US Partnership – tax implication
Allan Madan, CPA, CA
LLP structure is one of the best entity for Canadian investors seeking legal liability as well as for avoiding double taxation whereas LLC is not recommended.
More and more Canadians, realizing the real estate opportunity available in the US are turning to Partnership structure for their real estate investments. However, not many Canadians are fully aware of tax implication on US Partnership. As such, this article will discuss the tax compliance side of US Partnerships and a curious case of US Limited Liability Corporation (LLC).
Limited Liability partnership (LLP)
Prudent Canadian investors understand the twofold benefits provided by an LLP: 1) LLP does not cause double taxation as do US Corporations; and 2) LLP provides asset protection for all of the partners. As such, there is no real reasons for choosing another type of Partnership for your US Real Estate investment (eg. General Partnership and Limited Partnership). For more information on the benefits of LLP entity when structuring your US Real Estate portfolio, please see my article on Best way to own a US property.
The LLP, as a Partnership are not a taxable entity. Rather, all of the Partnership income flows through to each Partner based on the % of their Partnership interest and the tax is paid by the individuals. However, the entity is still required by the US law to file a US Partnership Tax Information return annually. This form is called Form 1065 – Return of Partnership Income and must be filed by the 15th day of the 4th month following the year end. For example, if the year end of the LLP is December 31, 20×0, then the due date would be on the April 15, 20×1.
The partners, usually the Canadian investors will be required to file the Form 1040NR – Individual Nonresident Alien Income Tax Return which is due on the April 15th of the following year. On the Form, each individual’s portion of the Partnership’s income must be declared.
Finally, each Canadian investor will be required to include their portion of the US LLP’s income on their Canadian Personal Income Tax Return. The good news is that you will be able to use the US taxes paid above as a credit against the Canadian taxes.
Limited Liability Corporation (LLC)
In the United States, LLC can be treated differently depending on the number of Partners and whether or not the Partner(s) elect to be treated as a Corporation or not.
Single-Owner LLC
When a LLC is owned by a single Partner, the entity will be treated as a disregarded entity and essentially, the IRS will treat the entity as a sole proprietorship for tax purposes. This means that the LLC does not pay tax nor have the obligation to file any Partnership Income Tax Return. Rather, the individual Partner will report the income on his/her Personal Tax Return (Form 1040).
Multi-Owner LLC
When a LLC is owned by more than one Partner, the entity will be treated as a Partnership for US tax purposes. This means that the entity will have the same tax filing responsibility as the LLP mentioned above.
Election to be treated as C or S Corporation
For both Single and Multi-Owner LLC, an election can be made to have the entity be treated as either a C or a S Corporation for tax purposes. In order to do so, the owner(s) must file a Form 8832 – Entity Classification Election to the IRS and annual file the Form 1120 by the 15th day of the 3rd month following the entity’s year end.
Canadian Perspective
In Canada, all LLCs, regardless of their election status in the US are treated as a corporation. As such, double taxation will occur when you are a Canadian investor with a Partnership interest in a LLC and therefore, this structure is generally not advised for Canadian investors.
US Partnership taxation is a complex area of international tax and therefore, we highly recommend consulting a cross border tax expert before establishing a Partnership entity in the US.
Disclaimer
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.
ABOUT THE AUTHOR
ALLAN MADAN
CPA, CA
Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.
I’ve just purchased a rental property in the US through a LLC and I’m a Canadian resident. What can I do to avoid double taxation?
Hi Joseph,
Thank you for your question. The following procedure can prevent double taxation:
1) Register a Limited Liability Partnership (LLP) in the State where the property is situated. LLPs are not subject to double taxation.
2) The LLC will sell the property to the newly registered LLP. [Since you’ve just purchased the property, the fair market value of the property would be relatively close to the purchase price. As a result, the capital gain realized on the sale will be small].
3) Form a C-Corporation. This corporation will be the general partner of the LLP and will own 1% of the partnership units.
4) Register yourself as the Limited Partner. You will own 99% of the partnership units.
You should consult with a local real estate lawyer to confirm whether land transfer tax would be applicable.
Regards,
Allan Madan and Team
On what state should I establish the Partnership?
Hi Singh,
It is generally recommended that you set up the Partnership in the state in which you will do your business/purchase real estate investment.
Regards,
Allan Madan and Team
Can I use my Canadian Corporation instead of a US C Corporation as a general partner of the LLP that holds the property?
Thanks for this article; it was very helpful. How is an LLLP different from LLP? When would you recommend this structure?
Hello Lukasz,
You can use your Canadian Corporation as a general partner. However, it is generally not advised as the Canadian Corporation will be exposed to two tax authorities – CRA and IRS. If you use US C Corporation as a general partner, you will only be exposed to the IRS.
Regards,
Allan Madan and Team
Hi Hanson,
An LLLP is a modification of a Limited Partnership (LP). The main advantage of this structure is that it offers the general partner(s) limited liability protection. It would be beneficial where an individual is acting as the general partner in an LP. To avoid having to accept full responsibility for partnership liabilities, the LP will elect to be a LLLP. This will afford the general partner limited liability.
Note that LLLPs are only available in certain states.
Under an LLP, there are no general partners (who accept full responsibility for partnership liabilities). Instead, each partner is responsible for his/her own liabilities.
Regards,
Allan Madan and Team
How do you form a Limited Liability Company (LLC)?
Hi Natasha,
The precise rules regarding formation of LLCs differ by state. Generally, a LLC can be formed by filing the “Articles of Organization” with the state’s filing office. This involves paying a filing fee and completing a form that asks basic questions such as the name of the LLC, its members and their contact information.
Even though it is not legally required in most states, an operating agreement can be prepared to specify business arrangements and how the LLC will be managed. The operating agreement will clearly mention the rights and responsibilities of the members. Without an operating agreement, the inner workings of the LLC will be based on the operating rules of the state.
Regards,
Allan Madan and Team
Once the formation documents for a Limited Liability Partnership are filed, is there anything else that I should do?
Hi Navdeep,
Yes. It is very important that a Limited Liability Partnership (LLP) have a partnership agreement outlining who the general partners and the limited partners are. The partnership agreement agreement provides details with respect to:
a) The state laws governing the LLP
b) Registered office of the partners
c) Ownership of units in the LLP by the partners
d) Subscription price for the units of the LLP.
Such documents are placed in the LLP’s minute book which contains all the legal documents related to the LLP. You should contact a professional accountant or legal counsel to prepare the documentation for your LLP.
Regards,
Allan Madan and Team
Hi,
What’s the tax filing requirements if I have US Partnership?
Hi Sandra,
Assuming that the partners are Canadian residents, you will have to file form 1065, 8804, and 8805 by the 15th day of the 4th month after the year end. Additionally, more forms may be required to be filed if your partnership’s activities are extensive.
Regards,
Allan Madan and Team
In addition to what Singh asked, and further to the answer provided, I just have a follow-up question. In which states are the regular LLPs and LLLPs allowed?
Thank you for the article by the way, it’s great!
Hey Sofia,
LLPs rules are established and governed by the state. They are generally permitted in most states, except where LLPs are only allowed for professional uses such law, accounting, and architecture: California, New York, Oregon, and Nevada.
Some of the well-known states that allow the creation of LLLPs are Delaware, Florida, Georgia, Hawaii, Illinois, Maryland, Minnesota, Nevada, Pennsylvania, Texas and more.
Regards,
Allan Madan and Team
I’m confused by the tax treatment of a LLC. Is it a corporation or a partnership?
Hi Rudy,
This is a common area of confusion among Canadians. The US LLC is a hybrid tax structure. Based on the method chosen, a LLC can be treated as a disregarded entity, a partnership or a corporation.
It is important to involve a cross-border accountant who can advise you on how to structure your LLC properly.
Best Regards,
Allan Madan and Team
I just want some clarification on the answer to Singh’s question above. Why is it recommended to setup a partnership in the state in which you plan to purchase real estate?
You do not want the hassle of reporting and filing the real estate activities to multiple state-tax authorities. Completing your reporting/filing obligations for multiple states could be cumbersome, not to mention the fees associated with filing.
I am a passive Canadian investor in a US Partnership that holds several real estate in the US. They say that because I am a non-resident of the US, they have to withhold nearly 40% of my share of the Partnership’s income as withholding tax. Is this true? How can I get it back?
Hi Igor,
Yes. The US tax law requires any US Partnership to withholding 39.6% in taxes from any non US Partners. This is called section 1446 withholding tax. Once you file your US personal return and report the Partnership income however, you will be able to get the withholding tax amount back as a refund less any US taxes that you actually owe.
Best Regards,
Allan Madan and Team
Hello. Is it possible to change the year end for a corporation in the U.S.?
Yes. To request for change in year end, Form 1128: Application to Adopt, Change or Retain a Tax Year must be filed. More information can be found on the IRS website at http://www.irs.gov/uac/Form-1128,-Application-To-Adopt,-Change,-or-Retain-a-Tax-Year . The webpage will contain the form as well as the instructions on completing the form.
Best Regards,
Allan Madan and Team
Hi Allan,
Under what circumstances can a partnership not file a 1065 return?
Hi Irina,
Every partnership must file Form 1065, unless it neither receives income nor incurs any expenditures treated as deductions or credits for federal income tax purposes.
Best Regards,
Allan Madan and Team
Hi, I live in US and recently change my address. As I earn Canadian income and have to file a Canadian tax return annually, how do I inform CRA to update my address in their system?
Hi Mario,
You can change your address in 3 ways:
1) Call CRA
2) Use My Account on the CRA website
3) Complete and mail Form RC325 to your tax centre
Best Regards,
Allan Madan and Team
Hi Allan,
What is the difference between a LP and and a LLP?