By Agustin Ceballos and Katrina W. Wu
The Tax Cuts and Jobs Act (TCJA) has brought diverse tax benefits to foreign investors, depending on what income is earned within the U.S., or what kind of business they are doing in the U.S.
Attorneys advising foreign investors with inbound investments into the United States should be aware of how the TCJA affects potential investments, and how to take advantage of the benefits offered. While the TCJA does not focus specifically on EB-5 investors, it could have a direct impact on the EB-5 program.
DOING BUSINESS IN THE UNITED STATES
As is widely known, investments by foreign residents or citizens into U.S. entities is generally allowed under U.S. laws.
Essentially, there are four basic forms of doing business in the U.S.: sole proprietorships, corporations, limited liability companies and partnerships. When advising what is the most appropriate form to do business in the United States, a decision matrix can be presented to the client to better illuminate the advantages and disadvantages of each structure. Specifically, highlight a few factors that may impact the client’s decision in adopting a certain business form: liability protection, pass-through taxation versus double taxation, and ease of formation.
At times, there may not be a single entity form that is perfect in all respects, but weighing the pros and cons of each entity will assist the client in finding the most suitable form based on their specific needs and circumstances.
It should also be noted that when making a decision, there is also the jurisdictional aspect to consider, for example state the entity is formed in, particularly taking into account where the place of business will be, what the applicable state tax rate is and the complexity of the corporate laws of the state.
SOLE PROPRIETORSHIP
A sole proprietorship is the simplest form of doing business in the United States. It is not a separate legal entity, and it is also not subject to separate income taxes. A sole proprietorship is the business owner for tax and liability purposes, and there are no filing requirements to begin doing business as a sole proprietorship. Although the ease and simplicity of doing business as a sole proprietorship may be appealing, it is almost never recommended that clients undertake such business form because of the lack of liability protection. The business owner is and will remain personally liable for the sole proprietorship’s debts and obligations.
Most clients who immigrate to the U.S. who are contemplating starting or importing their business from abroad are almost always involved in businesses that could benefit from liability protection, such as a lawsuit stemming from a slip and fall by a renter living at the client’s investment property.
CORPORATIONS
Corporations are a common entity selection. A corporation offers liability protection for its shareholders, but is subject to two layers of taxation, once at the corporate level when it reports its income, and once more at the shareholder level when the shareholder receives dividends from the corporation. The double taxation is usually not preferred by clients in their selection process, but some may nonetheless choose to form a corporation for other considerations, for example to accomplish the goal of taking the company public at some point.
The most popular variation of a corporation is the “S corporation”, elected by filing Form 2553 with the IRS to be an S Corporation, which if done, would render the corporation a pass-through entity and get around the double taxation issue. However, there are stringent requirements to be an S corporation, e.g. the number of shareholders cannot exceed 100, only one class of stock can be issued, and shareholders cannot be non-U.S. persons.
LIMITED LIABILITY COMPANY
The limited liability company ( LLC) is probably one of the most popular entity selections for clients, given that it offers the dual advantage of being a pass-through entity and not subject to two layers of taxation as in the case of a C corporation, and that it offers liability protection for the owners. An operating agreement (which is the governing document of an LLC) is given a lot of flexibility under California law, and voting rights, distribution rights, management of the company are generally flexible and can be tailored to the client’s specific needs.
Some international clients are concerned with their names being displayed in public records and have preferences for anonymity. While corporations would be the most direct way of accomplishing this (the identity of the shareholders generally do not have to be disclosed), there are ways to structure a LLC to achieve this desired anonymity.
PARTNERSHIPS
Partnerships are yet another form of doing business in the United States and are divided in two structures: general partnerships and limited partnerships. A general partnership is the automatic default form of business when two or more people come together to carry on a business, similar to a sole proprietorship but for two or more people, and while there are no filing requirements for the formation of a general partnership, the partners are exposed to the liability, debts and obligations of the partnership. For this reason, a limited partnership may be more desirable.
Limited partnerships require at least one designated general partner, who manages the partnership and has unlimited liability, and the limited partners enjoy liability protection as in the case of corporations and LLCs. It should be noted that multi-entity structuring is possible (and at times recommended) to achieve an efficient tax treatment and to protect against potential liability. For instance, the general partner of a limited partnership can be a corporation or an LLC (this is done to limit the general partner’s obligations). Similar to an LLC’s operating agreement, the limited partnership agreement is the governing document of a limited partnership, and enjoys much flexibility in terms of voting rights, management, and other rights and privileges of the limited/general partners.
THE TAX CUTS AND JOBS ACT
The TCJA is the most comprehensive reform to the U.S. tax code in over 30 years and its effects are being felt both by U.S. citizens, tax residents and foreign investors worldwide. The TCJA has benefited mostly corporations and wealthy families, while affecting wages earned by workers and increasing the deficit and the federal debt. This is contrary to its projected impact on the economy, which was expected to increase the GDP by 1.7 percent, resulting in 1.5 percent higher wages and 4.8 percent larger capital stock, as reported by the Tax Foundation. Regardless of these “internal” or domestic effects, the TCJA presents unique opportunities for inbound investments.
Arguably, the most visible change from which foreign investors can benefit from is the lowering of the corporate income tax rate from (up to) 35 percent, to a permanent 21 percent.
Also, the TCJA establishes a 20 percent deduction of qualified business income from certain businesses (such as a pass-through U.S. LLC).
Similarly, the TCJA provides for a one-time “transition toll tax” on post-1986 accumulated (i.e., not distributed) earnings and profits in certain foreign (i.e., non-U.S.) corporations. This transition toll tax could apply to both individual U.S. citizens or residents, or U.S. corporations owning stock in foreign corporations. Also, the U.S. shareholder of such a foreign corporation may elect to pay the tax over a period of eight years.
Separately, with respect to the changes to individuals (including EB-5 investors residing within the U.S.), the TCJA lowers the top personal income tax rate from 39.6 percent to 37 percent and revises the applicable tax brackets.
In addition, the TCJA temporarily increases (through 2025) the lifetime exemption amount for gift and estate tax purposes from $5,6 million to $11,2 million per person. This exemption applies only to foreign investors which are domiciled in the United States. For foreign investors who are not domiciled within the United States, the lifetime exemption amount (for estate tax purposes only) remains unchanged at $60,000.
HOW THE TCJA COULD AFFECT EB-5 INVESTMENTS
Given the benefits that the TCJA offers, an EB-5 investor could invest through a U.S. corporation, which would be subject to a flat 21 percent rate. This low tax rate is favorable to a foreign investor seeking to reinvest the corporation’s earnings.
Similarly, a pass-through U.S. LLC with foreign investors that earns qualified business income would have a 20% deduction on such income, benefitting its members (some or all of which could be EB-5 investors).
Additionally, EB-5 investors (considered “U.S. persons” under the Internal Revenue Code) that have foreign investments through foreign corporations might also be affected by the “transition toll tax.”
Taking into account that the TCJA benefits mostly wealthy families, it is expected that investments in U.S. properties are likely to increase, as will the value of such properties. This would likely cause a direct effect on an EB-5 investor planning on coming to the U.S. (i.e., limited purchasing “power” deriving from the increase in property value), or for the EB-5 investor already residing in the U.S., a healthy increase on their investment.
Finally, because the increased gift and estate tax lifetime exemption amount is a temporary change, it is important to do cross –border estate tax planning with the assumption that the old exemption amount will apply in 2026.
During these mentioned circumstances, even when an EB-5 investment into the United States does not have a tax efficiency motive behind it, it will be important for foreign investors and their U.S. attorneys to evaluate how the TCJA can affect their inbound investment into the U.S., particularly with respect to their choice of entity. In addition to this, some preimmigration tax planning (such as the use of a trust) might also benefit the EB-5 investor, prior to becoming a U.S. tax resident, or domiciled in the U.S. With careful tax planning, an EB-5 investor could have the “best of both worlds,” or invest in the United States and potentially obtain their permanent residency/citizenship, while creating tax efficient vehicles that could further increase the net return on their investments and protecting their wealth.
Agustin Ceballos
Agustin Ceballos is an associate with Seltzer Caplan McMahon Vitek. His practice focuses on international estate planning, cross-border tax and corporate matters, advising on tax reporting, and compliance and tax controversy. Ceballos earned his law degree, summa cum laude, from Universidad del Noreste, and pursued post-graduate studies in taxation law at the Escuela Libre de Derecho. Agustin earned his LL.M. in international taxation, with distinction, from Georgetown University Law Center. He is originally from Hermosillo, Sonora, Mexico, and is fluent in both Spanish and English.
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