International Tax Planning for S Corporations and their Alien Shareholders

Brian Dooley, CPA for International Tax Counselors writes:  A dual resident taxpayer who determines his tax liability as if he or she were a non-resident alien must timely file an income tax return (including extensions) on Form 1040NR.[1] Sounds confusing?   It is.

Dual residents that are citizens of nations that have a tax treaty with the U.S have choices. Thus, to see if this applies to you, you must read the tax treaty. 

International Tax Planning for S Corporations and their Alien Shareholders

A general rule is that dual resident residents are treated as U.S. residents for purposes other than applying tax treaties.  This link provides an IRS legal memorandum on this topic.

Resident aliens are often shareholders of S corporation. Here the dual resident international tax planning needs to be cautious.  IRS regulations provide that if a dual resident taxpayer is a shareholder in an S corporation and the alien claims a treaty benefit as a non-resident alien, the taxpayer is as a non-resident alien for the S corporation’s rules.  As a result, the entity’s S corporation election will be terminated. The termination is effective as of the first day the alien claims a treaty benefit. This is due to the rule that a non-resident alien cannot be an S corporation shareholder.[2]

Planning:  Non U.S. citizens should use a limited liability company and not a S corporation

The dual resident taxpayer who does not claim treaty benefits to reduce United States tax is not subject to this rule and, thus, may be or become a shareholder in an S corporation.[3]

A dual resident taxpayer who claims a treaty benefit and is therefore treated as a non-resident alien under these rules can elect to be treated as a U.S. resident for purposes of the S corporation rules

Planning- fixing the problem: This is done by  the taxpayer and the S corporation entering into an agreement to be subject to tax and withholding as if the dual resident were a non-resident alien partner in a partnership.

If the dual resident taxpayer does this then:
1.  the character and source of the S corporation items included in the dual resident shareholder’s income are determined as if realized by the shareholder and
2. the dual resident shareholder is considered as carrying on a business within the United States through a permanent establishment if the S corporation carries on such a business.[4]

This exception is not available if the S corporation was a C corporation[5]

Special IRS reporting: A dual resident taxpayer who is an S corporation shareholder must:
1. comply with the filing requirements and
2  must include an additional declaration indicating that he understands that claiming a treaty benefit as a non-resident will terminate the S corporation’s election, unless the exception applies. [6]   IRS Form 8833, Treaty-Based Return Position Disclosure (under Section 6114 or 7701(b)) is required if the payments or income items reportable because of that determination are more than $100,000.

[1] Warning:  The regulations 301.7701(b)- 7(b).  state that the filing of a Form 1040NR by dual resident taxpayer may affect the determination by the Immigration and Naturalization Service as to whether the individual qualifies to maintain a residency permit.

[2] Regulation 301.7701(b)-7(a)(4)(iii).

[3] Regulation 301.7701(b)-7(a)(4)(ii).

[4]  Regulation 301.7701(b)-7(a)(4)(iv).

[5]  Regulation 301.7701(b)- 7(a)(4)(iv).

[6] Regulation 301.7701(b)-7(c)(3).