There are several considerations to be applied when determining the appropriate entity to use in the conduct of your US trade or business. Among these, a business owner should consider legal restrictions, liability protection, income tax effects, reporting or banking matters as well as the requirements and expectations of investors. Often, one or more of these considerations may appear to be in conflict with other of these considerations, and sometimes complex structures are needed to achieve the desired results. It is always a good idea to ensure there is a good working relationship with your legal counsel as well as your tax accountant, as these matters require specialized assistance.
Setting up business considerations
A business beginning, changing or expanding its operations must decide on the most advantageous form of legal entity in which to effectively conduct operations. Many factors will affect this decision. Among them are the following:
- taxation, (state, federal and international);
- limitation of personal liability of the owners or investors;
- ability to raise capital and various covenants associated with attracting capital
- level of complexity of operating, reporting and organizational processes; and
- size of the organization.
Types of US business entities
Among the more common types of entities from which to choose are the following:
- Sole proprietorship. This is generally the easiest entity to create and dissolve.
- Partnership. Partnerships are either limited or general partnerships. Partnerships are referred to as ‘pass-through entities’ in that the income of the operation is generally taxed in the hands of the partners and not the partnership.
- Limited liability company (LLC). LLCs may be single or multiple member entities and offer personal liability limitations to their members (shareholders).
- Subchapter C corporation.
- Subchapter S corporation.
In the United States, a number of entity types can be re-classified after registration according to an entity classification system.
US LLC Classification
The entity classification regulations, more commonly referred to as the ‘check-the-box’ regulations create both a default and elective classification for domestic and foreign eligible entities. These rules provide a mandatory classification for federal tax purposes for some organizations such as domestic and foreign corporations. They also outline the proper means for electing a classification for other organizations.
Under these regulations, eligible entities (e.g. LLC’s) with two or more members are classified by default as a partnership, and eligible entities with one member are, by default disregarded altogether. The entity may make a positive election not more than 75 days after the effective date of the election to be treated as a corporation for federal tax purposes. Most states have adopted these federal ‘check the box’ provisions in their state statutes.
Thus, a single-owner limited liability company (LLC) will be treated as a sole proprietorship, unless it elects to be treated as a corporation. Numerous courts have held that the check-the-box regulations are reasonable and are a valid exercise of the IRS’s authority. Thus, if a single-owner LLC does not make an election to be treated as a corporation, the owner will likely be personally liable for taxes that have not been paid by the LLC.
Canadians looking to do business in the United States should take particular care in the choice of business entity as some differences between Canadian and US rules may create mismatches of income and credits that yield unexpected and often unfavorable results.
A corporation is generally defined as an entity organized under either federal or state statute (whether US or foreign), or a statute of a federally recognized Indian tribe, that refers to the entity as incorporated or as a corporation. The statute can also define the entity as a body corporate, a body politic, or as certain entities classified as associations. Reg. Sec. 301.7701-2 provides a list of foreign entities that are considered to be corporations for US federal purposes. These entities defined as corporations are not permitted to select another classification. By contrast, business entities not defined as a corporation will generally default to the classification of partnership or, if there is only a single owner, disregarded as an entity.
Entity classification has been simplified by the default rules, which classify an entity as either a partnership or as a corporation and allow entities to change their classification by election if they so desire.
Some special entities such as trusts and other special entities have provisions of the US Internal Revenue Code that provide specific rules on the treatment and taxation of these entities. Elections to change the classification are not available to these entities. Examples of entities that are denied the option of electing their classification are banks, heavily regulated entities such as joint-stock companies, insurance companies or entities wholly owned by a state or municipality.
Local business operations may have different considerations than those that involve activities in many states or countries. You must carefully consider which business entity, or combination of business entities, will satisfy the needs of your investors, including your banker and other third parties as well as the requirements set out by the various taxing authorities where you have operations. The choice of business entity may have a profound effect, either positive or negative on the end profitability of your business. We recommend that you consult with a tax professional prior to setting up any business entity.
AG TAX LLP Can Help
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.