FAQ for foreign-owned entities that want to expand to the U.S.
Companies that are considering expansion into the U.S. need to plan carefully to limit their tax liabilities and reduce the risk of penalties. Every decision — from entity structure to state of incorporation — comes with potential tax and financial consequences.
Here are common questions that foreign-owned companies need to address before expanding into the U.S.:
1. What entity structure should I use for doing business in the U.S.?
There are several ways a foreign company can conduct business with U.S. customers. Consider the tax and legal implications of each option before choosing an entity structure in the U.S. Options include:
- U.S. branch: This type of entity structure works well when a foreign company simply ships or delivers products or services directly to U.S. customers from outside the U.S. and there is no activity in the U.S., except those protected by a U.S. tax treaty. This structure is not recommended when a foreign company conducts business directly in the U.S. (e.g., by hiring U.S. employees). Such activities could result in permanent establishment or a taxable presence in the U.S.
- U.S. joint venture (JV): JVs can be used to enter the U.S. with a strategic partner for larger-scale projects such as manufacturing or distribution operations. Since a U.S. JV is usually taxed as a flow-through partnership, a foreign company must consider establishing a U.S. legal entity for ownership in the JV to avoid filing U.S. tax returns for the foreign company.
- Limited liability company (LLC): A foreign company can establish an LLC for its U.S. operations. The LLC can be owned by one or more foreign or domestic members, but they will be required to file U.S. tax returns and to report and pay U.S. tax on their share of the LLC’s taxable income. LLCs with foreign members should elect to be taxed as a corporation to eliminate the need for U.S. tax filings for the foreign company.
- U.S. C corporation (C corp): A C corp is the most common and recommended legal and tax entity for a foreign company operating in the U.S. Businesses can use this corporate structure for early-stage U.S. expansion, as well as long-term growth. C corps are taxed on net income at the corporate level, eliminating any entity classification elections for tax purposes and removing the U.S. tax filing requirement for the foreign owner.
2. How do I choose a state to incorporate in?
If your business will operate from a physical location, incorporating in that state is recommended. When selecting the state for your physical location, consider the proximity of customers and suppliers, workforce availability and state incentives for creating jobs. You should also consider the availability of suitable sites for your type of business, including sufficient power supply and transportation options.
What if you don’t need a physical location? Many foreign companies opt for a Delaware corporation due to its long-standing pro-business legal system. Others consider no-tax states such as Nevada or Wyoming.
Think long-term when you decide to incorporate in a U.S. state. For example:
- Many businesses have multistate requirements for income and sales tax. This applies regardless of where they incorporate.
- You need to register in each state you conduct business, regardless of the state you incorporate in. What constitutes doing business varies by state. It can include hiring employees who reside or work in a state, owning real or personal property in a state, providing services to clients in a state or reaching a threshold of sales to customers in a state.
- You will be required to have a registered agent and a registered agent address in the state you incorporate or register to do business in. If you don’t have a physical location in a state, you can use a third party as your registered agent.
- Annual filings are required to remain active in the states you are incorporated or registered to do business in. Filing requirements vary by state, but they may require disclosure of corporate officers, some financial information and an annual filing fee.
- Federal anti-corruption legislation passed in January 2021 requires you to disclose beneficial ownership when a company is formed or registered to do business in a state. Currently, there are few requirements, if any, among the states.
3. Are there statutory requirements for minimum capital or financial reporting in the U.S.?
The U.S. does not impose any minimum capital requirements when establishing a U.S. trade or business. But there are limitations on the tax deduction for business interest expense, so a company with a high debt-to-equity ratio may be impacted.
There is no statutory requirement for private companies to provide financial statements. Financial reporting requirements for a foreign-owned U.S. subsidiary are often determined by the parent company and the group auditor’s needs. Any company with a lending relationship with a financial institution will be required to comply with the financial reporting requirements of the debt covenant.
4. Is operating as a U.S. branch easier than setting up a subsidiary?
The short answer is no. It may seem easier to start doing business in the U.S. with an existing foreign corporation, but there are disadvantages. For example, activity carried out in the U.S. could lead to a permanent establishment or taxable presence in the U.S.
Operating as a branch generally creates a U.S. tax-filing requirement for the foreign corporation, which requires a federal employer identification number (EIN). Income derived from a U.S. trade or business is taxed on a net basis at the current federal corporate rate (21%, subject to change). As a branch, U.S. income and related expenses must be carved out of the foreign company’s operations without the benefit of a separate legal entity in the U.S. This task is typically easier in concept than in practice. In addition to corporate income tax, a 30% branch profit tax may also apply unless reduced by a U.S. income tax treaty.
If the branch hires employees in the U.S., the foreign corporation must meet all U.S. employer requirements. This includes a long list of federal and state requirements, plus withholding and remitting payroll taxes — and it often results in compliance gaps. Additionally, a U.S. bank account will be required to issue U.S. payroll.
You do not have to establish a U.S. legal entity to operate a branch, but you have to register in all states in which you do business. Operating as a branch does not provide any legal barrier for the foreign corporation. However, using a U.S. corporation to conduct U.S. operations can.
If the branch activity in the U.S. creates a permanent establishment, the foreign corporation must meet almost all the requirements of a U.S. subsidiary. Doing so as a branch of a foreign corporation is generally more complex, time-consuming and costly in the long run. Additionally, a branch could be subject to an additional layer of branch profits tax. Therefore, operating as a branch in the U.S. is not recommended due to the ease of establishing a U.S. corporation and the lack of advantages that come from operating as a branch.
5. What tax requirements do I need to meet when I expand to the U.S.?
The U.S. tax structure has multiple layers, including federal and state income tax, which are assessed to and paid by each taxpayer based on their tax structure and operational results.
A domestic or foreign-owned corporation is currently subject to a federal tax of 21% (subject to change) of net taxable income. There are some differences between book and taxable income, including accelerated tax depreciation and a limitation on business interest deduction for tax, among others.
The next layer of tax is at the state level. Most states have a net income tax; 10 states have a tax rate of 5% or below, six states have a tax rate of 9% or higher, a few states have a gross receipts tax instead of an income tax and a few states have no income tax. Some states have filing thresholds or minimum tax. Many states are moving away from nexus based on physical presence in the state to economic nexus based on a threshold of sales to customers in that state.
The laws for determining whether you are taxable and how tax is calculated are different across all 50 states. For example, factors such as sales, property and payroll are used differently across each state to allocate income subject to state tax. How you determine which state a sale is allocated to also varies by state.
The bottom line is that state income tax can range from straightforward to complex, depending on what you are selling, how much you are selling, and where you are selling. Many corporations are subject to tax in multiple states. A tax advisor can help you determine applicable state income tax requirements.
Businesses operating in the U.S. may be required to collect and remit taxes from customers, employees or vendors. These taxes can include sales tax, payroll withholding tax and U.S. income tax on certain transactions with foreign parties. Although these taxes are not assessed to the company that’s required to collect and remit them, there is a compliance cost to meet these requirements. If a company fails to fulfill these withholding requirements, the actual tax plus penalty and interest can become their responsibility upon audit.
6. Do I have to file a tax return before the start of my U.S. operations?
It depends on what steps you completed to establish your foreign-owned subsidiary in the U.S.
- If you established a legal entity, such as a U.S. corporation — this step alone does not create a tax filing requirement.
- If you applied for and received an EIN for the new U.S. entity — then, yes. The EIN confirmation you receive from the Internal Revenue Service (IRS) will include your initial federal tax filing requirements. This includes your choice of tax year-end and the anticipated start of your U.S. payroll.
For example, if you establish a legal entity on November 1 and apply for an EIN with a tax year-end of December 31 and a U.S. payroll start date the following April, the IRS will expect you to file a tax return for the period between November 1 and December 31, even if you have no other activity. It would also expect you to file the initial quarterly payroll tax returns in July of the following year.
Even if you are required to file a “no activity” federal corporate income tax return, there are some key disclosures required for foreign-owned corporations. Even without operational results to report, these disclosures can have significant penalties if not reported accurately and timely. Requirements include disclosures of all direct and indirect foreign ownership that meets several different percentage thresholds and all reportable transactions with foreign-related parties, including loans but not equity transactions.
If you are planning to establish a U.S. subsidiary near the end of the tax year, consider waiting until the new year to avoid a short period of no activity federal income tax filing.
How Wipfli can help
By expanding into the U.S., you can tap into new markets and customer segments, building on strengths and lessons learned at home. Our international expansion specialists work closely with foreign companies that want to take advantage of opportunities in the U.S. We tailor our solutions and advice based on your unique situation and business goals so you’re set up to be compliant and thrive. Contact us today to get started.
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