This is a common question we are asked on a regular basis and an important one. In fact, it tends be a common concern with Canadian clients doing real estate projects in the U.S. Here are some basics that can help you if you are a foreigner or investing with a foreign partner.
Why an S-Corporation in the first place? It’s no secret that an S-Corp is a fantastic entity for U.S. real estate investors rehabbing, fix and flipping or wholesaling properties. Moreover, it’s perfect for consulting, selling a product or getting commissions. The S-Corp can be phenomenal to save on Self-employment tax. Thus, it’s no surprise that many foreigners will often hear or read about the benefits of an S-Corp and wonder if this is the right choice for them.
Some Foreigners don’t need an S-Corporation? Understanding that S-Corps save on Self-Employment tax, it then begs the question: “Is this particular foreigner subject to SE Tax?” It all comes down to the question if the individual is considered a resident or non-resident alien. To many, it’s a pleasant surprise that non-resident aliens are exempt from SE Tax. However, choosing to operate as an LLC or a C-Corporation could be worse than SE Tax because a corporate tax may apply and thus create a ‘double tax situation’. Thus, the foreigner is placed into a precarious situation…should they try to qualify for an S-Corp, or choose a different entity altogether and be thankful they avoided the SE Tax in the process. If you are from a foreign country living here in the U.S. with a ‘Visa’ or ‘Green Card’ it’s even more critical to know what the rules are.
Who qualifies for an S-Corporation? In order to be eligible to be a shareholder of an S-Corp you need to at least be a “Resident Alien”. There are a two tests to determine if you can qualify as a Resident Alien if you aren’t already a U.S. Citizen.
First, is the “Green Card Test”. This where the alien actually has to be a lawful permanent resident with a green card (Immigration Form I-551); if you have one of these documents it doesn’t matter how long you’ve been present in the country, you can qualify as an S-Corporation shareholder. However, if your Visa is a non-immigrant visa, then that would not constitute lawful permanent residence, so you wouldn’t qualify under this test.
The second test is the “Substantial Presence Test”. This test is essentially mathematical. It is satisfied if the alien individual is physically present in the United States for the requisite amount of time, either for the calendar year in question or for the three-year period that ends with the year in question. For purposes of the test, presence during any portion of a day is considered presence for a full day. Regs. §301.7701(b)-1(c)(1).
The “Substantial Presence Test” is met in either of the following circumstances:
– the individual is physically present in the United States for 183 days or more during the target calendar year, or
– the indvidual is present in the United States for at least 31 days for the year in question and has been present for 183 days which are the sum of (a) days during the target year counted as full days, plus (b) days in the first preceding year counted as one-third days, plus (c) days in the second preceding year counted as one-sixth days.
In sum, if you have a ‘Green Card”, or if you have been living in the U.S. for 183 days or more during the calendar year, then you would meet this test and be eligible to be a shareholder of an S-Corp. Remember you need to continue to meet this test every year until you actually get the “Green Card”.
Consider the Tax Treaty with the U.S. Every country and the U.S. have a treaty or ‘agreement’ to say it another way on how foreigners from the other country will be taxed when doing business in the U.S. However, it goes both ways. The foreign country is also going to dictate how an entity in the U.S. will be treated under their foreign tax laws, and even more importantly, if a tax credit is given to the foreigner and how much when they file in their own country and show what type of tax they paid in the U.S. Understanding the dynamics in this relationship is paramount in saving big dollars in taxes. Lets consider Canada for example…
The Canadian versus Australian. Lets assume a Canadian and Australian citizen are both operating in the U.S. and creating ‘ordinary income’ (i.e. rehabbing multiple properties with holding periods of less than 12 months). If the foreigner is considered a resident Alien, an S-Corp would be a great fit in either situation. However, if the individual is considered a non-resident alien, it’s a whole different story. The Australian would benefit by using an LLC in any U.S. State in which they are doing business, while the Canadian would have a terrible tax result by using an LLC. (Under NAFTA and Canadian tax law, the LLC is not treated as a “flow-thru entity”, but a C-Corporation, and thus double tax would apply without a foreign tax credit). For a Canadian, the best choice would be an LP (limited partnership) or LLLP (limited liability limited partnership). See my article blog article “When do Limited Liability Limited Partnerships Make Sense?” for a discussion regarding the LLLP.
What if my partner is a foreigner? This shouldn’t effect you in an negative way. However, if your foreign partner is best suited to have your ‘partnership’ taxed as a C-Corporation, it could have a significant impact on your tax return. But, in most instance, if you are a U.S. Citizen creating ordinary income (i.e. doing fix and flips or rehabs), you will most certainly want to consider operating as an S-Corp. If it is a good fit for you in your situation, then you can have an S-Corporation and make it a ‘partner’ in the project with your foreigner. However, the best entity for you an your partner can depend in large part on the tax treaty between the U.S. and your partner’s country of origin. For example, you might need to operate as an LLC, LP, or LLP and then simply have your S-Corporation be the partner or member in that entity.