Synch U.S. Playbook
Get Moving in the U.S.
Ten Facts to Know Before Starting a U.S. Business
If you are like the majority of my clients, then you have a great concept, you have had success scaling your company’s growth in Europe and now you are ready to conquer the USA! Here are ten tax facts that will help you avoid some common mistakes and minimize risks associated with your U.S. venture.
- Consider organizational structure and overall group tax planning. The first step is to determine what type of entity you want to establish. In the U.S. there are several different entity types, and each comes with its own advantages and disadvantages. It is important that you work together with lawyers and accountants in your home country and in the U.S. to determine which entity fits best from both a legal and tax perspective. When structuring, it is also important to consider your long-term plans for the U.S. entity and where you want it to be placed in your organization (i.e. subsidiary, parent, sister company). In making this decision it is helpful to compare the tax rates in your home country to those in the U.S. and consider transfer pricing options that can help minimize taxes for the group.
- There are 50 U.S. states and each one has its own separate tax rules and rates. For corporations, federal income taxes are imposed by the U.S. government’s Internal Revenue Service (IRS) at a flat rate of 21%, and on top of that, your company may also have to pay state income tax. Most states impose income taxes ranging anywhere from four to nine percent, however there are a few states that impose other taxes in the place of income tax. If a company operates in multiple states, then income needs to be allocated, or “apportioned,” to the states in which it does business and a separate tax return filed in each of those states. Generally, this allocation is driven by sales, however salaries, and property can also be factors. You may also have to register your business in various states regardless of where your entity is formed. Think of each state as its own country with its own rules and regulations.
- The U.S. does not have a statutory audit requirement; however, tax returns must be filed. Audits are only required if you are a publicly traded company, if a lender requires it as terms of a loan, or other occasional circumstances where a higher level of assurance is needed. There are a few other financial statements such as a review or compilation that provide less assurance than an audit, but again these are optional. It is however, a requirement for companies to file annual corporate tax returns, even if the company is dormant or had no activity. Oftentimes, a first-year tax return will be filed for a short period (less than 12 months) as it covers the time from formation to the first declared year-end.
- International tax reporting forms typically have $10,000 penalties for non-filing. There are, unfortunately, lots of traps for international companies doing business in the US. Many international tax reporting forms come with penalties starting at $10,000 per form per year. Some of these forms include Foreign Bank Account Reports (FBARs), Treaty Elections (Form 8833), and Foreign Ownership of U.S. Corporations (Form 5472), among others. The FBAR is an informational report requiring a listing of all non-U.S. owned bank accounts and their highest balances for the year. Treaty elections, filed on form 8833, are needed for those taking advantage of a tax treaty between the US and their home country. Form 5472 is for foreign owned U.S. companies and reports information on the majority shareholders and any related party transactions.
- Your foreign company may need to file a treaty election. If you are sending employees into the U.S. from abroad, that can trigger U.S. tax exposure for your foreign company, as well as for your employee. Even though most tax treaties will offer protection for short term employee visits, it is important to know that in the U.S. you cannot claim treaty protection without making a timely election. A common misconception is that treaty protection is automatic. Typically, this election is made by filing a US tax return. Failure to disclose a treaty-based position can result in a penalty of $10,000.
- Certain activities can create U.S. tax return filing requirements for your foreign company. There are various activities that can create what is called a “permanent establishment,” or PE, for your foreign company. This includes things such as holding inventory in the U.S., owning or leasing property, and having employees working or conducting sales activities in the US. Particularly, if you are sending employees into the U.S. from overseas and they are signing contracts on behalf of your foreign company, the IRS views this as doing business in the U.S. via a branch. Furthermore, if the IRS determines that your foreign corporation was operating in the U.S. and did not file a tax return, they reserve the right to tax your company on its U.S. gross receipts with no deductions for expenses. Again, timely filed tax returns with treaty elections can help protect most of these activities and avoid substantial penalties.
- Certain payments to foreign persons are required to have 30% tax withholding, unless reduced by a treaty. This rule applies to foreign persons or businesses receiving U.S. sourced income. Typically, if the income is fixed, determinable, annual, or periodic (FDAP) then the U.S. person or company making the payment must withhold 30% tax. This includes items of income such as interest, dividends, royalties, rents and a few other passive income types. Most tax treaties will allow for a reduction of this rate, but a filing must be made to receive this benefit. So, for example, if you create a U.S. subsidiary that will be paying dividends back to your foreign parent company, a 30% tax will apply to the dividend payment and a tax form must be filed to report the transaction. If your country’s tax treaty allows for a lower rate, the same filing can be used to make this election.
- Help your executives get settled with pre-immigration tax planning. If you are planning on sending executives or employees to the U.S. from overseas, you don’t want to get them in trouble because of something that you did not prepare them for. As with corporations, there are several traps for foreign individuals who move to the U.S., many of them resulting in serious consequences or penalties to the individual. Oftentimes, if faced with penalties, employees will blame their employer for not notifying them of all the individual tax consequences connected with their U.S. assignment. It is recommended that your employees talk with an immigration attorney and a specialized U.S. tax advisor before moving to the US. This ensures your employee receives the proper visa and a chance to simplify their tax circumstances as much as possible before it is too late.
- Instead of a Value Added Tax (VAT), most states in the U.S. impose a sales tax. Both taxes are a form of consumption tax, however there are some key differences between the two. While VAT is imposed on each step of production, sales tax is only imposed on the customer in the final stage. Sales tax can be a very tricky topic as it is determined on a state by state basis, and the rates can vary between regions within the same state. It is estimated that the US has over 8,000 state and local jurisdictions that impose sales tax. Additionally, what is taxable can vary between states, for example some states charge sales tax only on tangible property, while others will tax services as well.
- Hire a tax preparer with international expertise. While this may seem like shameless self-promotion, it is actually a very serious matter. I have witnessed too many companies hire U.S. tax preparers that were not familiar with international reporting requirements and have created huge penalty exposure for their clients nearly extinguishing their business. After all, I like to say, “you don’t go to your family doctor when you need brain surgery.” International tax is very specialized, and it is not worth saving a few hundred dollars to expose your company to tens of thousands in penalties.