US LLC Owned by a Canadian: Fixing the Double-Tax Trap

Is a US LLC a tax mistake for a Canadian resident?

Only when the two countries' views of it cost you money. Unless it elects otherwise, the US ignores a single-owner LLC and taxes you personally, on Form 1040-NR, on profit effectively connected with a US trade or business, such as from work you do in the US (Form 8832 instructions; Publication 519). Canada treats the same LLC as a corporation, whatever its US treatment (IC71-17R6, ¶88).

The mismatch costs money in three ways:

• US tax may not offset Canadian tax. Canada may tax the profit to you each year, as it is earned, as foreign accrual property income (FAPI) when you perform the services yourself (s. 95(2)(b)), tax the LLC itself if it is resident or carries on business in Canada, or tax a dividend when cash comes out, often in a different year from the US tax. Canada's FAPI relief counts tax paid by the company, and with a disregarded LLC you pay the US tax, not the company (s. 95(1), "foreign accrual tax"). A foreign tax credit for your own US tax may help, but how it applies to income Canada taxes as FAPI is unsettled (s. 126).
• The treaty may not help. Under Article IV(7)(a), US-source income of a US entity that Canada treats as a corporation is not considered derived by its Canadian owners, even though the US treats the entity as transparent (Technical Explanation, Article IV).
• Two sets of filings. An information-only (pro forma) Form 1120 with Form 5472 in any year with a reportable transaction, with a US$25,000 penalty for each failure (Form 5472 instructions), plus Form T1134 within 10 months after your year-end (s. 233.4(4)).

On the US side, the LLC may cost little beyond filings if you do all the work in Canada and have no US trade or business: service income is generally foreign-source for the US when the work is done abroad (Publication 519). Canada is another matter. An LLC whose owner does its work here may carry on business in Canada, and one run from here may be resident here; either way it files a T2 (s. 150(1)(a)). An unelected LLC gets no treaty protection, so Canada can tax all its profit from business carried on here, with no permanent-establishment limit, plus branch tax of 25% if it is not resident here (s. 2(3); s. 219; IC71-17R6, ¶89). Formed outside Canada, it cannot be a Canadian-controlled private corporation, so it gets no small business deduction (s. 89(1); s. 125). A small, dormant LLC needs only a line on the T1134 summary, not a full supplement (CRA). The tests are in Canadian owner of a US LLC: what to file.

A case is not simple when you already pay US tax on Form 1040-NR or take money out of the LLC, the LLC is run from Canada (it may be a Canadian resident corporation), filings were missed, a Canadian corporation owns it, or the fix is an election that locks for 60 months.

Gather: formation papers and operating agreement, the EIN letter, every Form 5472, pro forma Form 1120 and Form 1040-NR filed, T1134 copies and your T1 returns, the LLC's books and bank statements, a list of its assets and debts with their cost, its client contracts, a note of where and by whom its decisions are made, a log of days worked in the US, and your plans for the next two years.

How do the four options compare?

Electing and converting reach the same US tax result; converting also makes the company a corporation under state law. Moving to a Canadian corporation can leave the profit free of US federal tax when there is no US permanent establishment. Keeping the LLC avoids a switching cost but keeps the mismatch.

Which signs say fix it now?

Any one of these is a reason to review the structure now. With none, the LLC may cost mainly its yearly filings.

• You pay US tax on Form 1040-NR every year. That tax is yours, not the company's, so it may not reduce Canadian tax on the same profit in the same year.
• You take distributions. Canada treats a pro rata payout from a foreign affiliate as a dividend, though the US disregards it (s. 90(2)). A deduction is meant to stop profit already taxed as FAPI being taxed again (s. 91(5)); it does not fix US tax paid in another year.
• A client withholds tax from what it pays the LLC. A US client withholds 30% from pay for services you perform in the US, unless you claim a treaty exemption on Form 8233 (Form W-8ECI does not cover such pay), and from royalties and other passive US income (Publication 519; Form W-8ECI instructions). The treaty generally does not lower either for income earned through the LLC (Technical Explanation, Article IV(7)(a)). After electing, the company is a US corporation and gives clients Form W-9 instead (Form W-9). A Canadian client paying an LLC not resident here for work done in Canada withholds 15% unless the CRA waives it (Regulation 105; Withholding on services in Canada).
• You run the LLC or do its work from Canada. A company is generally resident where its central management and control is exercised (CRA), and one whose work is done here may carry on business here; either can put the LLC on a Canadian T2 (s. 150(1)(a)).
• A second owner, investors or a sale is planned. A second owner makes the LLC a partnership for US tax by default (Form 8832 instructions); for a sale, see Selling a US business from Canada.

Fix 1: Should the LLC elect to be taxed as a corporation on Form 8832?

Electing makes the LLC a US C corporation for tax, so both countries see a corporation. It fits mainly where the LLC has real US operations or US-taxed profit; with no US trade or business, it can put corporate tax on profit the US did not tax before. It does not end Canadian tax on income from services you perform, so compare both countries' tax before filing.

• US. The company files a full Form 1120 and pays 21% on all its taxable income; only a foreign corporation is limited to US-connected income (26 U.S.C. 11). It still files Form 5472 for reportable transactions with you (Form 5472 instructions).
• Treaty. A company taxable in the US can be a US resident under the treaty; an LLC that is not itself taxable in the US cannot (Technical Explanation, Article IV). Its payouts to you become dividends under the treaty, which an unelected LLC's are not: US tax is capped at 15% for you, or 5% for a company owning at least 10% of the voting stock (treaty, Article X(2); Technical Explanation, Article X).
• Canada. T1134 reporting continues, or begins if the LLC was resident in Canada, where the election can also trigger emigration tax (see What does each fix cost at the moment of change?). Income from services you perform is still FAPI, but US tax the company pays now counts as foreign accrual tax. You deduct that tax times 1.9, so at US corporate rates it offsets only part of the FAPI (s. 91(4); s. 95(1), "relevant tax factor").
• Filing and timing. You sign Form 8832 as owner and file it with the IRS; a copy also goes with the company's Form 1120 for the election year (Form 1120 instructions). The effective date can be no more than 75 days before filing and no more than 12 months after (Form 8832 instructions). The change takes effect at the start of that day, so a date on the first day of the tax year avoids splitting a year (26 CFR 301.7701-3(g)(3)). If the date falls mid-year, the first Form 1120 is a short-period return, due by the 15th day of the 4th month after that period ends (Form 1120 instructions).
• Lock-in. After a change, the LLC generally cannot change again by election for 60 months (Form 8832 instructions).

For yearly filings after electing, see Canadian owner of a US corporation. If the election was late or never went through, see Late LLC election relief.

Fix 2: When does converting or merging into a state-law corporation beat an election?

For US tax going forward, a state-law corporation gives the same result as electing: a C corporation filing Form 1120. The extra state filings matter mainly when you want the company to be a corporation under state law too, for example to issue stock. If investors want a Delaware corporation, see Moving a startup into a Delaware corporation.

• No way back by election. An entity formed under a statute that calls it incorporated is a corporation for US tax and cannot elect another classification (26 CFR 301.7701-2(b)(1); 26 CFR 301.7701-3(a)).
• US at the change. The regulations set out deemed steps only for an election (26 CFR 301.7701-3(g)). Check a conversion under the rules for transfers to a controlled corporation before filing (26 U.S.C. 351).
• Canada at the change. No official Canadian source sets the result of a state-law conversion. If Canada sees your LLC shares as cancelled or exchanged, that is a disposition, and any gain can be taxable (s. 248(1), "disposition"). A merger of the LLC into a new US corporation may instead fit Canada's foreign merger rule, which carries your cost over to the new shares when, among other conditions, you receive only shares and each company was resident outside Canada right before (s. 87(4), (8) and (8.1)). Whether a given state merger fits needs review.
• State steps. Each state sets its own conversion or merger filings and fees.

Fix 3: When should the business move into a Canadian corporation?

When you do the work in Canada and have no US office, staff or agent, a Canadian corporation's business profits are generally taxable in the US only if attributable to a US permanent establishment (treaty, Article VII(1)). In that case the LLC may add filings without adding a US tax benefit. The treaty covers only US federal income tax, so a state applies its own rules (treaty, Article II(2)(b)).

A Canadian corporation engaged in a US trade or business that claims the treaty exemption still files Form 1120-F with Form 8833 (IRS). What creates a US permanent establishment, and the filing details, are in Canadian corporation US tax return. For the Canadian side, see Incorporating to contract for US clients.

In this order:

1. Incorporate in Canada and get the corporation's business number.
2. Sign new work in the corporation's name and give US clients its Form W-8BEN-E.
3. Let the LLC finish and collect its open invoices. If contracts, software or client lists must move, price them at market value: the two companies do not deal at arm's length, so Canada's transfer-pricing rules apply (s. 247(2)).
4. Pay any tax the LLC owes, then pay out its remaining cash, settle state fees and file the state dissolution. If it owed Canadian tax, you can be liable for it up to what you received, and the CRA can assess you at any time (s. 160).
5. File the LLC's final pro forma Form 1120 with Form 5472, which reports dissolution payments and distributions (Form 5472 instructions). In Canada, file its final T2 if it files one, and Form T1134 for the last year it was your foreign affiliate (s. 233.4). For the other closing steps, see Closing an unused LLC from abroad.

What does each fix cost at the moment of change?

Electing has a defined US cost and, if the LLC was resident in Canada, possible Canadian emigration tax. A conversion or merger has no deemed steps in the US regulations and no official Canadian answer (see Fix 2). Moving to a Canadian corporation costs the closing filings, and cancelling your LLC shares on closing is a disposition for Canadian tax (s. 248(1), "disposition").

US side of an election. You are treated as contributing all the LLC's assets and liabilities to a new corporation for its stock, just before the close of the day before the election takes effect (26 CFR 301.7701-3(g)(1)(iv), (g)(3)). No gain or loss is recognized on property transferred solely for stock when you control the corporation right after (26 U.S.C. 351), but liabilities above the assets' tax basis can create gain (26 U.S.C. 357(c)).

Canadian side of an election. For an LLC not resident in Canada, the election changes the US view, not Canada's, which already sees a corporation (IC71-17R6, ¶88). An LLC resident in Canada is different: once taxable in the US, the treaty can make it resident only in the US, where it was created, and Canada then deems it not resident (treaty, Article IV(3); s. 250(5); CRA). A corporation that ceases to be resident in Canada is treated as disposing of its property and can owe emigration tax (s. 128.1(4); s. 219.1). Check residence before filing Form 8832.

What about the years already filed or missed?

A fix works forward; it does not cure past years. An election reaches back at most 75 days. Simplified late relief reaches back up to 3 years and 75 days only if no returns inconsistent with corporate status were filed, so years already filed as a disregarded LLC can block it, leaving a private letter ruling as the route (Form 8832 instructions; Late LLC election relief). Catch up missing years on their own track: missed Form 5472, missed T1134 and missed Form 1040-NR. The fix and the catch-up use the same books and bank records.

Example

Illustrative only, in US dollars; no tax is computed.

Toronto developer with a US desk

A developer in Toronto owns a single-member Wyoming LLC earning US$120,000 of profit from US clients, and works part of the year from a shared US office. Assume the LLC is not resident in Canada.

• Before. The LLC files a pro forma Form 1120 with Form 5472. The US office work is a US trade or business, so she files Form 1040-NR and pays US tax herself. Canada likely taxes the profit to her as FAPI because she performs the services, and her personal US tax is not tax paid by the company, so it does not reduce her FAPI the way company tax would; whether a foreign tax credit on her own return covers it is unsettled. She takes out US$80,000, a foreign dividend for Canada, with relief for profit already taxed as FAPI.
• The change. She elects corporate status effective 1 January. Just before the close of 31 December, she is treated as contributing the LLC's assets to the new corporation for its stock.
• After. The company files Form 1120 and Form 5472 and pays US corporate tax. That tax times 1.9 is deducted from her FAPI, so part of the FAPI is still taxed in Canada. A US$80,000 dividend faces US withholding capped at 15%, which she can claim as a foreign tax credit in Canada, within its limits.

If the LLC were resident in Canada because she runs it from Toronto, the election could trigger Canada's corporate emigration rules; check that before filing. Either way, her work in Toronto can mean the LLC carries on business in Canada and files a T2.

Vancouver consultant with no US presence

A consultant in Vancouver does all the work at home for US clients through an LLC, with no US office or staff and no US work days.

• Before. No US trade or business, so no US income tax; the LLC files a pro forma Form 1120 with Form 5472 in years with transactions. Because she does all the work in Vancouver, the LLC likely carries on business in Canada and files a T2. She makes every decision here, so it may also be resident in Canada; if it is not, she also files T1134.
• The change. She incorporates in British Columbia and signs new contracts through the corporation from 1 March. The LLC invoices its last project in April, pays her the remaining US$15,000 and dissolves in June.
• After. The LLC files its final pro forma Form 1120 with Form 5472, reporting the distribution and dissolution, and its final T2; she files a final T1134 if it was not resident in Canada. The corporation gives clients Form W-8BEN-E; with no US permanent establishment, its profit is generally free of US federal tax.

Calgary holding company as owner

A couple's Alberta holding corporation owns all of a US LLC. The treaty rule that blocks benefits on income earned through the LLC applies the same way; the holding company's yearly filings are in What if a Canadian corporation owns the LLC?. The same election is one option, with the same residence check before filing. Afterward, dividends to the holding company, which owns all the voting stock, can qualify for US withholding capped at 5%.

Different for you?

• You already pay US tax on the LLC's profit, take distributions, or are behind on Form 5472 or T1134: the fix and the catch-up need one plan. Get cross-border tax help.
• The LLC is run from Canada or you do its work here: it may be resident or carry on business in Canada, which changes the yearly filings and the cost of electing. Get cross-border tax help.
• You have not formed anything yet: compare structures in Setting up a US business as a Canadian resident.
• You want a new US corporation instead: see Forming a US corporation from Canada.
• Your books must serve both countries' views: see Books for a US LLC owned by a Canadian.
• You are deciding how to take money out: see Paying yourself from a US company.
• The LLC already elected corporate status, or you are not sure: check its IRS record in How the IRS classifies your LLC; if it files a full Form 1120, see Canadian owner of a US corporation.
• You own the LLC with a spouse or anyone else: it is a partnership for US tax by default. See Canadian partner in a US LLC.
• You live outside Canada and the US: see Foreign-owned LLC taxed as a corporation.
• You are a US citizen or green card holder: the US side changes completely. See Americans living in Canada.
• You are moving between Canada and the US, or formed the LLC before moving to Canada: see Moving across the border with a company.