About Foreign Nationals and Check the Box Rules

About Foreign Nationals and Check the Box Rules

Foreign Nationals & Check the Box Rules (and vice versa) 

When Foreign Nationals want to move to the United States — and they either already own a business abroad or they reside abroad and want to open a business from abroad — there are various US tax implications that they should be aware of before doing so. Issues involving whether the non-resident alien intends on becoming a US person or not and whether the foreign national is seeking a formalized US structure or simply disregarding the entity will have a big impact on the business that is being formed. Likewise, foreign nationals must be aware of the check-the-box rules when it comes to determining the type of entity structure they want to choose since it will impact the taxation rules. As a result, there are various considerations to assess before moving forward with US business opportunities. Let’s take a brief look at how to check the box rules for foreign nationals. 

Foreign Person, Permanent Establishment, and ECI

A key starting point for foreign nationals is to determine whether they will be operating in the United States sufficiently to become required to file US tax returns and Form 5472. If the foreign nationals are non-US persons and do not establish a Permanent Establishment in the United States, they may be able to avoid US tax on their U.S. sourced income. In general, the permanent establishment rules can get very complicated, and their application is impacted significantly by the language set forth in the various international tax treaties. Foreign nationals considering opening up shop in the United States should consider the permanent establishment rules first.

Foreign Nationals Who Become US Persons

When a foreign national already owns a business overseas and then becomes a US person there are many moving parts to contend with. The key issue will be whether or not they own at least 10% of the business — and if so do they (and other US persons) own more than 50%. As a 10% shareholder, they will have to file a Form 5471 but may not have an ongoing requirement to file Form 5471 — but instead a Form 8938 which is typically easier to file. But, if the taxpayer along with other US persons owns more than 50% of the foreign business it may be considered a Controlled Foreign Corporation – which leads to other complicated tax issues such as Subpart F and GILTI.

Foreign Nationals and US Business

When a foreign national has a US business or disregarded entity, there are also tax and reporting requirements to be aware of. For example, when a nonresident alien has ownership of a US company or a disregarded entity, they may have a Form 5472 filing requirement in order to disclose certain US transactions—as well as form 1120-F.

Check the Box Rules (US Business)

      • For U.S. businesses, the check-the-box rules are as follows:

      • Domestic default rule.

        • Unless an election is made on Form 8832, a domestic eligible entity is:

          1. A partnership if it has two or more members.

          2. Disregarded as an entity separate from its owner if it has a single owner. A change in the number of members of an eligible entity classified as an association (defined below) does not affect the entity’s classification. However, an eligible entity classified as a partnership will become a disregarded entity when the entity’s membership is reduced to one member and a disregarded entity will be classified as a partnership when the entity has more than one member.

US Person starts a Foreign Business (Comparison)

To compare, when a US person has a foreign corporation, there are a whole other set of invasive US tax rules to contend with. From a baseline perspective, it is important to determine what the entity structure is for US tax purposes. That is because even though the company may have been created overseas, a US person is subject to US tax on their worldwide income – as well as global reporting. Thus, depending on whether it is a foreign corporation, flow-through company, partnership, or other structure chances are it will be reportable and possibly taxable. It may require the filing of Form 5471, as well as Forms involving Subpart F Income and GILTI.

Check the Box Rules

      • Foreign default rule.

        • Unless an election is made on Form 8832, a foreign eligible entity is:

            1. A partnership if it has two or more members and at least one member does not have limited liability.

            2. An association taxable as a corporation if all members have limited liability.

            3. Disregarded as an entity separate from its owner if it has a single owner that does not have limited liability.