During the last few years many Israelis are discovering the investment market in the United States, while most of the investments Israelis make in the United States are made through S corporations, also known as LLC companies.
In the following review we will explain the meaning of the term, whether it is beneficial tax – wise to act through LLC companies in the United States, who this solution could be profitable, and what tax risks are involved in such a process.
What is the Meaning of the Term S Corporation in the United States?
An S corporation in the United States is a term that is referring to an American LLC company, which stands for Limited Liability Company. Through the use of S corporations in the United States it is possible to make investment in American properties, while the legal standing of the S corporation, much like the legal status of every company in the United States, grants the shareholders protection.
Having said that, unlike regular companies in the United States, companies of this type are considered transparent in term of the federal taxation terms in the United States, and this in accordance to the tax regime in effect in the United States, except for situations where the decision was made otherwise.
The Difference Between an S Corporation in the United States and a Sealed Company in Israel
As a general rule, when an investor decides to be taxed as an LLC company in the United States, the meaning of this decision is that the income generated by the company will be attributed to the right holders of the company (meaning, its partners).
Accordingly, the partners in the company are those who would be required to take direct accountability for the taxes on the earnings of the company. Although, in the United States there is a ruling according to which, under certain circumstances, foreign partners who are not citizens of the United States and are holder of an LLC company in the United States, may be entitled to receive a tax exemption.
This is differently from the tax laws in Israel, that dictate that LLC companies are taxed as a “sealed” entity, from a tax standpoint. This means that in an LLC company in Israel the tax owed on the income and expenses of a company is not the responsibility of the right holding partners in the company as individuals, but rather the company itself.
The Advantage of Being Taxed as an S Corporation in the United States
When tax – payers choose to be taxed under the framing of an S corporation in the United States, this will lead to a situation where the expenses and income generated by the LLC company are attributed to the tax – payers who are partners in the company.
As a result of this, it is possible to avoid double taxation and enjoy the benefits of overseas tax refunds. This being said, the deciding factor for this is that the tax being paid outside of Israel will be paid through the same source that generates the income the is created the tax being owed in Israel.
In Taxation Terms, is it Beneficial to Operate Through LLC Companies in the United States
Despite everything previously mentioned, and despite the perceived attractiveness of making investments in the United States using S corporations, the treatment of the subject of taxing LLC companies and their partners, is complicated, and not always clear, which is why it could possibly lead right holders in a company into a tax trap that would be better avoided.
The reason for this is that as far as the tax laws in Israel go, it is still not clear if the status of an American LLC company will remain transparent in every situation.
Since the difference in classification of LLC companies in the United States and Israel could lead to double taxation, following the failure to receive tax refunds for taxes paid in the United States and are relevant in Israel, the Israeli tax authority published a notice called “refund on foreign tax for Israeli citizens owning an LLC”.
What Does the Notice Determine on the Subject of Refunds on Foreign Tax for Israeli Citizens Owning an American LLC Company?
This notice published by the Israeli tax authority, provides Israeli investors working through LLC companies in the United States with two possible solutions in order to avoid double taxation:
- The classification of the LLC company as a “sealed” company in the United States as well as Israel. This solution preemptively prevents the issue of double taxation since the treatment of both countries to LLC is the same.
- The classification of the LLC company as an S corporation in both the United States and Israel.
The Tax Repercussions of Classifying Companies as an S Corporation in the United States and a Sealed Company in Israel
The ruling in Israel has dictated that Israeli partners in an American LLC company that is classified as an S corporation in the United States but remains in a sealed company status in Israel tax – wise, will not be allowed to receive a tax refund in Israel for taxes that were paid in the United States on dividends from the company in the United States.
Moreover, in the case that the tax – payers do not actively choose the classification of the LLC company in Israel, the company’s tax status will automatically be treated as a sealed company for tax purposes – which means that the dividends that will be distributed from the company to the rights holder, will be considered as income from dividends and not as business income.
How Will Turning an LLC Company to an S Corporation in the United States Affect the Tax Collection in Israel?
A tax – payer who will chose to turn their company in the United States into an S corporation will owe ongoing tax payments in Israel for the income of the LLC company that they own. The income will be calculated in the tax year they were generated in, and not the date that the dividend was actively distributed. These profits will be taxed in Israel according to the classification of the origin of the income – according to the tax reporting in the United States.
A tax – payer who decided to turn their LLC company to an S corporation in the United States will not be protected against double taxation, according to the treaty between Israel and the United States to avoid double taxation. This is because an LLC company that is undeclared as a company for tax purposes in the United States and is owned by a foreign citizen who is not a citizen of the United States, is not considered an American company, therefore the orders in the treaty are not valid towards it.
What Tax Risks are Involved in Turning LLC Companies Transparent?
Even though, as mentioned before, there are certain benefits to turning an American company into an S corporation, a move like that involves tax risks as well, that are important to think about ahead of time.
Following is a number of tax issues that should be examined by a company that provided American tax consultation services to Israelis, before you decide to turn your LLC company transparent:
- What will happen to the losses of the LLC company that underwent transparency?
- Do share – holders in the company that was turned transparent still have the right to enjoy tax breaks as individuals in other matters?
- How will LLC company investments be classified in Israel in child or grandchild companies that are classified as transparent companies in the United States in their own right?
- Does the LLC company provide sufficient protection against estate tax for foreigners in the United States?
This is of course, only a small percentage of the varied issues that have to do with tax risks and the traps that can be caused when turning an LLC into an S corporation. Although in this case it is important to remember the issue of taxation of controlling members of a controlled foreign operation.
Who Might Profit Off of Starting an S Corporation in the United States?
Given the instruction in the “refund on foreign tax for Israeli citizens owning an LLC” notice, starting an S corporation in the United States could be beneficial for a tax – payer who is the sole rights – owner to the LLC company. The recommendation in this case is to make the American LLC company an S corporation right from the first report on its income.
With that, considering the Israeli tax authority’s stance along with the risks found when a company undergoes this change, it is often discovered that turning an LLC company into an S corporation for tax purposes in the United Stated – is not profitable for Israelis.
Who Can Be Consulted with About Transition to a Transparent Company in the United States?
In case you are considering turning your LLC company into an S corporation in the United States, it is very important to turn to consultations with tax advisors and American accountants who are trained and experienced with tax consultations with investors in the American market. Contact us now and we will be happy to help.
