Canadian Investment in the U.S.: Entity Choices

August 4, 2020

In a recent video, we review the legal entities available for investing in the United States, including LLPs, LLCs, S, and C corporations. Each of these entities has different tax implications in Canada and the United States that help determine whether they are advantageous or inappropriate in terms of the impact on the rate of return and overall tax liabilities. As with any tax situation, the outcome will depend on your specific facts and your goals. 

You can watch the video here.

Options From a Canadian Perspective

While advantageous to U.S. residents, some of the entities commonly used in the U.S. have different consequences from a Canadian income tax perspective. Limited Liability Companies (LLCs), carry certain tax advantages for U.S. residents. However, as a Canadian resident, you can be exposed to tax in both countries without offsetting foreign tax credits. The advantages that accrue to a U.S. resident using an LLC to conduct business do not necessarily work for a Canadian resident. There may be better choices for operating a business in the United States. However, as a Canadian resident investor, you may not have a choice in the type of entity being used for conducting business, because you are a minority investor. In these cases, your strategy should shift to mitigating adverse tax consequences.

Alternatives to LLCs

Limited partnerships are usually a better choice for Canadians investing in the U.S. as opposed to an LLCs and other types of entities like Limited Liability Partnerships (LLPs). In addition, the U.S. tax reform in December 2017 lowered the US federal income tax rate on U.S. corporations from a top marginal tax rate up to 35% to a flat rate of 21%.  For that reason C corporations, have become more attractive U.S. investment entities for Canadians. The S corporation is another type of entity that may be advantageous as an investment vehicle, but it is primarily for U.S. citizens and residents.

A key concept is how U.S. tax law treats income in an investor’s hands. In Canada, the general approach is to use corporations and have income and gains taxed in the corporation and then make choices regarding when and how to distribute them to shareholders. In contrast, flow-through entities are often the entity of choice for U.S. investors, which means that the entity itself isn’t subject to tax. Instead, the entity allocates the income and expenses to the investors to be taxed, personally only and avoid corporate level tax.

It is not always necessary to form a separate entity to do business in the United States. This is often the case with consultants who perform the majority of their work in Canada for U.S. clients, but may travel to the U.S. to meet with clients. This group of people may be able to take advantage of provisions in the Canada-U.S. income tax treaty to avoid paying U.S. federal income tax. 

Factors Affecting Entity Choice

The choice of entity depends on a number of factors including, the status of the individual in Canada, who their partners are in the United States, the industry they are in, the level of activity that occurs in the U.S., and long-term exit strategies. We take these factors and the pros and cons of each using each entity into account when we help clients determine which entity is the optimal choice to achieve their business and personal objectives.

If you have questions about U.S. investment entities, you should seek professional advice. We invite you to contact us. We can help you assess your situation, review your options, and implement a plan that best achieves your goals.