As per IRS, rental income will be taxed depends on whether or not the foreign person who owns the property is considered "engaged in a U.S. trade or business." Ownership of real property is not considered a U.S. trade or business if it consists of merely passive activity such as a net lease in which the lessee pays rent, as well as all taxes, operating expenses, repairs, and interest in principal on existing mortgages and insurance in connection with the property. Such passive rental income is subject to a flat 30 percent withholding tax (unless reduced by an applicable income tax treaty) applied to the gross income rather than the "net rent" received. Thus, the real estate taxes, operating expenses, ground rent, repairs, interest and principal on any existing mortgages, and insurance premiums paid by the lessee on behalf of the foreign owner-lessor, must be included in gross income subject to the 30 percent withholding tax. The gross income and withheld taxes must be reported on Form 1042-S, Foreign Persons U.S. Source Income Subject to Withholding to the IRS and the payee by March 15 of the following calendar year. The payor must also submit Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, by March 15.
So I guess my question is, is there a way we can set up another LLC that provides services to my other LLC to become engaged in a US business and reduce tax that way?
I am just curious of the options we have as 35% is a lot of money to pay in taxes!
@Brandon Hall I would love to hear your opinion on this too, I enjoy reading your posts as they all always very informative. Thanks!
@Jay Patadia sorry, forgot to tag.
There is no tax on cash disbursement to foreign partner, tax is only on the net rental income (includes Depreciation, Amortization). If there is loss, no need to withhold anything.
@Jay Patadia that's what I thought, however I had somebody tell me that the tax would be on the gross rents which did not make sense to me.
A lot of wealthy foreign individuals become shareholders in a Corporation who ultimately invests in the partnership fund.
Joshua Davies, LLC has 2 memebrs in his LLC; Joshua Davies and International Corp, Inc
The shareholders in International Corp, Inc. are International Investor 1 and International Investor 2.
When money is distributed by the Corporation to the investor - it is no longer rental income; it is dividend income.
The Partnership is now not required to withhold or file form 1042 since the member is not a foreign partner.
The international investors avoid having to file a US tax return because they are receiving dividend income instead of "rental income"
There are some pros/cons associated with this approach.
Possibly more administrative costs(registering of corp), filing of corporate tax return etc.
however, many foreign investors like this approach.
@Basit Siddiqi thanks for your response. In this case we would have to withhold 35%? I am looking for a way for us to elect to be taxed on a net basis, that way the partners file a US tax return, but as we would have a passive loss on paper there would be nothing to tax.
Do you know what our options are for this?
@Basit Siddiqi tag isn’t working.
Foreign investors have to be concerned with FDAP(fixed, Determinable, Annual, Periodical) income or ECI(effectively connected income).
Rental income is normally considered FDAP but you can make an election to make it taxed as ECI.
ECI is more advantageous if you expect expenses to leave income below $0.
Regardless of the strategy you choose - they shouldn't have to pay 30% on gross income(as long as you make proper elections).
Taxes involving foreign investors can get tricky. You should look to do everything by the book. Otherwise you can be on the hook for any unpaid taxes if the foreign investors failed to file a tax return.
@Basit Siddiqi And how do we elect the ECI option? Is that done at the time of LLC set up?
With deductions and depreciation, I would expect the net income to be $0.
@Basit Siddiqi thanks for sending! That was a good read. In the situation that we elect to be taxed on a net basis like this, how are the distributions processed? Would the foreign investors then be taxed again on this?
You should have the UK investors consult with a CPA to protect yourself. You don't want to provide incorrect advice.
Distributions from a partnership are normally not a taxable event unless the distribution is in excess of the partner's basis in the partnership.
Another thing to be wary about is how the UK will tax their income generated through the US LLC.
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