Why do LLCs Result in Double Taxation for Canadians?
Allan Madan, CA
If you are a Canadian interested in making a U.S. property investment, using an LLC will ultimately result in double taxation for you.
How is a Limited Liability Company Taxed?
Under the U.S. taxation system, an LLC may be treated as:
1) Disregarded Entity
An LLC with a single member is classified by default as a disregarded entity by the IRS. The IRS does not consider the LLC as being separate from its owner and, as a result, the LLC’s income is reported on the owner’s personal tax return.
2) Partnership
An LLC with more than one member is by default classified as a partnership by the IRS. Form 1065 (U.S. Return of Partnership Income) should be filed, and each owner should show his or her share of the partnership income.
3) Corporation
A unique feature of an LLC is that it can elect the manner in which it is taxed. Thus, an LLC which, by default, is either a disregarded entity or partnership can choose to be treated as a corporation by filing Form 8832 (Entity Classification Election).
However, designating an LLC as a corporation will result in a heavy taxation burden since the corporation pays tax on its income first and once the after-tax corporate income is distributed to the individual shareholders through dividends, the shareholders are required to pay personal tax on the dividends received. Therefore, income is essentially taxed twice.
Why are LLC’s a Major Headache for Canadians?
If you are a Canadian resident who owns U.S. property through an LLC, the IRS will first tax any income you earn from the property. On the U.S. side, you will elect to treat the LLC as a designated entity, partnership or corporation. However, it is recommended that you treat the LLC as a designated entity as the income will be taxed directly in your hands resulting in it being taxed at the lower individual tax rates.
As a Canadian resident, the income earned from the property in the U.S. must be reported to the CRA. The issue for Canadians is that the CRA deems an LLC to be a corporation and is therefore taxed as a separate entity. Consequently, the CRA will tax the owner on the full amount of income and will not allow the use of foreign tax credits for any tax paid to the IRS. Thus, resulting in the dreaded double taxation.
Practical Example:
Let’s look at a simple example to help illustrate the tax implications for Canadians investing in the U.S. through an LLC.
You, as a Canadian investor, purchase a U.S. rental property through an LLC. Being the sole owner, you decide to treat the LLC as the default disregarded entity for U.S. tax purposes.
In the first year, you earned $2,000 in rental income and none of the income earned was withdrawn and distributed. For simplicity, let us assume the tax rate for both countries is 25%.
Since the LLC is classified as a disregarded entity, the income is reported and subject to tax on the U.S. personal tax return. Total tax paid on the U.S. return is $500 (25% of $2,000). The income would not be taxed on the individual’s Canadian personal tax return. If the income was withdrawn and distributed then on the Canadian Personal Tax Return, the income received would be treated as a foreign dividend and would be subject to Canadian tax. Let’s take a closer look into this.
In the second year, no income was earned but you decided to withdraw $500 for yourself.
Since no income was earned you are not subject to tax on your U.S. personal tax return. However, the $500 withdrawal is treated as a foreign dividend and is subject to tax on your Canadian personal tax return. Tax paid on your Canadian Return is $125 (25% of $500).
Consequently, on the $2,000 income earned, you paid a total tax of $625 ($500 year 1 and $125 year 2) and as a result, you were double taxed.
What is the Best Alternative for Canadians?
Canadians should not be deterred from investing in the U.S. as there are ways to avoid double taxation one being purchasing property by setting up a U.S. Limited Partnership (USLP). The benefit of a USLP is that the flow through of the structure is recognized both in the U.S. and Canada, unlike the LLC, so it allows Canadians the use of foreign tax credits granted for tax paid to the IRS.
In conclusion, using an LLC to make a U.S. property investment may not be beneficial to you, as a Canadian, due to the result of double taxation. However, U.S. investments can still be positively made through a USLP in order to avoid double taxation.
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
CA.CPA.CGA
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.
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please help me,
my brother is US citizen engaged in motel business via his corporation. VFM inc.
I am canadian citizen bc resident currently unemployed never had any corporation , llc or partnership.
in july 2016 after death of my wife, i sold my primary residence and given money to my brother as loan 150k US dollars.
Brother is paying 12 % per annum interest. Gives me cheque each month.
What kind of tax we both have to pay?
Hi Jay,
You have to include the interest payments received in your Canadian taxable income. Your brother does not have to deduct taxes on interest payments made to you because of the Canada-US tax treaty.
Hi Allan, thanks for this very clear article. Question: would there still be a double tax problem for Canadian resident LLC owners if the distribution occurs in the same year as the US income recognition? For example, let’s say a US citizen living in Canada with an LLC receives LLC capital gain income with an immediate distribution. Income gets reported as a long-term capital gain on the US side; Canada will treat it as a foreign dividend. Will Canada give a full foreign tax credit for the US capital gains tax paid, or is there a problem with the mismatch of capital gain/foreign dividend income? Thanks.
Hi, great question. If the amount and timing of the cash distribution is the same as the income allocation in the US, then double taxation should not arise. But it’s difficult to get a perfect match.
Going off John Smith’s comment – why would the timing be difficult? Can’t you simply withdraw from a business bank account to your personal one and have that represent the US distribution in addition to the Canadian foreign dividend?
If you are working as a professional with a LLC, can’t the same thing be done?
Hi Caleb, yes, it can be done. However, many times the company’s profit is tied up in company assets (e.g. inventory, accounts receivable, equipment) and cannot be paid out during the year to the owners.
Hi: Madan
Will you have to file T1135 foreign property form for LLC property. I understand not as it will be treated as a separate entity for the purpose of Canadian Tax.
Hi Jay,
Form T1134 must be filed with the CRA by the owner(s) of a LLC. This is because a LLC is treated as a foreign corporation by the CRA.
What entity would you recommend as a General Partner in the US Limited Partnership? Is it better do have a US LLC instead of Canadian Ltd? Does it matter who controls the GP (Lets say 3 people enter the LP, 33/33/33/1 – does it matter who controls the 1%?) Would you recommend a Cross-Border Trust for Canadian Investors?
Thank you
Hi Ivette,
Thank you for your question. I recommend either an LLC or a US C-corporation to act as a General Partner of a US Limited Partnership. If an LLC has a single member, then it does not have to file a tax return, which is a benefit. On the other hand, an LLC does cause double taxation for Canadian members. Having said that, the LLC only owns 1% of the partnership’s units, and therefore the double taxation on 1% of partnership profits is not material.
Another option for the General Partner is a US C-corporation. A US C-corporation does not cause double taxation for Canadian owners, which is a benefit. However, a corporate tax return has to be filed for a US C-corporation, which is a disadvantage.
Hello, i live in Canada and i’ve set up an LLC through this site http://www.confiduss.com/en/jurisdictions/the-united-states/business/company-formation/ .
Is there any way for me to migrate my company to a USLP? please help
Hi John,
Consider transferring your units in your LLC to a newly created US Limited Partnership through a “Quit Claim Deed.” This transfer pay results in capital gains taxes.
Hi Allan
I’m a Canadian living in Canada with a US partner and we are starting to buy properties. We opened up a Corporation and and llc. The Corp owns the LLC. And when we transfer profits from the llc to the Corp. when I want to pay myself in Canada I transfer the US profits from the US corp to the Canadian Corp I opened up.
My question to you is will I as the Canadian pay double tax this way?
We were advised that this is the best option because I have a US partner and he wants to be protected as well .
Is this strategy safe for me as a Canadian?
Thank you for your help.
Hi Jay,
Yes, you will be double taxed. In fact, there are 3 lawyers of tax imposed based on your structure:
1. US Corporate Income Tax (21%)
2. Dividend withholding tax (15% of the dividend paid to the Canadian corporation)
3. Canadian Corporate Income Tax (50% of the dividend received, less the withholding tax deducted)
Furthermore, you will pay personal income tax when your Canadian corporation pays a dividend to you. I recommend that you setup a US Limited Partnership to purchase U|S rental properties in order to avoid double taxation and to limit your liability.
Would the USLP not open you up to personal liability in the event of a lawsuit? This is of course not the case with an LLC. Is there a way around this?
Hi John,
Limited Partners of a US LP are only at risk for their investment in the partnership and their personal assets are safe.
Hi,
I hope this thread is still open.
I own a small corporation in Canada. My brother and his business partner have and LLC in the USA that buys commercial investment properties. I would like to lend this LLC money from my Canadian corporate account. I would be the first and only title holder on the property. I am wondering about the tax implication of such an arrangement. Thank you in advance.
Hi Yvonne,
As a Canadian resident (individual or corporation), you will be double taxed if you invest directly in a US LLC. To solve this problem, I suggest that you and your American partners open up a US Limited Partnership (LP). The US LP can purchase US real estate and the limited partners (including yourself, or your Canadian corporation) will not be double-taxed.
Hi Mr Madan,
I’m canadian and mg partener is a permanent resident in canafz, we’re planing to creste LLC in the Usa, we’ll purchase from american suppliers ans sell it on Amazon USA, our contact, he’ll help us to find suppliers he said with american LLC it’s more easy to be accepted from american suppliers.
Do we have any way to avoid double taxation.
Thnaks!
Hi Aron,
Do not do business in the US through a US LLC. Canadian residents pay double taxes on income earned by a US LLC. To avoid double taxation and limit your liability, setup a US C-corporation to do business in the US. I can help you with this.
Hi Allen,
This was incredibly helpful! Just so I’m clear, I would need to set up a Canadian corporation to use as a partner to a USLP that I set up in order to purchase a US property for investment purposes? Would this be the case if I was co-purchasing with a US LLC?
Hi Jane,
A limited partner can either be a Canadian individual or a Canadian corporation. Either way, you will not be double-taxed. This will also be the case if you are co-purchasing a US LLC.
Hi, we own ltd in Canada, we are signing a JV with two other corporations in the US. We would be operating on a GP, LP structure. The three companies will own 1/3 of the GP. We are wondering what the ideal corporate structure for the GP is, so we avoid double taxation.
And if we end up with shares on the LP if we should keep those as individuals or as part of the assets of the Canadian Ltd.
Hi Ari,
I recommend that the GP be a US LLC. The GP will own a fraction of a percent of the US LP. As a result, any double taxation that results will be immaterial, since the income allocated to the GP LLC from the partnership will be minimal. Furthermore, the units of the US LP can be held by individuals or Canadian corporations.
Hello,
Thank you for such a clear and concise video! I have two clarifying questions:
1) If no income is withdrawn, does the individual who owns the LLC still have to pay tax to the CRA?
2) If the income is withdrawn in the same year that it was earned, does this prevent double taxation?
Thank you again! I really appreciate your insight on this confusing situation.
Hi Janelle,
If no income is withdrawn, then you do not have to declare a dividend for Canadian tax purposes. However, you may have an income inclusion for Canadian tax purposes under the Foreign Accrual Property Income rules.
Generally speaking, if you withdraw the same amount as the LLC has earned in the year, you will avoid double taxation.
Hi Allan,
What is the best way to keep my current property in the US as a rental property without being taxed heavily?
I do not plan on making any profit from the rent collected. The rent would only be paying off the mortgage and also cover any expenses while renting the property, therefore I plan on having a $0 income from the property.
Hi Chad,
If you don’t expect to make a profit, hold the property in your name or in a US LP. I would still avoid a US LLC, because at some point, your property will become profitable, or you may have a capital gain when you sell it. LLCs cause double taxation for Canadians.
Hi Allan,
Thanks for your help.
I am Canadian Citizens considering to buy small Liquor store with my Partner being a US citizen. For this, I dont want to use Canadian or US Corporations anywhere. My US partner wants to form Multi Member LLC to buy this Liquor Store business.
Here this business being an Active business, please suggest if i can:
1.. Invest personally into MM-LLC directly or,
2.. Do I still need Limited Partnership (where I personally will be Lp and my single member LLC will be Gp), and through this Limited Partnership i further invest into MM-LLC.
Kindly help me with this situation where my US Partner wants to use MM-LLC to buy an active business of Liquor Store. Thanks.
Hi Sunil,
Set up a US LP and have the US LP take an ownership interest in the multi-member LLC.
Hi Madan, great article. I’d like to invest in us farmland through platforms such as FarmTogether. They however purchase the farms in the usa through LLCs. I’ve asked them if they could do US LP for their Canadian investors but we’re just not worth it 😉 What would therefore be the best way for me as a Canadian to invest using these platforms that exclusively use LLCs? Will there still be complicated reporting requirements even though the investment is through a crowdfunding platform? Thank you!
Hi Rick,
Form a US LP to hold the units in the operating LLC (FarmTogether). The operating LLC will issue a K1 slip to the US LP and the US LP will issue a K1 slip to you. A partnership return must be filed, form 1065.
Hello Madan,
Thank you for this valuable information!
I have two questions, and I would appreciate your clarification.
I am a Canadian resident and I have a Wyoming-based LLC (selling in Amazon USA market – e-commerce)
1) Do I need to report my USA income to the CRA?
2) Would I be double taxed if I didn’t withdraw the income from the US-based bank account?
Thank you in advance!
Hi Ali,
Please complete form T1134 Summary and file it with the CRA to disclose your ownership interest in a US LLC. T1134 Supplement is not required if the cost amount of the shares / units in the capital stock of your LLC is less than $100,000 and the LLC is dormant.
Cash distributions made from the LLC to you are treated as foreign dividends and subject to Canadian income tax at your marginal tax rate.