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Taxation Law – FAQs

How are a “C” corporation and its shareholders taxed?

A “C” corporation is a taxpayer separate and distinct from its shareholders. Thus, the profits of a “C” corporation are taxed to the entity when earned and not to the shareholders. The shareholders of a “C” corporation are taxed on those profits only when those profits are distributed to them in the form of dividends, when their stock is redeemed or sold, or when the “C” corporation is liquidated. Any losses incurred by the “C” corporation are only useable to offset income (present, past or future) of the “C” corporation and cannot be passed on to its shareholders. In that profits are first taxed at the “C” corporation level and then taxed at the shareholder level when dividends are received, this generates the common view that the “C” corporation profits are taxed twice.

How is an LLC (or partnership) and its members (or partners) taxed?

An LLC (or partnership) is, for tax purposes, a pass-through entity and is not directly subject to income tax (certain limited California taxes on the LLC or partnership do exist). The income and losses of the LLC (or partnership) flow out to its members (or partners), who must include their share of the LLC (or partnership) income and loss on their own tax returns. The members (or partners) can use their share of losses, subject to a number of restrictions, to offset their other income. An LLC (or partnership) is very flexible in that different members (or partners) may have different types of interest and each may have a different share of the LLC (or partnership) income and loss. In contrast to a “C” corporation, the profits of the LLC (or partnership) are only taxed at one level – to the members (or partners).

Will foreign investors impact my choice of entity?

Yes. If you plan or expect to have foreign investors, your company cannot be an “S” corporation because “S” corporations cannot have foreign shareholders. Foreign investors will generally not want to invest in an LLC (or partnership) because the U.S. business of the LLC (or partnership) will be attributed to them and expose them to U.S. taxes on their pro rata share of the net business income and require them to file U.S tax returns. Therefore, if you wish to set up an entity with foreign investors, a “C” corporation is likely the best choice. But, it is safest to consult an attorney to review all the relevant factors. Other home-country concerns may also impact the choice of entity and the structuring of the entity preferred by the foreign investors.

I am a Canadian looking to buy real estate for investment in California. What U.S. taxes should I be concerned about with regards to buying, owning, and selling real estate in the United States?

Typically, there are no special legal obstacles to foreign inviduals or foreign business entities purchasing real estate in California. Foreigners are subject to the same types of taxes – property, income, and capital gains taxes – as U.S. tax residents. The application of the appropriate income tax treaty (Canada – U.S. Treaty in this case) or of the Foreign Investment in Real Property Act (“FIRPTA”) when there doesn’t exist a relevant income tax treaty or the treaty doesn’t address the relevant issue dictates how rents, capital gains, and other real estate income of foreign residents is taxed.

I’m the owner of a Chinese business looking to operate in California. Should I set up a subsidiary?

For U.S. income tax purposes there are three “Chinas” - The People’s Republic of China (“PRC”), Hong Kong Special Administrative Region (“Hong Kong”), and the Republic of China (“Taiwan”). (This contrasts with other U.S. laws, such as U.S. immigration laws). The United States has a full income tax treaty with the PRC, only a shipping income tax treaty with Hong Kong, and no income tax treaty at all with Taiwan. This means that U.S. income derived by tax residents of those locations may be taxed differently depending upon the specific location of residency. Setting up a subsidiary business entity (like a “C” corporation) in California may be better for business, legal, and tax reasons than operating directly in California. A full analysis of the options and benefits or consequences thereof should be undertaken by a competent tax and business attorney.

I’ll be working abroad. Will the IRS tax the income that I or my company earns outside the United States?

The United States taxes U.S. tax residents (which include U.S. citizens, U.S. green card holders, corporations created in any of the 50 states, among others) on their word-wide income! U.S. tax residents must file U.S. federal tax returns and associated documents declaring their world-wide income, even if all their income is earned outside the United States. Proper tax planning and tax filing helps minimize the tax bite associated with income earned outside the United States. Consulting an international attorney – like Johan Deprez – is strongly recommended.