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A single member LLC is a disregarded entity for US federal tax purposes. The Australian entity assumes all US federal tax obligations instead.
Single Member LLC
A single member LLC is a popular way to sell from Australia into the US through a 3PL service. In this episode Ross Treeby of Treeby Tax Limited will walk you through the US tax side of single member LLs.
Here is what we learned but please listen in as Ross explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
Single Member LLC
A Single Member LLC (‘SMLLC’) is a disregarded entity in the US (putting a 8832 election aside). But not in Australia if central management and command is in Australia, but let’s put Australia aside for now and just look at how the SMLLC is taxed in the US.
Let’s assume we have an Australian Pty Ltd holding a single member LLC that sells purchased products through an Amazon Distribution Centre into the States.
SMLLC
The Singe Member LLC (SMLLC) is created under US state law (Wyoming and Delaware are the two most popular states for SMLLCs) and represents a legal entity, but is disregarded for US tax purposes under Treasury Regulation Subchapter F Section 301.7701-3(b)(ii)) and instead its single member, the Australian Pty Ltd, is the tax reporting entity.
The Australian Pty Ltd is a foreign corporation as per Section 7701(a)(5) since formed outside the US.
Since the SMLLC. is a disregarded entity (assuming no 8832 election), any tests establishing taxing rights (eg. USTB, ECI etc) are applied to the single-member and not the SMLLC itself.
Filing Obligations
If the single member was a US tax resident, the SMLLC would have no filing obligations at all as a disregarded entity and all income would go directly into the member’s return (1040 if an individual member or 1120 if a corporate member).
However, since the Australian Pty Ltd as the single member is not a US resident, the foreign-owned SMLLC has one filing obligation and that is a three-page Treasury Information Report (Form 5472) as noted in Treasury Regulation Section 1.6038A-1(c) – attached to a Pro-forma 1120 – disclosing its member’s EIN and any reportable transactions.
The penalty for not filing, filing late or filing an incomplete 5472 is USD 25,000 (Section 6038A(d)). The IRS can waive penalties if there is a reasonable cause defense (Treasury Regulation Section 1.6038A-4(b)).
Any income derived by the LLC is treated as derived by the foreign entity and goes into the Pty Ltd’s 1120F (or 1040NR if the single member was an individual).
Other Obligations
Even though disregarded for federal income tax purposes, all other obligations still apply to the SMLLC itself. So the LLC still needs to maintain books and records as a separate entity (Treasury Regulation Section 1.6038A-3). This is important. So you can’t just run your US sales through the accounts of the Australian Pty Ltd if the Australian Pty Ltd also has other income, but instead you need a separate accounting ledger for the SMLLC. If the Australian Pty Ltd has no other income, then you just need one ledger.
Pty Ltd
As a non-resident the Pty Ltd is not taxed on its worldwide income per se but only on US sourced income or Effectively Connected Income (ECI) to a US Trade or Business (USTB).
That the actual trading happens through the LLC doesn’t matter. The Pty Ltd steps into the shoes of the LLC to look at the source of income and for ECI.
USTB
Neither the Internal Revenue Code nor Treasury Regulations define when a company has a USTB. It is subjective. The court decisions on this issue have resulted in varying outcomes, but seem to usually stipulate that an USTB requires a dependent agent in the US working to further the business.
A 3PL service like FBA does not count as a dependent agent, so on this basis the Pty Ltd would have no USTB.
“However, the facts assumed in this example – US entity – making regular and substantial sales to US customers – owning inventory in the US at an Amazon Distribution Center – collecting sales tax in the US – LLC Bank Account – using a Digital Pay Service – might create a USTB in IRS eyes. There is no specific law or court case to counter the IRS position, so there is little defense if the IRS claimed an USTB to exist. The safer position is therefore to assume that the Pty Ltd has a USTB.” Ross Treeby
Sourcing Rules
Whether a foreign entity has US sourced income depends on whether it has control over the manufacturing process of goods sold into the US.
Self Created Product
You have a self created product when you produce (manufacture and create) your own unique product for which you hold the trademark (property right). You might have a third party manufacturer but as long as you control key facets of the manufacturing process as detailed in Treasury Regulation Section 1.863-1(a)(3) and further explained in Treasury Regulation Section 1.954-3(a)(4), you have a self created product.
If a foreign entity has a self-created product, it all depends on where it manufactures its products. If production is outside the US, it counts as foreign income. And hence not considered effectively connected income per s863(b) and s864(c)(4)(B), even if sold within the US through a 3PL service.
Third Party Product
You have a third party product when you just buy and sell a product without any control over the manufacturing process.
Income from third party products purchased outside the U.S. and sold inside the US (title passage test) counts as US sourced as per s861(a)(6),
“(a) The following items of gross income shall be treated as income from sources within the United States:……
(6) Gains, profits, and income derived from the purchase of inventory property …without the United States (other than within a possession of the United States) and its sale or exchange within the United States.“
Where the sales takes place depends on where the customer resides (s861(a)(6)) and where the product is at the time of title transfer (Treasury Regulation Section 1.861-7(a)). If the customer resides in the US and title transfers in the US (e.g. Amazon fulfillment center), sales take place in the US.
Summary
So this is the US position. Unless the Pty Ltd manufactures the product outside the US, the Pty Ltd would have taxable income in the US. And this income would be taxable at 21% if ECI or 30% flat withholding if not ECI. Under US primary law.
However, then the treaty comes in. And it will most likely remove the taxing rights since no permanent establishment. But let’s cover that in another episode.
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US Taxation of Australian SMSFs
Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 16 December 2022
Tax Talks spoke to Ross Treeby - Tax Law Specialist at Treeby Tax Limited - for more details.
