How do U.S. LLCs work? In the United States, Limited Liability Companies (LLCs) are business entities created by state statutes. Canadians do not have this type of business structure. Limited Liability Companies cannot be formed in Canada; however, U.S. companies can still conduct business in Canada.As a general rule, LLCs with one member are treated as disregarded entities for tax purposes in the United States. The term disregarded entity means that LLCs are regarded as separate entities from their owners. Tax returns for disregarded entities are filed by their owners. The LLC is considered a partnership if it has two or more members.Filing Form 8832 with the IRS allows an LLC to elect tax treatment as a corporation. It is also known as "check the box,” which means to check a particular box on the form to make this selection.The owners of LLCs receive their income on their tax returns when the LLCs are not treated as corporations under the U.S. tax code. This process can be a little confusing! In legal terms, all assets are owned by LLC, limiting liability, but all assets belong to the owners for tax purposes.
The Procedure
For tax purposes, LLCs are treated as corporations by the Canada Revenue Agency (CRA). To take advantage of the LLC's "pass-through" treatment under United States tax laws, Canadian taxpayers cannot take advantage of many intended tax efficiencies.Members of an LLC, which the CRA classifies as corporations, can face several consequences. In the first instance, if Canadian residents control the LLC, the CRA will likely treat it as a Canadian resident corporation. Common law dictates the residence of the "controlling mind" of a corporation. Here, the Canadian members of the LLC act as the corporation's controlling mind. There is a mismatch between the LLC's classification under Canadian and United States tax laws if it is treated as a disregarded entity or a partnership.Double taxation can result from the misclassification of LLCs under Canadian and U.S. tax laws. Internal Revenue Service (IRS) must be informed of the LLC's income. LLCs are disregarded entities or partnerships. Therefore their income is taxed by the IRS at the individual tax rate. As a resident corporation of Canada, LLCs are also required to report their income to the CRA. LLC income is taxed at the same corporate rate as Canadian corporations. This results in double taxation and cannot be rectified.Double taxation cannot be resolved by applying the tiebreaker rules of the Canada-US Tax Convention. When an entity is subject to tax both in the United States and Canada, the tiebreaker rules of the Convention apply. Since the LCC is a disregarded entity or partnership, it is only taxed in Canada, so the tiebreaker rules are not applicable.LLC members are taxed twice on the same income, but they are also not eligible for tax credits available to shareholders of foreign corporations. If the LLC distributes the income to its members in Canada, the income will be taxed again. As the CRA treats the LLC as a corporation, the income is taxed once at the corporation level. Once dividends are distributed, the income is taxed again at the shareholder level, in this case, the LLC members. Because the LLC is likely considered a Canadian resident corporation, the LLC member cannot claim the Foreign Dividend Tax Credit. Therefore, the income is taxed a second time at the hands of the LLC member who is a Canadian taxpayer.
Final Words
For most Canadian taxpayers, LLCs are not only tax-inefficient but also a burden. However, there are exceptions. With the newly lowered federal tax rates in the United States, an LLC can provide Canadians with an ideal way to arrange their affairs in some situations. Each taxpayer's circumstances determine whether the LLC is suitable for them. If you want to know more about taxation, feel free to contact us.