Foreign investors and entrepreneurs who would like to do business in the United States are confronted with a number of legal decisions to make and, if not familiar with the local law, these decisions can be quite daunting. One question that invariably comes up for foreign investors who desire to form a Delaware entity is this: how will it be taxed?
Is the income taxable?
Your entity will be taxed if two conditions are present: (1) the entity is engaged in the sale of goods and services in the United States (referred to as “engaged in trade or business” or “ETB”); and (2) the entity earns income that is effectively connected with United States sources (such income, is often referred to as “effectively connected income” or “ECI”).
TIP: If your entity is subject to taxation in the United States, you may be able to offset the taxes by carefully planning how distributions will be made to the ultimate beneficial owner (i.e., the foreign shareholders or partners) and by taking advantage of the numerous tax treaties to which the United States is a party.
Taxation of Delaware C-Corporations
Federal Taxation
If your entity is a corporation and is subject to tax in the United States, it will be subject to double taxation. This means that the ECI will be taxed once upon receipt by the corporation and then a second time if it is later distributed to stockholders (such as through a dividend or liquidation). The current federal corporate tax rate is 21 percent of the ECI.
Delaware Taxation
Generally, Delaware will only assess a tax on ECI that is attributable to Delaware sources or if it has assets, employees, or activities in Delaware.
Taxation of Delaware LLCs and Partnerships
Federal Taxation
Generally, the federal government does not impose a tax on ECI that is received by the LLC or partnership but it does tax the members or partners directly. Thus, while an LLC or partnership can avoid double taxation, the members or partners will be exposed to federal and state and local taxes and will need to file US tax returns that report worldwide income. This may not be ideal for various reasons.
In such cases, each member or partner may form a “blocker” corporation to hold its membership or partnership interest. In such cases, the blocker corporation and dividends to its ownership will be taxed but reporting requirements on the ultimate beneficial owner will be reduced.
Delaware Taxation
Delaware does not impose income taxes upon LLCs and partnerships; however, the state will impose a gross receipts tax on income from Delaware sources.
Any foreign person or entity that desires to do business in the United States through a Delaware entity is advised to partner with US-based lawyers and accountants who are familiar with the legal and tax requirements.
Andrew Silverman is an attorney in the firm’s Business Department whose practice includes complex corporate governance and financing matters. If you are a Delaware business owner and desire guidance, call (610) 840-0286 or email [email protected].
