Doing business through a US LLC means rights and obligations in the US. And the main obligation is always taxes.
The effective tax rate for running a business through a US LLC can be easily brought to 0% if you are not a US resident.
In this article, we delve into:
- Company tax versus personal income tax
- Taxes that LLCs and C-Corps must pay in America
- How to 0% Tax with LLC in America
- Corporate tax
- Sales tax
- Franchise tax
- Value Added Tax (VAT) with European customers
- Why America is failing to collect more tax
Corporate Taxes v. Personal Income Taxes
You are one person and the company is another person. Therefore you pay tax and the company also pays tax.
The company pays taxes on its profits. The profits are what remains when you subtract all the expenses from the total revenue.
When a company pays out money to its directors, employees, and contractors, their income is considered their earnings. They have to pay personal income tax on it.
The flow of money, from the moment it enters the company to the moment when you, as its owner, can spend it legally, goes like this:
Money flows into the company, so it pays tax, then it flows into your account, so you pay tax on it.
Further in this article, we will go into the details of the taxes the LLC has to pay. You can control how much money you will send to your personal account, and therefore control your tax obligations in your home country. However, there is no way to eliminate the obligation to pay personal income tax as long as you live in your home country and are a tax resident there.
American companies pay corporate income tax at the federal and state levels. This means that they pay US federal tax on the same profit, plus the tax of the state where the company is incorporated. Seven of the states levy a tax on gross income, not profits.
Corporate tax (profit tax) for LLC companies registered in America by Non-Residents
In short: If you do not live in America, do not have your own premises there, and do not employ Americans, the effective rate will be 0%. That’s why a US LLC is the best structure and jurisdiction for people who need an overseas company to do business online.
A longer version of the answer, with much more detail, looks like this:
LLC (Limited Liability Company) is a pass-through entity. This means that the tax obligations of the company are transferred to the owners.
The company practically pays no tax. The corporate tax is owed by the owner of the company and paid as personal income tax. But you’re not a tax resident of the United States, so you don’t owe tax either unless your business is effectively connected to the US.
Before proceeding, we need to explain two things:
- Tax resident. States collect taxes from people who use their services, institutions, etc. Somewhere in their laws, they set a limit on who they will collect money from in order to put it in the common budget and finance common needs. America charges all its citizens. Macedonia and most countries in the world charge those who have been in the country for at least six months. A resident is someone who lives in a certain place. A tax resident is one who, according to the laws, has to pay tax somewhere in accordance with criteria determined by the same law (usually the criterion is presence in a certain country).
- Effectively connected trade or business (to the US). In general, digital businesses are not considered effectively connected to America. There are two conditions that you must fulfill in order to have no tax obligations:
- Have no premises in the US. This means not having premises that you own or premises that you rent just for yourself. This does not include using the address of the registered agent or using Amazon FBA warehouses or any other warehouses across America that are available to anyone other than you.
- Have no employees (dependent agents) in the USA. That means not having regularly employed Americans or green card residents, as well as freelancers working for you for about 40 hours a week (which is effective employment). You can hire American freelancers and agencies, but they don’t work exclusively for you.
- Not spend more than 30 days in the United States during a calendar year. It can be more, but it will require some paperwork and communication with the IRS.
On the other hand, there are several types of income for which tax is paid at the rate of 30% in any case. This rate applies to income that by its nature is passive income, such as:
- Rents from real estate investments
- Stock dividends
- Income from affiliate marketing
- Royalty income (not if you sell a design, audio, or video, but if you get royalties for using them over and over again)
You can read the whole list at this link.
Two important things to know about this tax:
- Whoever pays you these earnings should withhold 30% for tax. For example, Amazon will retain you if you do affiliate marketing for them. The money that Amazon will send you is yours and you don’t have to pay taxes on it. If Amazon doesn’t withhold tax, the IRS will ask them for that 30%, not you.
- The tax rate remains the same unless the US and your country have a double taxation treaty.
At the beginning of each calendar year, you are required to file the following tax returns with the IRS:
- 1120 pro-forma and 5472 if the LLC has only one member
- If there are more members (founders), then 1065 for each of them.
More about the forms to the IRS at this link.
Corporate tax (profit tax) for C-Corp companies registered in America by foreigners
The federal tax is 21%. The tax rates of each of the federal states are available at this link.
If you have a gross income of $100,000 and expenses of $20,000, you are left with a profit of $80,000.
If your C-Corp is incorporated in Wyoming, then you must pay:
- Federal tax of 21%, which in this case is $16,800
- Wyoming has no state corporate tax, so you don’t pay extra for it
- You end up with $63,200.
If your company is registered in Delaware, then you need to pay:
- Federal tax of 21%, which in this case is $16,800
- Delaware state tax of 8.7%, which in this case is $9,690
- Gross income tax, which ranges from 0.09 to 0.7%, which in this case amounts to $720 for the lower rate.
- You end up with $52,790 (with a good accountant, startups manage to save a lot of money, they don’t choose Delaware by accident. But you get the math).
If you have an LLC, the tax game is different.
Sales tax is the US version of VAT. It is a consumption tax. As soon as you cross a certain income or transaction threshold in a certain federal state, you will need to start charging a small percentage of sales tax on your price to consumers from that state, and then send that money to the IRS account.
A few quick facts about sales tax:
- Most businesses are exempt from the sales tax because few businesses exceed the thresholds in the number of transactions or revenue
- Each state sets its own thresholds and tax rates
- Each state also decides what income is subject to the thresholds (somewhere the income from freelance services will not be calculated in your total income when determining whether this tax should be paid, and in some states, Amazon sales won’t count)
- If you have to charge sales tax in one state, you only have to charge it to consumers in that state (for example, if you exceed the thresholds in Florida, you only have to charge sales tax to buyers in Florida, not those in New York or California)
- Thresholds range from $100,000 to $500,000 in revenue per year, or from 100 to 200 transactions per year – all in just one state (you can see all the thresholds at this link)
- Tax rates usually range from 4-6%. Some countries have a rate of 0%, and nowhere is charged more than 11.5%.
Your business has to be doing very well to have to pay sales tax.
Here are some examples to better understand how this tax works:
Example 1: You provide marketing services through your LLC registered in Wyoming. You have clients in San Francisco, Chicago, and Stockholm. In one calendar year, you have earned the following income:
- $42,000 from San Francisco client (minimum $500,000 income threshold, excluding service income)
- $12,000 with Chicago client (minimum $100,000 revenue threshold
- $4,000 with the Stockholm customer (transactions with European customers are subject to VAT, but the threshold is not exceeded here)
Considering that you have not exceeded any threshold, next year you do not charge sales tax anywhere.
Example 2: You provide programming services while also running several e-commerce stores. Your income is as follows:
- $120,000 in sales in Illinois, of which $70,000 is from e-commerce (from 2000 transactions), and $50,000 is from services. Of the e-commerce revenue, $53,000 (about 1700 transactions) is from its own Shopify stores, and the rest is from Amazon.
- $17,000 in e-commerce revenue in California
The threshold in California is $500,000 and you are not over it.
The threshold in Illinois is $100,000 in revenue or at least 200 transactions. In addition, services and products sold through online marketplaces such as Amazon and Etsy are exempt. Hence, only $53,000 made over 1700 transactions is subject to the sales tax threshold.
Under Illinois rules, the threshold is exceeded if you have at least $100,000 in sales or at least 200 transactions. You don’t have that much in sales, but you do in transactions. Therefore, during the next calendar year, you will add a sales tax of 6.25% to your price for consumers from Illinois (only there, not in other states).
If you sell a product for $100, the invoice will say that $100 is the price, and $6.25 in tax is charged on that.
Example 3: You have an e-commerce business and you sell all over America. Your income is as follows:
- $42,000 in California income
- 2,000 income in Minnesota
- $7,000 in income in Michigan
- $18,000 income in New York
- $22,000 in income in Texas
You have not exceeded the thresholds in any federal state, so you do not charge any sales tax whatsoever.
Some federal states charge a franchise tax, which is also known as a privilege tax. The state where the company is incorporated charges for the privilege of having a company registered there. These include Delaware, California, New York, and several other states.
The Delaware franchise tax is $300 per year for an LLC. You will have to pay this tax both if you have zero income and if you have an income of $100,000.
That’s why Neubase’s service includes only LLCs in Wyoming, which do not charge such a tax. With that, the annual costs of running the company are lower by $300.
If you sell products or services in Europe, you may need to charge European customers VAT.
Currently, the European Union is in the middle of VAT reform, which will last until 2028. That’s why we won’t go into the rules in detail here. What is currently valid is available at this link.
Why the US Does Not Collect More Taxes From Us?
At first glance, it looks like the US lets us do business without asking for anything in return, but if you look a little below the surface you will see that this is not quite the case.
C-Corp companies pay tax anyway, only foreign LLCs can get to the 0% rate.
Even if you have an LLC that doesn’t pay tax there, you are using the services of US companies that you pay, and they then pay taxes.
You use Mercury, Stripe, US supplier services, Amazon or Etsy services, maybe hire US marketing agencies, etc. Or you invest the profit that remains in the US stock exchange, in US companies.
If you enter the American economic system and your money passes through it, you will leave money there even if it is not in the form of taxes.