How an LLC is taxed: the pass-through principle
One of the most attractive features of an LLC is its tax treatment as a "transparent entity" (pass-through taxation). Unlike a corporation (C-Corp), the LLC itself does not pay federal income tax. Income and expenses "pass through" directly to the owner (member) and are reported on their personal return.
For a non-resident with a single-member LLC, this means the IRS treats the LLC as a "disregarded entity": income is reported as if the owner had received it directly.
If you live in Latin America or Europe, your services are performed outside the U.S., and you have no employees or office on American soil, you generally do not pay U.S. federal income tax on that income. This is known as income that is "not effectively connected" with the U.S. (non-ECI).
However, this does not mean you have no reporting obligations to the IRS. And this is where many entrepreneurs make costly mistakes.
Form 5472: the obligation you cannot ignore
Form 5472 is the form that non-residents with U.S. LLCs must file with the IRS when there are "reportable transactions" between the LLC and its foreign owner or other related parties.
What are reportable transactions?
Basically, any movement of money between you and your LLC counts as a reportable transaction. This includes:
- Capital contributions (money you put into the LLC)
- Distributions (money you take out of the LLC)
- Loans between the owner and the LLC
- Payments for services the LLC makes to you as a contractor
- Purchases or sales of assets between the LLC and the owner
Form 5472 is filed together with a "pro forma" Form 1120 (basically a corporate income tax return completed only to accompany the 5472). The deadline is generally April 15 of the following year (with a possible extension to October 15).
The penalty for not filing Form 5472 on time is $25,000 USD per year, per form. If the failure continues more than 90 days after the IRS notifies you, an additional $25,000 is added for every 30 days of delay. This is no minor penalty.
The IRS has stepped up its scrutiny of foreign-owned LLCs in recent years. Failing to file the 5472 is one of the most common, and most expensive, mistakes.
Annual Report: do you have to file it?
The Annual Report is a yearly filing that some states require to keep your LLC in "good standing." It is important not to confuse it with your tax return: they are different things.
- New Mexico: No Annual Report required. One of its main advantages.
- Wyoming: Requires an Annual Report before the first day of the anniversary month of formation. Fee: minimum $60 USD, based on assets located in Wyoming.
- Delaware: Requires an Annual Report with payment of the Franchise Tax (minimum $300 USD).
- Florida: Mandatory Annual Report with a $138.75 USD fee, due by May 1.
If you do not file the Annual Report in states that require it, your LLC can lose its "good standing" status and eventually be administratively dissolved by the state. This can cause banking, contractual and legal problems.
Tax calendar: key dates for your LLC
Tax treaty benefits: how they can help you
The United States has double taxation treaties with more than 65 countries, including Spain, Mexico, and several countries in Latin America and Europe. These treaties can reduce or eliminate withholding tax at source on certain types of income.
However, tax treaties apply mainly to natural persons (individuals), not directly to the LLC as an entity. If you are a resident of a country that has a treaty with the U.S. and your LLC receives certain types of payments (dividends, royalties, interest), you can benefit from reduced rates by claiming the treaty on a Form W-8BEN.
For most digital service entrepreneurs, the most relevant treaty benefit is the tax exemption on services performed outside U.S. territory, which is protected by the non-ECI (not effectively connected income) rule.
Common mistakes to avoid
- Not filing Form 5472: the most expensive mistake. Minimum penalty of $25,000 per year.
- Confusing EIN with ITIN: the EIN belongs to the LLC, the ITIN belongs to you as an individual. They are different and serve different purposes.
- Forgetting the Annual Report: depending on the state, it can lead to the administrative dissolution of your LLC.
- Not keeping books: even if the LLC owes no taxes, the IRS may require accounting records that support the transactions reported on Form 5472.
- Mixing personal and business finances: one of the most common reasons for bank account rejections and problems with the IRS.
- Assuming "I don't pay taxes in the U.S." means "I have no obligations": the reporting obligation exists even when no tax is owed.
Start Companies provides administrative assistance, not tax or legal advice. The information in this article is for educational purposes and does not constitute tax advice. Every situation is different. We recommend consulting a CPA (Certified Public Accountant) familiar with international taxation and non-resident LLC taxation.
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Written by
Ignacio Navarro
Ignacio Navarro is a Certified Public Accountant, founder of Start Companies and a specialist in U.S. companies for entrepreneurs, freelancers and digital businesses in Latin America. With training in international taxation and studies at UCEMA, he advises non-resident clients on forming and maintaining LLCs, opening bank accounts, invoicing, accounting and taxes. His experience combines tax strategy, compliance and practical vision for operating in the U.S. in a simple, organized and professional way.
