of income tax liability at the marginal depending on the member’s entity interest expense deductible, rate of the taxpayer. status; please consult your tax specifically as it relates advisor. 2. General business credit to payments made to a. 1099-K foreign related Various business credits are available to provide special Form 1099-K is an IRS information 5. Other significant items incentives for the achievement return used to report certain payment transactions to improve • No deduction generally is of certain economic objectives. voluntary tax compliance. If you allowed for a contingent In general, these credits are have received payments from card liability until such liability is combined into one ‘general business transactions (e.g., credit or stored- fixed and determinable credit’ for purposes of determining each credit’s allowance limitation value cards), or payments in • Costs incurred for for the tax year. The general settlement of third party network entertainment must meet strict business credit that may be used for transactions, you will receive Form tests to be deductible a tax year is limited to a tax-based 1099-K by January 31st of the following year from your payment • Royalty payments, circulation amount. In general, the current service provider. costs, mine exploration, and year’s credit that cannot be used in a development costs, and other given year because of the credit’s You must report all income received miscellaneous costs of carrying allowance limitation may be carried on your tax return for all income on a business are deductible, back to the tax year preceding the you receive, you will need the subject to certain conditions current year and carried forward to information from Form 1099- K and limits. each of the 20 years following the when computing your federal current year. income taxes. Note that certain states also require 1099 reporting and have different activity thresholds for required reporting. Please consult with your tax professional for more information.

A guide to the key U.S. tax issues 22 b. Reporting payments to US c. Withholding on payments to d. Withholding on payments to US people or companies non- US people and people and US companies non-US companies A US entity engaged in a trade or All US and non-US entities are business that during the calendar If your new LLC makes certain responsible for information year makes payments to a US non- payments to entities or individuals reporting and backup withholding exempt payee totaling $600 or more outside of the US, you must for payments made to US non- must report the amount of the consider withholding requirements exempt recipients. Backup payments on Form 1099-MISC, in the US. withholding at the current rate of Miscellaneous Income. Payments 24% is required if the US non- People and companies making US- subject to Form 1099-MISC exempt recipient fails to provide a source payments (‘withholding reporting include compensation for taxpayer identification number agents’), such as US-source interest, services (other than wages paid to (TIN) in the proper manner prior to dividends, and royalties, to foreign employees), rents, royalties, payment or if the payor is instructed people or foreign companies commissions, gains, and certain to backup withholding by the IRS. generally must withhold 30% of the types of interest. US payers are payment amount as tax withheld at Payments made to US exempt responsible for reporting the source. In other situations, recipients are not subject to payment whether made by cash, withholding agents may apply a reporting or backup withholding check, or wire transfer. Amounts lower rate of withholding if the and such recipients are not required paid by payment card (including payee is eligible for a reduced rate to provide a TIN. Exempt recipients debt, credit, and procurement) are under a tax treaty or by operation of include governments (federal, state, not subject to Form 1099-MISC the US tax laws (e.g., portfolio and local), tax-exempt organizations reporting by the payor. interest exemption). under IRC Section 501(a), individual Form 1099-MISC must be furnished retirement plans, international The ability to apply a reduced rate to payees no later than January 31 of organizations, foreign central banks depends on whether the the year subsequent to the year of of issue, and most corporations and withholding agent receives valid payment and must be filed with the financial institutions. documentation evidencing the IRS by February 28 of the year foreign payee’s eligibility for a lower Payments made to US non-exempt following the payment. Requests to rate of withholding. Valid recipients for dividends, gross extend these dates may be made, documentation includes proceeds, interest, compensation for but extensions are not automatic. documentation provided using services, rents, royalties, prizes, The payor also must file Form 945, Form W-8. Since there are various awards, and litigation awards, Annual Return of Withheld Federal Forms W-8, the payee must among others, must be reported. A Income Tax, to report any backup determine which one is the correct proper TIN should be obtained from withholding. Form 945 must be form to be completed. all US payees to avoid backup filed with the IRS by January 31 of withholding. A TIN is best obtained the year succeeding the year by receiving a valid Form W-9, of payments. Request for Taxpayer Identification Number and Certificate, from US payees, including exempt recipients. The IRS’s TIN Matching Program also can be utilized to help to establish names or TINs with IRS records to help to establish accuracy.

23 PwC e. Reporting payments to non-US f. FATCA g. Other Informational Forms people and non-US companies FATCA, the Foreign Account Tax As part of the federal income tax Any taxes withheld on payments Compliance Act, was enacted in return, you may be required to made to foreign payees must be 2010 to prevent and detect offshore submit other informational forms. reported to the IRS on Form 1042, . FATCA requires many For example, Form 5472 is required Annual Withholding Tax Return for foreign financial institutions (FFIs) for foreign owned US companies US Source Income of Foreign and some nonfinancial foreign and is used to report certain Persons. A foreign person is a entities (NFFEs) to enter into transactions that occur between person who is not a citizen of the agreements with the IRS under foreign and US companies that host country in which he or she is which they undertake procedures to are related. residing or temporarily residing. For identify which of their accounts are 2. Filing requirements example, a foreign national in held by US people or US companies Canada is someone who is neither a and annually report information a. Tax period Canadian citizen nor a permanent regarding such accounts to the IRS. US LLCs are required to report resident of Canada. Form 1042 must FATCA imposes registration, due income tax filings on an annual be filed with the IRS on or before diligence reviews, information basis. The LLC may choose a tax March 15 following the calendar reporting, and tax withholding year that is different from the year in which the income subject to obligations on entities that qualify calendar year (refer to details reporting was paid, unless an as foreign financial institutions above). extension of time to file is obtained. (FFIs). Legal entities with FFI Form 1042 must be filed if a Form b. Tax returns characteristics must determine 1042-S is filed (see below), even if whether they are, in fact, FFIs and, The US tax system is based on the there is no withholding on the if so, whether they are required to principle of self-assessment. A payment. A withholding agent must register with the IRS. For example, multimember LLC must file an file with the IRS and furnish to each taxpayers with an interest in, or annual tax return (Form 1065) by foreign payee Form 1042-S, Foreign signature or other authority over, the 15th day of the third month Person’s US Source Income Subject foreign financial accounts whose following the close of its tax year. to Withholding. Form 1042-S is the aggregate value exceeded $10,000 Taxpayers can obtain a six-month information return used by at any time annually generally must extension to file its tax return, withholding agents to report US- file “Foreign Bank Account Report” provided it timely and properly files source payments paid to foreign (FBAR); this refers to FinCen Form Form 7004 and deposits the full payees. Form 1042-S must be filed 114, Report of Foreign Bank and amount of any tax due. Failure to with the IRS and furnished to the Financial Accounts. The FBAR is a timely file may result in interest and foreign payee on or before March 15 calendar year report and must be penalties. Taxpayers who elect to be following the calendar year in which filed on or before April 15 of the year taxed as a C-corporation, please the income subject to reporting was following the calendar year being refer to the filing requirements in paid, unless an extension is reported. Effective July 1, 2013, the “Stripe Atlas – PwC Corporate obtained. Form 1042-S is required FBAR must be filed electronically Guide to US Taxes”. The IRS treats whether or not withholding on the through FinCEN's BSA E-Filing one-member LLCs owned by payments has occurred. System. The FBAR is not filed with a individuals as sole proprietorships federal tax return. for tax purposes. Businesses that do not adhere to the new obligations under FATCA may face a variety of consequences.

A guide to the key U.S. tax issues 24 This means that the LLC itself does 4. Tax accounting methods 5. Penalties not pay taxes and does not have to For US federal tax purposes, the two Civil and criminal penalties may be file a return with the IRS. As the most important characteristics of a imposed for failing to follow the sole owner of your LLC, you must tax method of accounting are timing Internal Revenue Code when paying report all profits (or losses) of the and consistency. If the method does US taxes. The civil penalty LLC on Schedule C and submit it not affect the timing for including provisions may be divided into four with your 1040 or 1040NR tax items of income or claiming categories: delinquency penalties, return, due by the 15th day of the deductions, it is not an accounting accuracy-related penalties, fourth month following the close of method and generally, IRS approval information reporting penalties, and the calendar year (or by the 15th day is not needed to change it. In order preparer, promoter, and protester of the tenth month following the to affect timing, the accounting penalties. Many, but not all, of these close of the calendar year if the method must determine the year in provisions, include exceptions for return is on extension). which an income or expense item is reasonable cause should reasonable c. Payment of tax to be reported. cause exist. In addition, many include rules as to how a particular In general, in order to establish an A taxpayer’s (members) tax liability penalty interacts with the other accounting method, the method generally must be prepaid penalties. Failure to file the 1065 must be consistently applied, which throughout the year in four equal Partnership Tax Return means that typically means two years of estimated payments and fully paid the IRS will charge a late filing consistent filing. Once an by the date the tax return is initially penalty. The late filing penalty for a accounting method has been due for that year. For calendar-year 1065 Partnership Tax Return is adopted for federal tax purposes, corporations and individuals, the $195 dollars per partner (K-1) and any change must be requested by four estimated payments are due by month. The IRS defines a month as the taxpayer and approved by the the 15th days of April, June, “any part of a month”. September, and December (the 15th IRS. Changes in accounting of January of the following year for methods cannot be made through individuals). For fiscal-year amending returns. The two most corporations, the four estimated common methods of accounting are payments are due by the 15th days the accrual-basis and of the fourth, sixth, ninth, and cash-basis methods. twelfth month of the tax year (individuals do not have fiscal years). Generally, no extensions to pay are allowed. Failure to pay the tax by the due dates can result in estimated tax and late payment penalties and interest charges. 3. Statute of limitations The IRS generally has three years after an original return is filed to assess income taxes. A return will be deemed to have been filed on its extended due date, even if the return is actually filed on an earlier date.

25 PwC State and local tax issues

Companies with activity in the United accounting impacts on companies, States often are surprised that such including LLC’s. Therefore as a activity may trigger both federal and business owner/member, it is state-level taxes. Even more surprising, important to be aware of the constant there are no uniform rules among the changes, and account for them to states as to whether state tax liability reduce your potential risk. attaches; in some cases, significant If you are a resident of one state and state tax liabilities may be imposed earned non-resident income in another, even if little or no US federal tax you generally need to report this obligations exist. income on your resident state tax return. You are required to pay tax on Activities that could subject an all income received, even if it is from entity to state tax other states. You also might have a filing and tax requirement in the A state generally may impose its tax on nonresident state; however you will an entity to the extent a sufficient likely be eligible to receive a credit on ‘nexus’ or taxable connection exists your resident state taxes. In those between the entity and the state. While cases, you could have a tax liability in US federal taxation generally requires a multiple states. threshold level of activity of being ‘engaged in a trade or business’ or Once again, there is no clear cut answer having a ‘,’ if you need to file – it depends. mere physical presence in a state, such Practically speaking, you may not owe as having employees, owning property, any taxes, but some states require storing inventory, or paying for rental returns even if you owe no tax. It's property in the state, generally may be important to know the requirements of sufficient for nexus to exist for state each state. taxation purposes. We also note Economic nexus could be deemed to physical presence is not necessarily a exist between a state and a company requirement to have nexus with a state; based on the presence of intangible for example, on June 21, 2018, the US property in a state. For example, the Supreme Court in South Dakota v. license of trademarks to a company Wayfair overturned prior Court located in a state could create nexus for decisions and ruled that a physical the out-of-state licensor on the basis presence is not required for the that the intangibles are ‘present’ in imposition of sales and use tax. This the state. decision will have far-ranging tax and

A guide to the key U.S. tax issues 26 We note that property tax is also a Sales tax generally is imposed in • There is no requirement to state tax that individuals and the jurisdiction in which the ‘sale’ file an Annual Report or pay businesses could be subject to. For occurs. The definition of ‘sale’ Franchise Tax. purposes of this Guide, we have not differs from jurisdiction to • Failure to pay the required annual included discussion on this tax jurisdiction; however, the taxes will result in a $200 penalty other than to point out it exists and definition generally includes both plus 1.5% interest per month. to consult your tax advisor for consideration and transfer of title, further advice. right to use, or control (possession) LLCs who have elected to be treated in the case of tangible property and as C-Corporations have a required Allocating taxable income completion of the service act in the Annual Report filing fee of $50 due among the states: multistate case of a service. March 1. Starting in 2018, the apportionment minimum tax is $175 for Local taxation corporations using the Authorized For US state tax purposes, a Shares method and $400 for percentage of the entire net income Many cities impose separate income corporations using the Assumed Par of an entity may be subject to tax by tax filing obligations. Compliance Value Capital Method. Maximum a state. That percentage generally complexities multiply as US taxation Tax is $200,000 for both methods relates to the proportionate level of geographies can be further divided unless it has been identified as a activity (e.g., sales, property, and within states and some US cities Large Corporate Filer, then their tax payroll) the entity has within the have significant taxing powers. will be $250,000. Please refer to the state as compared with its activity In addition, cities impose “Stripe Atlas – PwC Corporate outside the state. local-level sales and use taxes. Guide to US Taxes” for Administratively, the sales taxes further information. Indirect tax considerations usually are collected by and Delaware requires that businesses State ‘indirect taxation’ generally remitted to the state, and then with nexus in the state must be refers to any state tax that is not allocated to the localities. Generally, licensed to do business in the state based on income. The most common the rules for the localities are and pay a fee, the amount of which indirect tax is a state’s sales and use modeled after the rules for the varies depending upon the type of tax; other indirect taxes include states, but this is not always the business. Additionally, such franchise taxes, real estate transfer case. The rules can vary from businesses are generally required to taxes, telecommunications taxes, jurisdiction to jurisdiction. pay a . The gross commercial rent taxes, and hotel Overall, there are thousands receipts tax is imposed on a occupancy taxes. The indirect taxes of indirect taxing jurisdictions business’s gross receipts in that apply depend on the nature of in the United States. Delaware. When determining the the company’s business activities. gross receipts tax due, most Delaware Franchise Tax Once a company has nexus to a businesses are entitled to an state with respect to sales and use LLC’s have the following exclusion, which varies depending taxes, that company must register requirements: on the business activity conducted. Generally the gross receipts tax with the state’s tax department, file • Any entity that is formed in sales tax returns, and pay its sales applies only to gross receipts for Delaware (regardless of where Delaware sales, however businesses tax liabilities. Depending on the you conduct business) must pay volume of sales, the company may need to keep documentation of the an Annual Tax for the privilege out of state sales. be required to file returns on an of incorporating in Delaware annual, quarterly, or monthly basis. of $300. Generally, sales tax is imposed on retail sales, leases, rentals, barters, • Annual Taxes are due no later or exchanges of tangible personal than June 1st of each year. property and certain enumerated services unless specifically exempted or excluded from tax.

27 PwC US tax treaties

The United States has in place income • Income earned by teachers, trainees, tax treaties with more than 60 artists, athletes, etc. countries, including treaties with most • Gains from the sale of personal European countries and other major property trading partners, including Mexico, Canada, Japan, China, Australia, and • Real property income the former Soviet Union countries. • Employment income Under these treaties, residents (not necessarily citizens) of foreign • Shipping and air transport income countries are taxed at a reduced rate, or • Income not otherwise are exempt from US taxes on certain expressly mentioned items of income they receive from sources within the United States. For The categories of income covered vary state considerations, please see other from treaty to treaty, and no two state tax issues within this Guide. treaties are the same. There are many ‘gaps’ in the US tax To gain treaty benefits, it is necessary treaty network, particularly in Africa, to satisfy the conditions of the Asia, the Middle East, and residency article as well as certain South America. other requirements. US income tax treaties typically cover various categories of income, including: • Business profits • Passive income, such as dividends, interest, and royalties

A guide to the key U.S. tax issues 28 How can PwC help?

As can be seen from the discussion • Acquisitions and dispositions: above, the complexity of US Evaluate the US tax implications of has a profound effect on foreign- US inbound acquisitions and owned US operations as well as US- dispositions designed to owned operations, and, most implement key initiatives importantly, the return on • Business and tax alignment: investment. These complexities Align cross-border business provide incentive to manage and tax objectives efficiently the US businesses. In our experience with US activities, we are • Compliance: Address compliance seeing increased activity from the requirements with respect to US tax authorities in the areas of federal and state tax laws, jurisdiction to tax, income shifting, particularly targeted areas such as inbound financing, repatriation, transfer pricing and FACTA and withholding. • US income tax treaties and PwC’s Tax practice comprises a competent authority: national network of cross- Determine the applicability and disciplinary professionals dedicated desirability of obtaining the to understanding the unique benefits of US tax treaties in the nuances faced by both domestic and context of cross- border financing foreign-based Multi-National and investment, as well as Corporations (MNCs). We provide international mergers, technical support and end-to-end acquisitions, and dispositions view of issues to assist companies in • US tax benefits: Consider federal formulating their US policies. We and state tax benefits, including have identified, developed, credits and incentives available to implemented, and documented a US inbound companies wide variety of opportunities strategies to help foreign MNCs • Legislative and regulatory meet their business needs. services: Monitor real-time developments on fast-moving US In the current challenging federal and state legislative and economic environment, we can regulatory developments and their work together on: impact on business planning • Audit support: Respond to IRS and state revenue agency challenges, including proper characterization of US inbound financings as debt versus equity.

29 PwC Appendix A: Other taxes

1. Stamp taxes 2. Capital gain 3. Affordable Health Care Act (ACA) There is no federal-level stamp tax. The corporate tax rate on long- However, state and local term capital gains depends on the The Affordable Care Act contains governments frequently impose member’s status. For members comprehensive health insurance stamp taxes at the time of officially that are corporations, it is taxed at reforms and includes tax provisions recording a real estate or other the same rate as ordinary income. that affect individuals, families, transaction. The state or local sales Thus, the maximum corporate rate businesses, insurers, tax-exempt tax on real estate may be a stamp is 21%, excluding the additional organizations and government tax on the documents recording the phase-out rates. However, if the entities. These tax provisions transfer of the real estate. contain important changes, member is an individual it will be including how individuals and taxed between 10-23.8%. families file their taxes.

A guide to the key U.S. tax issues 30 Appendix B: Other issues

1. Group taxation 2. Thin capitalization 3. Payments to foreign affiliates A partnership may not be included Thin capitalization rules may apply A US limited liability company in a consolidated return, even if it to disallow interest payments generally may claim a deduction for is 100% owned by members of an related to ‘excess’ debt and to royalties, management service fees, affiliated group, since a partnership recharacterize such payments as and interest charges paid to foreign is not a corporation. However, a affiliates, to the extent the amounts dividends. One of the tax law member's earnings that flow are actually paid and are not in changes enacted in 2017 imposes a through from a partnership are excess of what it would pay an included as part of the consolidated new limitation on deductions for unrelated entity (i.e., are at arm’s group's taxable income or loss. business interest expense. The length). US withholding on these Filing on a consolidated (combined) limitation is earnings-based and is payments may be required. basis is also allowed (or may be imposed by section 163(j) of the Tax required or prohibited) in Code. For most taxpayers, certain states. deduction of net business interest expense is limited to 30 percent of their adjusted taxable income for tax years beginning after Dec. 31, 2017. For more information on section 163(j), please consult your tax advisor.

31 PwC Appendix C: Information reporting

Form W-8BEN, Certificate of In addition to Form W-8BEN Treaty claims made by nonresident Foreign Status of Beneficial Owner or Form W-8BEN-E, other forms alien individuals who provide for United States Tax Withholding, that can be provided by a foreign independent personal services in is the most commonly used Form payee to reduce or eliminate the US are made on Form 8233, W-8. That version is used to withholding are: Exemption from Withholding on establish that the payee is not a US Compensation for Independent • Form W-8ECI, Certificate of person and is the beneficial owner (and Certain Dependent) Personal Foreign Person’s Claim That of the income related to which the Services of a Nonresident Alien Income Is Effectively Connected Form W-8BEN is being provided. Individual, instead of on Form with the Conduct of a Trade or Form W-8BEN also can be used to W-8BEN. Business in the United States, is claim a reduced rate of withholding provided by a non-US entity or Forms W-8BEN, W-8BEN-E, W- based upon an applicable income individual that is engaged in a US 8ECI, and W-8EXP generally are tax treaty. Note: Form W-8BEN is trade or business and has income valid for three years from the date used only by individuals. Entities that is effectively connected with the form is signed. New forms are use Form W-8BEN-E. such US trade or business. required prior to the expiration of Form W-8BEN-E, Certificate of three years if there is a change in • Form W-8EXP, Certificate of Status of Beneficial Owner for the information disclosed by the Foreign Government or Other United States Tax Withholding and payee on the forms. For some Foreign Organization for United Reporting (Entities). Among other purposes (not applicable if treaty States Tax Withholding & purposes (e.g., FATCA), this form is benefits are claimed), the forms can Reporting, is provided by non-US used to establish that the payee is remain valid indefinitely absent a governments or non-US tax- not a US person and is the beneficial change in circumstances. Form W- exempt organizations. owner of the income related to 8IMY is valid indefinitely unless which the Form W-8BEN-E is being • Form W-8IMY, Certificate of there is a change in the information provided. Form W-8BEN-E also can Foreign Intermediary, Foreign disclosed by the payee on the forms. be used to claim a reduced rate of Flow Through Entity, or Certain Form 8233 is valid for only one withholding based upon an US Branches for United States year. Once the Company has applicable income tax treaty. Tax Withholding & Reporting, is collected W-8BEN, the Company Note: Form W-8BEN-E is used provided by a non-US flow- should retain copies on file in case only by entities. Individuals use through entity (e.g., partnership) requested by the IRS. Form W-8BEN. that is not engaged in a US trade or business. Form W-8IMY generally must be accompanied by Forms W-8 and/or Form W-9 for the beneficial owners and a withholding statement that allocates the income to the beneficial owners.

A guide to the key U.S. tax issues 32 Appendix D: Foreign company and individual considerations

When foreign limited liability There is no definition in the tax statute of a companies are investing in the US they trade or business within the United should be aware of the potential US tax States—instead, that concept has been implications for the foreign entity developed mainly by the IRS and court interacting with the US. While the US decisions through a facts-and- tax consequences of the US limited circumstances analysis. The following liability company are described have been considered by the courts and/or throughout this Guide, there are other the IRS: tax considerations for a foreign • The business must have a profit motive. company to manage the US tax risk of the activities of the foreign • Activities generally must be company. The following issues should ‘considerable, continuous, and regular.’ be considered: • Ministerial, clerical, or collection- related activities generally are not US trade or business sufficiently profit-oriented to constitute Generally, a foreign owned limited a US trade or business. liability company engaged in a US trade • Isolated activities generally do not rise to or business is taxed at regular US tax the level of a trade or business. rates. The LLC is taxed on income from US sources that is effectively connected • An agent’s activities in the United States with that business; if the LLC has may result in a US trade or business. income on US-source income that it is not effectively connected with, the withholding rate is 30 percent imposed on that gross income, unless lowered by treaty. A non-resident who earns income that is effectively connected with a U.S. trade or business (other than personal service income, e.g., wages) is subject to the same estimated tax payment requirements as residents.

33 PwC Is the foreign partner engaged in a You usually are engaged in a Reg. Sec. 1.875-1 provides that the US trade or business? US trade or business when you same test for determining whether Generally, when a foreign person perform personal services in the an individual is engaged in a USTB engages in a trade or business in the United States. applies for determining whether a partnership is engaged in a USTB. United States, all income from If you own and operate a business in Activities of the partnership that do sources within the United States the United States selling services, not rise to the level of a trade or connected with the conduct of that products, or merchandise, you are, business should not be attributed to trade or business is considered to be with certain exceptions, engaged in a partner who is a foreign person for Effectively Connected Income (ECI). a trade or business in the United purposes of determining whether This applies whether or not there is States. For example, profit from the such person is engaged in a USTB. any connection between the income, sale in the United States of and the trade or business being inventory property purchased either The Code itself does not provide a carried on in the United States, in this country or in a foreign general definition of the phrase during the tax year. A foreign country is effectively connected “trade or business within the United person is defined by the IRS to trade or business income. States.” In general, whether a include: an individual who is not a partnership is engaged in a USTB is Gains and losses from the sale or citizen or resident of the United determined through a factual exchange of US real property States, an individual who is a citizen analysis of the activities that interests (whether or not they are or resident of a US possession who transpire at the partnership level. capital assets) are taxed as if you are is not otherwise a citizen or resident The courts generally have required engaged in a trade or business in the of the United States, any that the activities in the United United States. You must treat the partnership, association, company, States be considerable, continuous, gain or loss as effectively connected or corporation that is not created or and regular to give rise to a USTB. with that trade or business. organized in the United States. Pinchot v. Comm'r., 113 F.2d 718 You are considered to be engaged in Income from the rental of real (2d Cir. 1940) (a foreign person a trade or business in the United property may be treated as ECI if holding substantial real estate in the States if you are temporarily present the taxpayer elects to do so. United States was engaged in a US in the United States as a business where its agent's Under Section 875(1), if a nonimmigrant on an "F," "J," "M," management activities were partnership is engaged in a US trade or "Q" visa. The taxable part of any considerable, continuous, and or business (USTB) then each of its US source scholarship or fellowship regular); Linen Thread Co. v. foreign partners is deemed to be so grant received by a nonimmigrant in Comm'r., 4 T.C. 802 (1945) engaged. This rule applies without "F," "J," "M," or "Q" status is treated (collecting income from investments regard to the number of ownership as effectively connected with a trade and sporadic sales was not the tiers interposed between the foreign or business in the United States. conduct of a business in the United partner and the operating States). Because the existence of a If you are a member of a partnership. This entity-oriented business in the United States is partnership that at any time approach, therefore, sweeps into the considered a factual issue, the IRS during the tax year is engaged in a domestic taxing net a foreign will not issue advance rulings with trade or business in the United partner regardless of the extent of respect to particular transactions. States, you are considered to be their ownership or degree of (Rev. Proc. 85-22, 1985-1 C.B. 550) engaged in a trade or business in the participation in the partnership. United States.

A guide to the key U.S. tax issues 34 Foreign-owned • An LLC owned by a non-US Certain types of foreign-source single-member LLCs company that has made an income generated through a US The regulations treat a US domestic, election to be disregarded for US office can be effectively connected disregarded entity wholly owned income tax purposes and is owned income. These include: by a single non-US individual, by a foreign person as a domestic • Rents or royalties for use of company, partnership or trust. corporation separate from its property located outside the owner for the limited purposes of A single-member LLC owned by a United States reporting, record maintenance foreign person is also generally and associated compliance • Foreign-source dividends or required to report LLC income, requirements. A foreign interest derived in active conduct deductions and credits on Schedule person includes: of banking business in the United C of their individual US tax return States, or received by a • An individual who is not a citizen (Form 1040NR) due by the 15th day corporation the principal business or income tax resident of the of the fourth month following the of which is trading in stocks or United States; close of the calendar year (or by the securities for its own account • Any partnership, association, 15th day of the tenth month company or corporation that is following the close of the calendar • Gain from the sale outside the not created or organized in the year if the return is on extension). United States of inventory United States; and property and property held for Foreign-owned sale to customers, unless the • A trust that is classified as foreign multi-member LLCs property is sold for use outside under either the control test or If the multi-member LLC has not the United States and a non-US the court test in Section made an election to be taxed as a C- office materially participates in 7701(a)(31) of the Internal Corporation, it is classified as a the sale. Revenue Code. partnership for US income tax The following US LLCs, among purposes. An LLC treated as a Determining if a foreign others, may be required to file partnership is required to file Form partner's income is effectively Form 5472 1065 (US Return of Partnership connected income • An LLC with a single non-US Income) annually with the IRS, The first issue in determining if a owner, which may be a foreign unless the LLC neither receives foreign partner's income is individual, company, partnership income nor incurs any expenditures effectively connected income is to or non-grantor trust; treated as deductions or credits for determine whether the foreign • An LLC owned by another LLC federal income tax purposes. partner is engaged in a USTB. If the which is owned by a single non- foreign partner is considered US owner, in which case both Effectively connected income engaged in a USTB, it next must LLCs may have a filing As mentioned above, passive-type determine whether the foreign requirement; income and gain from the sale of partner's income or its distributive • An LLC owned by a grantor trust capital assets are treated as share of partnership income is (whether domestic or foreign), the effectively connected to the US considered effectively connected to grantor of which is foreign; and trade or business and subject to US a USTB. tax if a connection with the US trade or business exists.

35 PwC Permanent U.S. source FDAP income and US source other than FDAP and Establishment (PE) capital gains capital gains Multinational businesses face a If a foreign partner is considered All US source income of a foreign variety of tax systems in the engaged in a USTB, its US source of taxpayer other than FDAP or capital countries where they operate. To Fixed, Determinable, Annual or gain income is treated as effectively reduce or eliminate double taxation Periodic income (FDAP) and capital connected to the taxpayer’s trade or between countries, promote cross- gains are effectively connected only business under Section border trading, and alleviate the to the extent such income either (1) 864(c)(3). This limited “force-of burden of administration and is derived from assets used or held attraction” principle brings within enforcement of tax laws, countries for use in the taxpayer’s trade or the US tax system not only ordinary typically enter into income tax business (so-called “asset-use test”) business profits generated by the treaties outlining how parties to the or (2) the activities of the taxpayer’s taxpayer’s US business, but also US treaty (contracting states) will be trade or business were a material source profits from sales that are taxed on income earned in each factor in the production of the unrelated to the taxpayer’s USTB. contracting state. income (so-called “material factor test”). (Section 864(c)(2); Reg. Sec. In general, a foreign partner Income tax treaties contain an 1.864-4(c)) In addition, the engaged in a trade or business article describing whether the regulations contain special rules for activity in the United States will be activities of an enterprise rise to a determining whether US source taxable on “business profits” level of a permanent establishment FDAP income and capital gains are generated from that activity under a (PE) in a contracting state. The income that is effectively connected bilateral tax treaty only to the extent existence of a PE is important in the case of a foreign person the foreign person has a “PE” in the because it gives the contracting state engaged with the “active conduct of United States to which the profits the right to tax the enterprise’s a banking, finance or similar are “attributable.” Thus, the income attributable to the PE. This business in the United States.” (See sometimes harsh results of the includes income from carrying on a Reg. Sec. 1.864-4(c)(5).) limited “force-of attraction” business in the contracting state and principle may be avoided under a passive income, such as interest, bilateral tax treaty where the dividends, and royalties. unrelated income would be exempt A PE generally means: from US tax since it generally would not be “attributable” to the • There is a fixed place of business taxpayer’s PE in the United States. through which the business of an enterprise is wholly or partly carried on, or • An agent acting on behalf of the enterprise has and habitually exercises the authority to conclude binding on the enterprise.

A guide to the key U.S. tax issues 36 Foreign source income Withholding of foreign If a foreign corporation has If a foreign partner is considered partner's share of effectively effectively connected income then, engaged in a USTB, in certain connected income in addition to the normal corporate narrow situations, foreign source If a partnership has “effectively income tax imposed on the foreign income may be treated as effectively connected taxable income,” Section corporation's net effectively connected income of a foreign 1446(a) requires withholding with connected income, the foreign taxpayer. Section 864(c)(4) provides respect to any portion of such corporation is subject to a 30 that, in general, certain categories of income that is allocable to a foreign percent tax (which rate may be foreign source income will be partner under Section 704. The reduced, eliminated, or prohibited treated as effectively connected if applicable withholding rate is the by treaty) on its “dividend the taxpayer has an office or fixed highest rate of tax imposed by the equivalent amount.” (Section place of business in the United Code on the type of partner 884(a)) Thus, foreign corporations States to which such income is involved. Each foreign partner may may bear effective US tax on attributable. The purpose behind credit the partner's share of the effectively connected income at a this rule is to tax income that has its Section 1446 withholding tax paid combined rate of 54.5 percent, true economic source in the United by the partnership against the computed without regard to state States, but which the taxpayer has foreign partner's federal income and local taxes. been able to convert to foreign tax liability. The branch profits tax is imposed on source income by virtue of the taxpayer’s effectively connected manipulation of the Code’s Branch profits tax earnings and profits, adjusted for source rules. The US imposes an additional tax (a increases and decreases in the Section 864(c)(5) provides detailed 30 percent “branch profits tax”) on taxpayer’s US net equity. The rules for determining when a the branch income of a foreign regulations specifically address how foreign person is deemed to have an corporation for income derived in these concepts are applied. the United States. This tax rate is office or fixed place of business and If an LLC elects to be treated as reduced if the dividends taxation when income is deemed to be a C-Corporation, please refer to rate is less under an applicable attributable to such office or fixed the “Stripe Atlas – PwC bilateral US income tax treaty. This place of business. Corporate Guide to US Taxes” for branch profits tax is a substitute tax further information. The office or fixed place of business for what would be a tax on a profits of a partnership is considered to be distribution (i.e., dividend) if the the office or fixed place of business branch had been incorporated as a of each of its partners. domestic corporation. Section 864(c) also characterizes as effectively connected certain items of income or gain that would have been treated as effectively connected if the transaction giving rise to the income or gain had occurred in an earlier year when the taxpayer was engaged in a USTB. In effect, these rules carry forward the taxpayer’s trade or business status to the year in which the income or gain is recognized.

37 PwC Appendix E: Transfer pricing

Due to growing government deficits, Under this principle, transactions Best method rule many jurisdictions are putting between two related parties should The Section 482 regulations provide additional pressure on transfer not produce results that differ from several specified methods to test pricing in order to secure a larger those that would have resulted from whether a price meets the arm’s- portion of entities’ profits for their similar transactions between length standard. Although there is tax bases. independent companies under no strict priority of methods, and no similar circumstances. This This can result in the risk of tax method invariably will be principle is cited in the US transfer assessments, double taxation of the considered to be more reliable than pricing rules (IRC Section 482 and same income by two jurisdictions, another, every transaction reviewed the Treasury regulations and penalties for failure to properly under Section 482 must be judged thereunder), the OECD Transfer allocate income among two or more under the method that, under the Pricing Guidelines, and the UN jurisdictions. Therefore, virtually all facts and circumstances, provides Manual for developing countries. large MNCs require consideration of the most reliable measure of There are some countries (e.g., international transfer pricing an arm’s- length result (i.e., the Brazil) that do not follow the strategies and potential risks. ‘best method’). international application of the Transfer pricing applies to a wide arm’s- length principle. The selection of a method also range of intercompany transactions, varies depending on the type of If a transaction between related including transactions involving: transaction. For example, the parties is priced differently than if it regulations provide five specified • Tangible goods (e.g., were between unrelated parties, the methods for transactions involving manufacturing, distribution) IRS has authority to reallocate tangible property, six specified income or expenses to reflect the • Services (e.g., management methods for service transactions, amounts that would have resulted services, sales support, contract three for transactions involving had the transaction been conducted R&D services) intangible property, and five for at arm’s length. platform contribution transactions • Financing (e.g., intercompany The Section 482 regulations are as part of a cost sharing loans, accounts receivable, extensive and attempt to address a arrangement. Methods not specified guarantees, debt capacity) full range of transactions in light of in the regulations are also • Intangible property the arm’s-length standard. In potentially applicable. Note that (e.g., licenses, royalties, cost practice, however, it is not easy to while each method is important sharing transactions, platform determine the appropriate arm’s- to understand, an examination of contribution transactions, sales length result based on a given set of each is beyond the scope of of intangibles). facts and circumstances. this discussion. Transactions of goods and services The international standard may embody unique, company or for determining the industry- specific elements that are appropriate transfer price is difficult to compare with the arm’s-length principle. transactions involving other companies. The Section 482 regulations concede the rarity of identical transactions, and instead, attempt to determine the arm’s- length results based on the ‘best method’ rule.

A guide to the key U.S. tax issues 38 Comparability factors Arm’s-length range Having contemporaneous transfer To determine the best method for a The Section 482 regulations pricing documentation that satisfies particular transaction, the relative recognize that a method is likely to the requirements under Section reliability of a method must be produce a range of arm’s length 6662(e) in place at the time the tax evaluated on the degree of results and provide that a taxpayer return is filed can provide comparability between the will not be subject to adjustment if protection against these penalties. controlled transaction or taxpayers the taxpayer’s results fall within Another avenue for avoiding and uncontrolled comparables, such an arm’s- length range. The potential transfer pricing penalties taking into account certain factors. arm’s-length range ordinarily is can be an advance pricing While a specific comparability factor determined by applying a single agreement (APA)—an agreement may be of particular importance in pricing method selected under the between a government and a applying a method, each method best method rule to two or more taxpayer that provides prospective requires an analysis of all the uncontrolled transactions of similar ‘certainty’ for a defined term factors that affect comparability comparability and reliability. regarding covered intercompany under that method. The comparables used for the transactions. APAs can be unilateral uncontrolled transactions must be (between the taxpayer and the IRS), Quality of data sufficiently similar to the controlled bilateral (with the IRS and another and assumptions transaction. If material differences tax authority), or multilateral (with Whether a method provides the exist between the two transactions, the IRS and more than one other most reliable measure of an arm’s- adjustments must be made in order tax authority). length result also depends upon the for the uncontrolled transaction to In the future, other approaches for reliability of the assumptions and have a similar level of comparability avoiding adjustments or penalties the sensitivity of the results to and reliability. In many cases, the for certain controlled transactions possible deficiencies in the data reliability of the analysis will be without the need for documentation and assumptions. improved by adjusting the range or APAs may become available. For The completeness and accuracy of through the application of a valid example, the United States is the data affect the ability to identify statistical method, often the considering providing safe harbors and quantify those factors that interquartile range of results. for certain types of routine would affect the result under any transactions, such as distribution particular method. Likewise, the Penalties and documentation functions of inbound companies. reliability of the results derived The Internal Revenue Code imposes The US view on this approach is from a method depends on the penalties if a taxpayer receives an similar to that outlined by the soundness of assumptions made in IRS transfer pricing adjustment OECD. However, the United States applying the method. Finally, the exceeding certain thresholds. The intends to implement any such sensitivity of results to deficiencies penalties do not apply, however, if policy in a bilateral fashion that in data and assumptions may have a the taxpayer has prepared and would require reaching a separate greater effect on some methods than documented a reasonable transfer agreement with each treaty partner. others. In particular, the reliability pricing analysis supporting its As a result, it likely will take some of some methods depends heavily reported transfer pricing. time before safe harbors become a on the similarity of property or component of US . Under Section 6662(e), the transfer services involved in the controlled pricing penalty generally is equal to and uncontrolled transaction, while 20% of the underpayment of tax other methods rely on broad attributable to the transfer pricing comparisons of profitability. misstatement, but increases to 40% of the underpayment of tax for larger adjustments.

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