How a US LLC create Tax Problems for Canadians?

 

An LLC (limited liability company) is created under the state laws in the United States.

Limited liability companies (LLC) offer its members liability protection while offering the benefits of being fiscally transparent. Fiscally transparent entity means that income is not taxes at LLC level, but it flows to its members and taxed at the personal level.

The LLCs are America’s favorite business structure, so much so that, local accountants in the US tend to recommend to everyone. Sometimes, they recommend it to residents of other countries without knowing the income tax consequences on those taxpayers in their countries.

Many Canadian taxpayers often go ahead an set up an LLC in the U.S. without knowing the serious income tax issues. An LLC is treated as a corporation in Canada whereas a flow through entity in the U.S.

Since Canada does not see an LLC as a fiscally transparent entity and consider it a corporation, the income of LLC is not included in the personal income of its member in the year when earned. It is, instead, included in the year when it is distributed.

LLC’s income is included in the year when it is earned only if it is a FAPI.

IN both cases, whether an active income coming as a distribution or a FAPI, the foreign tax credit is not available. A foreign tax deduction under subsection 20(11) is available and the remaining amount paid by the tax payer is used as nonbusiness foreign tax credit. Unused portion of nonbusiness foreign tax credit cannot be carried forward.

A great post by cross border income tax expert in Canada on how hybrid entities create problems of Canadian can be found here.

The best is to match the distribution with earnings of LLC. Even then it can result in leakage as FAPI. The taxpayers MUST consult a cross border tax professional if they have LLCs or other hybrid entities involved.