In a nutshell
A US LLC is exempt from tax in the US if
- the LLC has only one member (an individual or a legal entity), and
- that member is not a US citizen, not a US resident and not otherwise subject to US tax, and
- the LLC has no permanent establishment in the US.
In this case it is called a "foreign-owned disregarded entity LLC", or "exempt LLC" for short.
What is an LLC?
The LLC (short for limited liability company) is the most popular legal form in the US. Under company and liability law it is a corporation, but for tax purposes it is a partnership and therefore tax-transparent. Under tax law, profits are not taxed at company level but in the hands of the individual members of the LLC, as income on their own income tax returns, in proportion to their share.
The LLC exists in all 50 US states and in Puerto Rico. Company law differs slightly from state to state, which is why LLCs in some states are more advisable than in others. For tax purposes there are no differences.
What is a disregarded entity LLC?
The LLC is a relatively recent invention, dating from the 1970s. When this new legal form was introduced, the US tax authority, the IRS, faced a dilemma: a partnership with only one partner is normally impossible. So how should an LLC with only one member be treated for tax purposes? How could such a company file the partnership tax return required of a partnership?
The solution was revolutionary and far-reaching: the IRS decided that the one-member LLC is not a separate taxable entity, as other legal forms are. It is simply ignored for tax purposes. It does not have to file a tax return. As a taxable entity, the one-member LLC (single-member LLC) is identical with its only member.
That member has to report the LLC's income as self-employment income on his US income tax return and pay income tax on it.
A one-member LLC is therefore called a "disregarded entity".
What is an exempt LLC?
So what happens when a foreigner who does not live in the US, and is not otherwise subject to US tax, forms a disregarded entity LLC, that is, a one-member LLC?
In this case too, under US law the LLC is not a separate taxable entity. The LLC's income is treated as the member's own business income. But since the member does not live in the US, he is not subject to tax in the US and is not regarded as carrying on business there. It follows that the LLC's income is not taxable in the US either, because the member is not taxable in the US.
This is what is called a "foreign-owned disregarded entity LLC", or "exempt LLC" for short: an LLC that is exempt from tax in the US.
What about the LLC's US income?
A sole trader living abroad does not become taxable in the US even if he has customers there. There is no permanent establishment in the US, so no US tax liability arises, not even on profits from sales to US customers.
The same applies to the exempt LLC as a business: no permanent establishment in the US, no taxation.
The critical question, though, is exactly when a permanent establishment in the US is triggered. That can already be the case if the LLC has freelancers in the US, for example, or runs its own warehouse there. Using external service providers, Amazon FBA included, does not trigger a permanent establishment.
Because the permanent establishment question depends partly on double tax treaties and partly on how the LLC's contractual relationships are set up, we strongly advise you to get advice on this complex topic if you plan to build any kind of presence in the US.
Throughout this website, we assume that you have no presence of any kind in the US.
What about taxes at home?
Even though the exempt LLC is exempt from tax in the US, that says nothing about which taxes are due at home, that is, where the sole member lives and works and is personally taxable.
Following the logic of the exempt LLC, the member would have to pay tax at home on the company's profits as business income.
That is one of the reasons why the exempt LLC is only suitable for clients who live in a low-tax country of residence, one that exempts foreign income from tax, for example.
You can read more about the tax burden in your country of residence on the page on the tax status of the LLC outside the US.
What an exempt LLC has to file with the IRS
In the past, exempt LLCs did not have to file anything at all with the US tax authority, the IRS.
But the IRS had long been unhappy with this situation: it suspected that many foreign LLC owners were doing taxable business in the US without paying any tax.
A few years ago, the US legislator therefore decided to tighten the screws on exempt LLCs. Since then, LLCs have had to file a mini tax return every year, telling the IRS who the LLC's beneficial owner is and how much revenue the LLC generated. In addition, an FBAR has to be filed for every foreign account the LLC holds.
It is important to understand that none of this creates a US tax liability. The extra requirements are a nuisance, though, and the late filing penalties of $10,000 to $25,000 per form are enormous.
What to watch when setting up your exempt LLC
Against the background of the IRS measures described above, combined with the agency's threat to extend audits to more exempt LLCs, it is especially important to get these details right when designing and forming your LLC.