CPA, Tax Attorney, Tax and Legal Adviser to Startups and Established Businesses, Specialize in International Taxation
I focus on consulting individuals and businesses on inbound and outbound tax issues in the U.S. If you are a company looking to sell products or services overseas, hire foreign employees or subcontractors, or form a foreign subsidiary, I can guide you through this process.
CPA and tax attorney with over 9 years of experience advising businesses of all sizes and in many sectors. If your business operates across state lines or internationally, you need a tax adviser that can guide you through all of the relevant issues.
Under most circumstances you are allowed to form LLC's in any state you wish, as well as open bank accounts in a different jurisdiction. If you form a state in which you are not a resident, you'll have to appoint a local party to act as registered agent. If you form a Montana LLC, it's not necessary to have an account opened with a Montana branch of a bank. For example, many companies are formed under Delaware law because of the its favorable treatment to businesses, but the company headquarters and operations are generally based in another state. There may, however, be certain rules depending upon what type of business you wish to operate. For example, a law firm may be required to operate a client trust account within the same state, depending upon state & local law.
When hiring an overseas subcontractor, you should be mindful of both U.S. law and the laws of the local jurisdiction where your contractor lives or operates. When you hire a subcontractor in the U.S., you generally collect a signed Form W-9 from the contractor, which lists the contractor's name, address, taxpayer type and U.S. tax identification number (either the taxpayer's social security number or employer identification number). You may also be required to file a Form 1099 at year end to report the amount of gross payments made to the subcontractor. When hiring a non-U.S. contractor, you must still collect an IRS withholding certificate in order to verify the individual or company is not a U.S. tax resident. Individuals sign a Form W-8BEN, a corporation would complete W-8BEN-E, while a foreign partnership would complete a Form W-8IMY. It's also best to have a written and signed contractor agreement in place. You want to ensure that the relationship between you and the contractor is truly a subcontract relationship, and you do not create an employer-employee relationship.
A single owner of a U.S. LLC is by default a disregarded entity for U.S. federal income tax purposes. Essentially, this means the entity is transparent for U.S. tax purposes. A single owner may file an election, under certain circumstances, to be treated as an S corporation or a C corporation. A foreign owned U.S. disregarded entity must file Form 5472 each year to report the business activity of the LLC, as well as information about the non-resident owner. The owner completes this task by filing a proforma Form 1120 with the Form 5472 attached. It's very important that these returns are filed timely and accurately. The IRS has recently increased the penalty for noncompliance from $10,000 to $25,000.
You should be able to attribute the earnings to your S corporation. I would recommend a written independent contractor agreement between your S corporation and the third party company. You should provide the third party company with a signed IRS Form W-9 for your S corporation. The W-9 should list the legal entity name of the S corporation, the tax ID number for the S corporation, as well as the mailing address. Be sure to indicate the entity classification as "S Corporation" in Box 3. If the third party company issues you a Form 1099 at the end of the year, the compensation will be reported as paid to your S corporation rather than you as an individual. It's true that net earnings flowing through an S corporation are not subject to self employment taxes; however, as the principal shareholder of the S corporation, you should setup payroll and pay yourself a reasonable wage for being an employee of the company. The IRS heavily scrutinizes S corporations for reasonable compensation issues for sole shareholders.
If you have individuals or businesses working for your company in a capacity as an independent contractor, it is a best practice to have a written independent contractor agreement that lays out the terms of the agreement. A written agreement helps to corroborate your position that these individuals are independent contractors and not employees of your company. From a U.S. tax compliance perspective, there are IRS reporting obligations for these payments. If you pay a contractor nonemployee compensation that exceeds $600 during the year, you must file a Form 1099-MISC which reports the compensation. In order to accurately complete the Form 1099-MISC, the individual should provide you with a completed and signed Form W-9. Typically the Form W-9 is completed and signed contemporaneously with the signing of the independent contractor agreement.
Raising capital through a Delaware C corporation does not create any immediate U.S. federal or state tax consequences. You should however be mindful of the compliance obligations related to operating a U.S. C corporation. A Delaware C corporation is required to file Form 1120 on an annual basis, even if there are no revenues or expenses. In addition, if the C corporation is owned by a non-U.S. company, such as a Nigerian corporation, a Form 5472 should be included with the Form 1120 to report the non-U.S. ownership of the Delaware corporation. Cash outflows of funds from the U.S. to a non-U.S. company may be subject to certain disclosures. For example, if a U.S. corporation transfers cash to a foreign corporation, the U.S. corporation may be required to disclose the cash transfer on Form 926 if certain thresholds are met. The U.S. tax rules surrounding this area are complex. I would recommend seeking the advice of a competent CPA or tax attorney to assist the planning and compliance.
By CFC regulations, I'm going to assume you are referencing the controlled foreign corporation (CFC) rules that exist in many countries. CFC rules are designed to limit deferral of income taxes by using offshore entities. Generally, when a shareholder owns stock in a corporation, the shareholder does not recognize income until the corporation declares and pays a dividend to the shareholder. In effect, much of the income tax on earnings can be avoided or deferred indefinitely because companies would accumulate earnings in a foreign corporation and never pay dividends. The CFC rules prevent closely held companies from deferring income by never paying dividends. The rules provide that certain types of income must pass through currently to the shareholders and be subject to current income tax, even if no cash dividends are declared and paid during the tax year.
A U.S. C corporation is generally required to make estimated federal tax payments if the corporation expects its federal tax liability to exceed $500 for the year. For startup companies in their first year, if you are marginally profitable or have a net taxable loss, then you don't need to worry about estimated tax payments. The estimated tax payments are computed using Form 1120-W with the accompanying worksheets. The estimated payments are made each quarter throughout the tax year.
S corporations are flow through entities for U.S. federal and state income tax purposes. So, the entity itself is not subject to income taxes. The net earnings will flow through to your Form 1040 and you pay federal and state taxes at the shareholder level. S corporations are required to file Form 1120-S on an annual basis. Each shareholder in the S corporation is provided a Schedule K-1 which shows their allocable share of income and cash distributions during the year. The S corporation returns are due by March 15th, but you may file for an extension if you need to more time to gather information and complete the return.
When hiring an overseas entity or individual to perform work for your U.S. company, you should be mindful of both U.S. law and the laws of the local jurisdiction where the developer lives or operates. First, you should establish whether you want the relationship to be an employer/employee relationship, or do you prefer to hire these developers as subcontractors. Generally a subcontract relationship is easier. When you hire a subcontractor in the U.S., you collect a signed Form W-9 from the contractor, which lists the contractor's name, address, taxpayer type and U.S. tax identification number (either an SSN, ITIN, or EIN). You may also be required to file a Form 1099 at year end to report the amount of gross payments made to the subcontractor. When hiring a non-U.S. contractor, you still collect an IRS withholding certificate in order to verify the individual or company is not a U.S. tax resident. Foreign individuals sign a Form W-8BEN, a foreign corporation would complete W-8BEN-E, while a foreign partnership would complete a Form W-8IMY. So long as the foreign contractor is performing the work outside of the U.S., there should not be any U.S. tax withholding issues. It can become complicated if, on occasion, you have the developers travel to the U.S. to perform work. The nonemployee compensation could be considered U.S. source earnings and subject to federal and state taxes in the USA.
Issuing stock options to employees in a private closely held company can be a complicated matter, from both a legal and tax perspective. The exercise price per share should definitely not be an arbitrary number. It should be the fair market value of the shares on the day the stock options are granted to the employee. The IRS has very strict rules about setting exercise prices for employee stock options, and failure to comply can result in severe tax consequences. For non-qualified stock options, there are no immediate tax implications for the grant of options to the employee; however, when the employee does exercise the options in the future, the spread between the exercise price and the fair value of the shares at that time is reported as taxable income to the employee, which is another reason why it's important to be mindful of the exercise price when drafting these agreements. The IRS will generally require a valuation report (IRC Section 409A Report) to support the exercise price of the options. The vast majority of startups use an independent appraisal to prepare the 409A report. This also provides you some audit protection from the IRS, because they generally fall within the 409A safe harbor rules.