LLC has gain its increased popularity in the past years based on professionals’ advices. But it has been a challenging task to explain to foreign investors about tax benefit LLC entails.
From income tax perspective, an LLC is not a separate tax-paying entity in the eyes of IRS. Profits, losses, deductions and credits are allocated to each member who is separately and individually liable for his share. This scheme is called tax passing through. The benefit of it is that the company’s income is not taxed before it is allocated to members, unlike in corporation.
In direct contrast, income and profits are taxed at the corporate level when earned, then taxed again when distributed to the various shareholders as dividends.
S corporations are taxed in a somewhat similar fashion as are LLCs. The tax burden on retained earning in an S corporation passes through to the individual shareholders. Good news is that there is more to it, that it, the income can be re-characterized. For example, if the S corporation earns profits that would be taxed as ordinary income if earned by an individual, the S corporation can pay the earnings as a “distribution to shareholders." When one received payment in this fashion, they can avoid Social Security and Medicare tax, currently a 15.3% tax savings.
Unfortunately, all owners must be US citizens if a LLC desires to be taxed as S-corporation. Foreign investors have no better choice than LLC if they want to best protection and least hassle.