“Disregarded Entity” vs “Taxable Association”: What is the best way to structure your LLC?

For the past 20 years I have been promoting the USA as the ultimate banking solution for non-residents (or as some might say a “Tax Haven” — although that term has become rather unpopular over the years). My traditional proposal was to set up a US LLC, then take the default election of ‘disregarded entity’.

A ‘disregarded entity’ is an LLC that is treated by the Internal Revenue Service as a complete pass through entity. For tax purposes it does not exist. For all other purposes it does.

Then I open a bank account as manager of the company, and as long as the company is not earning any US Source/Effectively Connected Income, you will be fine. No need to file tax returns let alone pay any taxes.

That is no longer universally appropriate. FATCA has not changed the tax treatment issues, but has changed the reporting requirements for US payors such as PayPal, Amazon, Shopify, Stripe, etc. The issue of the W-9 (a reporting form for US resident payees receiving funds) and W-8Ben (reporting form(s) for non-US residents receiving funds) was always a little murky but now it is downright impossible to understand. Non-residents receiving payments from US payors, even if the funds are “not effectively connected” to US income, are now facing serious problems. No one really understands how the new W-8Ben system works since they have replaced the one form with 4 or 5 related forms that no one really knows how to use. To make matters worse the IRS seems to be equally at a loss on how to proceed. The payors, like PayPal, Stripe, etc., face serious penalties if they get it wrong. So most payors now refuse to open accounts for anyone who cannot execute a W-9. Again, only taxable individuals and entities can issue a W-9.

Because of this it has become very difficult for non-residents to use their US bank accounts to receive funds from these US payors. That means setting up accounts with PayPal, Stripe, Amazon, Shopify, etc. will be very difficult if not impossible with a US LLC treated as a ‘disregarded entity’.

Our solutions:

For those non-residents who do not need to receive funds from these US payors, the above described Disregarded LLC is still fine. Nothing to worry about.

For those receiving money from these US payors, you will need a more sophisticated structure. We advise you to establish a US LLC which then elects to be a ‘taxable association’. This entity that will be taxed separately like a C Corporation. This Taxable US LLC will act as a Payment Agent for a non-resident business with a written agency agreement to resell non-resident goods and services in the USA. 90% percent of the gross income goes to the foreign provider with an appropriate W-8Ben — that will be very easy. All operating expenses will come out of the 10% agency fee — there should be little or no taxes. What profits remain will be taxed at a flat 21% tax rate. A second US LLC is then established to act as a ‘disregarded entity’, and the funds can go from the Taxable US LLC to this non-taxable Disregarded US LLC.

This solution is simple and easy to implement. In fact old Disregarded LLCs can be converted to ‘taxable association’ Taxable US LLCs with little effort. Another alternative is to set up a second US LLC to be the Payment Agent that then transfers the 90% to the original company.

The only downside is that there is now a requirement to file an annual tax return for the Taxable US LLC which means there is a requirement to maintain a good set of books so that the tax preparer can accurately file the tax return. There may be little or no taxes due, but failure to file a tax return can cause a lot of problems. I have always advised my clients to maintain a set of books for professional reasons even if they were not required for US tax purposes. Now they are required.

So although it is not as easy as it used to be, it is still very easy.

For new clients this is the solution:

Company 1 is a US LLC electing to be a ‘taxable association’; a Taxable US LLC.

Company 2 is a US LLC electing to be a ‘disregarded entity’; a non-taxable Disregarded US LLC.

Company 1 accepts payments on behalf of Company 2 for goods or services through Paypal, Amazon, Shopify, Stripe, etc., receives a modest commission which is used to pay transactions costs and company fees, and then pays a modest corporate tax of 21% that will probably never go above 5% to 15% of the total net income of the entire venture.

There are of course other more complicated options that might be useful for some clients, but for most this is all that will ever be needed to setup and operate your e-commerce business in the United States of America.