Forming a US LLC with a permanent establishment: what the tax rules then require

If you build a real business in the USA, with an office, employees, a warehouse or management on the ground, you are forming an LLC that truly arrives in America for tax purposes. Its profit is taxable there, the LLC and its members file returns with the IRS, and the tax treaty decides how your country of residence treats that profit. This page explains when an LLC has a permanent establishment under US law and under the treaty, which forms follow and how the formation works.

1An LLC with a real business in the USA

This page is for entrepreneurs who really want to do business in America. You open an office or a workshop, hire staff, store inventory, run your business on the ground or move to the USA yourself. Your LLC is then more than a shell with a Registered Agent: it is an American business, and US tax law treats it as one.

That is exactly what we form LLCs for. What you need to know before ordering one of our LLCs, from residence to filing obligations, is set out in Important notes on the US LLCs we offer. Read that page in full before you order.

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Two questions drive everything else. Under US law: is the LLC engaged in a trade or business in the USA, and which profit is connected with it? Under the tax treaty: does the business have a permanent establishment in the USA, and which profit is attributable to it? Both tests run side by side, and for a real business in the USA they almost always reach the same result.

2When your LLC is doing business in the USA

The law does not define a trade or business within the United States exhaustively, but it does set the framework. Under Section 864(b) of the Internal Revenue Code, it expressly includes performing personal services in the USA at any time during the tax year. The IRS describes the basic case like this: if you own and operate a business in the USA that sells services, products or merchandise, you are, with certain exceptions, engaged in a trade or business in the USA. The activity must be considerable, continuous and regular.

For an LLC, it comes down to its tax classification. A single-member LLC is disregarded unless it makes an election; its business is treated as if the member ran it directly. A multi-member LLC is a partnership unless it makes an election, and Section 875 provides that a foreign partner is treated as engaged in a trade or business in the USA if the partnership is. So if you hold 20 percent of an active LLC, the IRS sees you as running a business in the USA yourself, even if you never set foot in the office.

The typical signs of an LLC with a real business are therefore easy to spot: an office, workshop or warehouse in the USA, employees there, management making decisions there, contracts negotiated and signed there. If you want to bring your family to the USA on a visa, you need exactly this picture anyway; an E-2 visa, for example, requires a substantial investment in a real US business that you build and run. How to plan the company and the visa together is covered in the visa roadmap for your formation.

3Effectively connected income: which profit is taxable in the USA

If the LLC is engaged in business in the USA, the profit connected with it is taxed as effectively connected income, or ECI. Section 864(c) sets out what counts. US-source income from the business itself, such as from selling goods and services, is ECI. For US-source interest, dividends, rents and similar income, the law asks two questions: does it come from assets used in or held for use in the business, and were the business activities a material factor in earning it? Foreign-source income becomes ECI only in narrowly defined cases, for example when it is attributable to an office in the USA.

ECI is taxed after deductions, just as for Americans. Under Section 871(b), an individual pays the regular graduated income tax rates on their ECI; as the IRS puts it, ECI is taxed after allowable deductions at the graduated rates that apply to US citizens. Under Section 882, a foreign corporation pays the corporate income tax under Section 11, which is 21 percent of taxable income.

On top of that come state taxes, which follow their own rules. Texas, for example, levies no personal income tax but does charge its franchise tax on the LLC; details are in Forming a Texas LLC. How business profits are taxed in the USA overall is explained in Taxation of business profits in the USA.

4The permanent establishment under the treaty

US law says what the USA wants to tax. The tax treaty between the USA and your home country says what the USA may tax when the business is based there. US tax treaties typically follow the same structure across two articles.

Article 7 draws the consequence. The profits of a business may be taxed only in its state of residence unless it carries on business in the other state through a permanent establishment there. In that case, the other state may tax the profit, but only as much as is attributable to the permanent establishment. What is attributed is the profit the permanent establishment would have earned as an independent business under the same conditions; expenses incurred for the permanent establishment are deductible, even if they arise elsewhere.

The table puts both tests side by side. For an LLC with an office, employees and management in the USA, the result is clear: it is engaged in business in the USA, it has a permanent establishment there, and the USA taxes its profit.

5What the LLC and its members file

Who files what with the IRS depends on how the LLC is classified. The table shows the four most common cases.

5.1A single member abroad

The disregarded LLC pays no income tax itself, but it is treated as a corporation for the reporting rules under Section 6038A. Every year it files Form 5472 with a pro forma Form 1120 cover sheet, by the Form 1120 deadline, which is the 15th day of the fourth month after the end of the tax year. Missing it risks a $25,000 penalty per year; more in Form 5472. The owner reports the profit personally: as an individual on Form 1040-NR, which anyone engaged in a trade or business in the USA must file; see Form 1040-NR. If the owner is a company, such as your company at home, it files Form 1120-F. A foreign corporation may also owe the branch profits tax under Section 884, 30 percent on the so-called dividend equivalent amount; whether the treaty limits it belongs in your tax plan.

5.2Multiple members

The LLC is a partnership and files Form 1065 with a K-1 for each member, by March 15 if its fiscal year is the calendar year; see Form 1065. Because foreign members are involved, Section 1446 also applies: the partnership withholds tax on the share of ECI allocable to foreign members, at the highest individual income tax rate for individuals and at the corporate rate for companies. To do so it files Form 8804 and a Form 8805 for each foreign member, generally by the 15th day of the third month after the end of the tax year, or by the 15th day of the sixth month if its books are kept outside the US. The members report their share themselves and credit the tax withheld. The partnership also needs a Partnership Representative with a substantial presence in the US.

5.3LLC electing to be taxed as a corporation

With Form 8832, the LLC can elect to be taxed as a corporation. It then pays 21 percent corporate tax on its profit itself and files Form 1120, together with Form 5472 if it has a foreign owner. Distributions to the members then follow the rules for dividends. Whether this election makes sense for you depends above all on your country of residence.

7The process: forming an LLC with a permanent establishment

Forming an LLC that runs a real business follows a set order. First, the structure and tax plan are settled: who the member is, you personally or your company at home, how the LLC is classified and how your country of residence treats it. Then the state is chosen. For a company that operates in the US, that is usually the state where the business takes place, because otherwise it would also have to register there as a foreign company; the comparison is in Choosing the right state.

Next come the formation document filed with the Secretary of State with a Registered Agent, the Operating Agreement and the initial resolutions, the EIN from the IRS, and the BE-13 report to the Bureau of Economic Analysis within 45 days if a foreign owner holds at least 10 percent; see BE-13 report. After that come the business bank account and substance on the ground: premises, contracts, employees. Payroll starts with your first employees, and depending on the state, sales tax starts with your first sales.

What this company costs in state fees year after year is set out in Annual costs of a US company. You can order the LLC on Form a US LLC, in six states, either as a subsidiary of your company at home or as a stand-alone company.

8The calendar for a year

An LLC with a permanent establishment has more deadlines than a dormant one. For a partnership whose fiscal year is the calendar year, March 15 is the first big deadline, with Form 1065 and Forms 8804 and 8805; an extension is available. For an LLC with a single foreign owner, April 15 is the deadline for Form 5472 with a pro forma Form 1120. Individuals abroad who file Form 1040-NR have until April 15 if they had wages with tax withheld, and until June 15 if not.

Then there are the state deadlines: the report to the Comptroller in Texas on May 15, the annual tax in Delaware on June 1, the Annual Report in Florida by May 1 and, depending on your activity, the ongoing sales tax and payroll tax returns. Which additional deadlines hit an LLC in January is covered in our article on LLC deadlines in January.

These deadlines are the price of running a real business in America. They can be planned, and if you have them in your calendar from day one, you won't miss a single one. We can handle the returns for your LLC if you wish; which service fits which structure is explained in LLC and LP tax returns.

In short

• An LLC with an office, employees, a warehouse or management in the US is engaged in a trade or business there; its profit from that business is effectively connected income and is taxed in the US at the regular rates.
• If the LLC is owned by a single person abroad, it files Form 5472 with a pro forma Form 1120, and the owner reports the profit on Form 1040-NR or, if the owner is a company, on Form 1120-F.
• An LLC with several members files Form 1065 and withholds tax under § 1446 on the share of its foreign members.

How we help you

• Form an LLCThe US LLC with a permanent establishment, turnkey in six states.
• Tax structureA clean structure between parent company and US subsidiary, or between you and your US company, coordinated with your accountant.
• LLC and LP Tax ReturnForm 1065 and K-1 for your LLC or LP.
• Your US Tax ReturnForm 1040 or 1040-NR, handled in English.
• Visa Roadmap for Company FormationFormation and visa in one plan, so the company carries the visa.
• Company formation consultationEntity type, state and tax consequences, before you commit.