Taxation of an LLC in the USA and Germany
Beware of tax pitfalls on shareholdings in U.S. Limited Liability Companies (LLC)
In the daily practice of structuring U.S. projects, the U.S. limited liability company enjoys great popularity. It provides not only an outstanding flexibility for drafting a company’s articles of association, but also offers attractive possibilities of limiting liability. Even for tax optimization purposes, the LLC offers some advantages, as it combines the attractive characteristics of a U.S. corporation with those of a U.S. partnership.
Notwithstanding these obvious advantages, caution should be exercised when founding an LLC. Though an LLC may be attractive from a U.S. point of view, German shareholders should not ignore the implications a shareholding in an LLC may have under German tax law. These should be closely examined in the run-up phase because wherever there is risk, there are opportunities, too.
Free choice of LLC tax status in the USA
For U.S. tax purposes, the shareholders of an LLC are free to choose the tax qualification for their LLC using the ‘check the box’ rules under which the LLC may be treated
- as a partnership,
- as a corporation, or
- as a single entity of the sole shareholder.
Once the respective box has been checked, the shareholders are bound by their choice for a period of 5 years.
Taxation of LLCs in Germany
The real problem is in the German tax law. In Germany, an LLC can be classified
- as a partnership,
- as a corporation. or
- as a dependent branch office of the sole shareholder.
In its classification of an LLC, the German tax administration is not bound by the LLC’s tax qualification in the USA. Instead the tax administration will decide on the LLC’s classification for German tax purposes based on the so-called ‘comparison of types test’.
The relevant criteria used by the tax administration are set out in the official statement the Federal Ministry of Finance (BMF) of March 19, 2004. The official BMF statement, also known as the ‘LLC decree’, is based on the judicature of the Federal Fiscal Court regarding the application of the ‘comparison of types’ test and is intended to determine whether an LLC’s structure has more in common with a German partnership or, on the contrary, has more of the characteristics of a corporation. However, many uncertainties and questions still remain unsolved.
Learn more about German income taxation for individuals and business companies:
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Conflicts of Qualification: Germany vs. USA
A deviating classification by the German tax administration can hence result in a so-called ‘conflict of qualification’. Such conflict occurs for example when the German tax administration classifies an LLC as a corporation for tax purposes, while the LLC’s shareholders have opted for being qualified as a partnership for US tax purposes.
Such conflicts of qualification have implications on the investors’ tax burden and, in some cases, can entail disastrous tax consequences. In such a scenario, for example, income earned in the USA would be subject to taxation in Germany too, or taxes already paid in the USA could not be credited in Germany, so that such income would be subject to double taxation.
Targeted LLC structuring offers tax offices less opportunities for attacks
Although the list of criteria offered by the BMF provides useful guidance, it cannot fix all the problems or provide answers to all questions. There is a good reason why the classification of the LLC and its tax consequences for shareholders is often the subject of disputes with German tax offices.
However, there are ways to considerably reduce the risk of disputes by a targeted LLC structuring. Please do not hesitate to contact us. We will be very pleased
- to advise you on how to control an already existing shareholding structure and help you find a low-risk solution for your tax exposure;
- to provide assistance and support before the founding of an LLC and advise you comprehensively, particularly, with regard to the legal framework under corporate and tax laws;
- to assist you in drafting contracts;
- to cooperate with the tax office for you.
Your contact partner for LLCs in the USA and Germany
Are you interested in the U.S. market and wish to found an LLC or invest in the USA as an LLC shareholder? Do you have questions regarding U.S. corporate law or the German and/or U.S. tax laws? If you have queries concerning any aspects of your U.S. business or US investment, our German and US attorneys based at our offices in Germany will be pleased to help you, on request, even in collaboration with our US based partner firms. Your contact persons are Stefan Winheller, German attorney at law (certified specialist for tax law) and Morgan Hangartner, US attorney.
We provide advice and assistance in German or in English. Please do not hesitate to contact us. The easiest way to get in contact is by e-mail (firstname.lastname@example.org) or by phone (069 / 76 75 77 80). We will be pleased to prepare an individualized, suitable offer for you.