Continuing low real estate prices in the United States have provided the opportunity for large numbers of Canadians to purchase U.S. property. Many investment savvy Canadian’s will search out US tax and legal advice before committing to investing in US real estate, but often times the advice they are provided with does not take into account the cross border implications of the different US investment vehicles. Take for instance the U.S. Limited Liability Company (LLC). This hybrid between a traditional corporation and partnership is often prescribed as the ‘best’ way for Canadian investors to structure their investments. In this post we will look at some of the unforeseen consequences that could arise from Canadian’s using U.S. LLCs.
Why an LLC?
U.S. LLCs are very useful investment vehicles when used within the United States. They provide limited liability to LLC members, in the same way a corporation does for its shareholders. However an LLC acts as a tax ‘flow through’ entity, meaning that the earnings of the LLC are not taxed at the corporate level before being distributed to the shareholder. The earnings ‘flow through’ the LLC, and are taxed directly in the hands of the LLC members. This prevents the double taxation that is common with more traditional corporate structures, where earnings are taxed at the Corporate level, and then again in the hands of the shareholder. In addition, a U.S. LLC can choose how it would like to be treated for U.S. Tax purposes. It can either be treated as a tax ‘flow through’, a partnership, or a corporation.
What are the dangers of an LLC?
It should now be clearer as to why LLCs are popular in the U.S. They provide limited liability while limiting double taxation at the corporate and individual levels. However, LLCs only receive these benefits while under the jurisdiction of the U.S. Internal Revenue Service (IRS). If a Canadian chooses to utilize a U.S. LLC, they must be aware that the Canada Revenue Agency (CRA) might treat the LLC in such a way that it would no longer be a favorable investment tool. The following adverse situations could result from the differences in treatment between the IRS and CRA:
• Unless special care is taken, the CRA does not recognize the flow through nature of the U.S. LLC. This creates a mismatch between the two taxation systems, and allows a scenario where double taxation can occur – despite the Canada US tax treaty which strives to prevent such scenarios
• Canadian Foreign Accrual Property Income (“FAPI”) rules might come into play if the US LLC holds passive assets. Application of FAPI rules results in increased compliance costs (which come with the increased chance of filing penalties being applied if the taxpayer is unaware of their obligations)
• Canadian foreign reporting requirements could also be triggered, requiring the filing of either forms T1134A/B or T1135 as needed
• Depending on the specific circumstances, U.S. estate tax might be an issue
• If personal property is owned through the U.S. LLC (such as a vacation home), the CRA could take the position that the LLC has conferred a taxable benefit to the LLC members and force the realization of said benefit. This can result in significant compliance related fees and eventual income tax liability when no cash has actually been received by the taxpayer from the LLC
• Depending on the state, there could be additional state and local tax requirements
• US tax compliance and registrations will need to be considered thoroughly
While not an exhaustive list, these are the main issues that arise when Canadian investors deal with US LLCs. While careful planning can reduce some of the issues listed above, any Canadian that is considering using a US LLC should seek out professional and qualified tax advisors.
AG TAX LLP Can Help
Our specialists at Aylett Grant Tax LLP have considerable experience in assisting Canadian investors in choosing the appropriate investment vehicle given their specific set of circumstances. We can help you to determine how best to navigate the various rules to ensure that you are properly complying with the various tax jurisdictions and are neither underpaying nor overpaying tax.
Additionally, if you have any other tax-related queries, and/or need assistance with tax planning/filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to U.S., Canada and other international tax laws.
We can assist with:
- Canadian Personal and corporate tax returns
- Cross Border Taxation and Business Planning
- Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
To obtain a quote or to arrange for a consultation to discuss your tax related queries, please contact us at:
- 416-238-5920 (Greater Toronto Area, ON)
- 604-538-8735 (Greater Vancouver Area, BC)
- 780-702-2732 (Greater Edmonton Area, AB)
Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.
