Tax Advice for Canadian Companies Doing Business in the U.S.
Originally published on January 20, 2021
Updated on November 1st, 2023
As a Canadian entrepreneur expanding your business into the United States, you can consider several business structures when setting up your operations. The right structure will ensure your business is in compliance with U.S. tax laws while minimizing your tax liabilities both north and south of the border.
The penalties for noncompliance are often steep. Talk to our international tax advisors today.
The least costly option is taking your Canadian operations into the U.S. without creating a U.S. entity. To do this, your Canadian corporation notifies the U.S. federal and state authorities that it is going to do business in the United States as a foreign corporation. From a tax standpoint, the company pays taxes in the U.S. on its U.S.-sourced income at the current corporate tax rate of 21% (plus any applicable state taxes).
As simple as it sounds, this option comes with some drawbacks.
For starters, your profits may be subject to additional 5% branch tax, and your entire company may be exposed to heightened legal liability since there is no separation between your U.S. and Canadian business.
Additionally, doing business in the U.S. by means of a foreign entity may add other unnecessary complexities to simple tasks like opening a bank account or paying a vendor.
A very common option is for the Canadian company to create a subsidiary incorporated in the United States. American corporations are organized under state law and each state has its own rules for creating and operating corporations.
Many entrepreneurs incorporate in Delaware or Washington due to tax-friendly state laws, but this is not a one-size-fits-all solution. Incorporating in the state where business activities will actually take place may be a more logical solution.
Income of a U.S. corporation would be subject to 21% corporate tax but sheltered from Canadian taxes until repatriated to Canada. Upon repatriation, there is another level of taxation similar to the 5% branch tax.
This double taxation of the same income is often considered a disadvantage of the corporate structure. However, you as the business owner have control over the timing of that tax (which is not the case with branch tax).
This form of business entity is considered a pass-through entity for U.S. taxes. This means that the partnership itself does not pay income taxes and instead flows its income to individual partners. Business income is then taxed at individual partner tax rates, which potentially may be lower than a corporate rate. The income also escapes the double taxation of the corporate structure.
The drawback of this structure is that non-US partners with U.S. business income will be required to file income tax returns and obtain U.S. tax identification numbers. This may be costly if there is a large number of Canadian owners.
Limited liability company (LLC)
Limited liability companies (LLCs) are the most commonly used business structure in the United States because of their flexibility. As with corporations, LLCs are organized under state law. However, there is no separate federal tax code related to them.
Instead, the IRS allows you to select how the LLC will be taxed.
LLCs with one owner can elect to be “disregarded” for taxes and treated as one and the same as the owner of the LLC. They can also be taxed as corporations. LLCs with more than one owner can be taxed as partnerships or corporations.
You might be tempted to create a disregarded LLC to accomplish a U.S. branch structure while preserving liability protection. Unfortunately, this solution may cause a big headache on the Canadian side as American LLCs are considered corporations in Canada and taxed separately from their owners. This may result in highly ineffective tax cross-border tax treatment, so make sure you proceed with great caution.
Which entity is best for your business?
To make sure you select a structure appropriate for your business, get a customized solution from an experienced tax advisor and legal counsel who understands the complexities of the border structures.
James Moore & Co.’s international tax accountants have the experience and knowledge you need to ensure that you’re meeting the obligations brought on by your global dealings and interests.
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