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Both LLCs and corporations are common entities used as holding companies for non-U.S. investors. Every state allows for the formation of LLCs and C corporations, regardless of ownership or location. Both entities limit owners’ liability for company actions and debts, and facilitate engagement in similar business activities. However, key differences in structure and taxation drive foreign investors to prefer corporations as U.S. holding companies.
A limited liability company, also known as an LLC, is one of the simplest corporate entity forms in the United States, organized under an operating agreement. This contract between the owners, or “members,” details how the business will be regulated and how economic losses and gains will be divided. LLCs tend to benefit from a simpler structure and fewer compliance requirements compared to corporations. However, the endless possibilities for an LLC’s structure can create challenging circumstances when learning how the company is governed, as it would require examining the complicated operating agreement and potentially additional contracts between the members as well.
An LLC is regulated by the laws of the individual state in which it is registered. Thus, these companies do not pay federal income taxes on their profits and offer pass-through taxation. Members of an LLC generally only pay personal income taxes on the income of the business. The formation of this particular business structure allows members to separate their personal assets from those belonging to the entity, limiting their financial liability. Altogether, LLCs provide limited liability protection for their members as a business entity. The owners’ personal assets are protected, as debt and obligation liabilities are tied to the company itself.
A corporation, or C-Corp, is a more complex entity type compared to an LLC. This structure is best for raising venture capital or issuing equity, since the company can issue stock and raise funds from investors. Unlike an LLC, the owners of a corporation are “shareholders.” A C-Corp acts as a divide between the operators of the business and the owners of the business, with ownership based on shares or stock. Each share represents a defined portion of control over the business and its financial benefits, which are transferable between shareholders or to new shareholders. Notably, shareholders can only lose up to the capital they previously contributed.
Although C-Corps involve more compliance burdens, they remain the preferred choice for foreign investors pursuing greater investment potential, especially for those seeking growth and outside investment. An LLC has minimal annual obligations and no required annual meeting, while compliance requirements are stricter for C-Corps. A C-Corp must hold yearly shareholder meetings, regular board meetings, and file an annual report with the Secretary of State. Yet, C-Corps make it more straightforward for non-U.S. entities to hold shares. Entities outside the U.S. can own shares in a U.S. corporation without limitations based on the number of shareholders allowed or the percentage that foreigners can hold. Furthermore, nonresident U.S. citizens may be required to file both U.S. taxes on their income from the LLCs and local taxes on that income, a process known as “double taxation.” However, C-Corps are only responsible for a flat 21% federal corporation tax on net profits. This makes C-Corps more appealing for foreign investors hoping to avoid direct pass-through income and complex cross-border tax reporting, reinforcing why corporations are favored over LLCs as holding companies in the United States.
Any U.S. corporation with 25% or more foreign ownership, of either individuals or businesses, is subject to additional reporting requirements that consist of one of the most commonly filed tax forms. A major filing requirement is the IRS Form 5472, previously known as Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. The IRS strives to be vigilant of U.S. businesses that have foreign ownership, and this form allows them to do so. Form 5472 is used to detail information about particular reportable transactions that exist with a foreign or domestic related party. A “reportable transaction” refers to property exchange or money that may exist as royalties, rents, sales, or interests. All related parties must be reported in the form, along with a separate form for each foreign owner. If a multitude of foreigners own a total of 25% of the company, the form is not required. However, if every individual owns at least 25%, then the form needs to be filed individually.
Failure to complete Form 5472 can result in the IRS having three extra years to audit the company’s tax return once the form is properly filed. Additionally, the penalty for not filing this form correctly has increased from $10,000 to $25,000 per form since the Tax Cuts and Jobs Act increased this noncompliance penalty in 2017. If the form is still not submitted within 90 days of the IRS notice, the penalty increases by $25,000 every month it is late. This penalty will continue to grow until the form is properly filed; there is no upper limit.
Blocker corporations provide a way to mitigate the company’s tax burden.. A blocker structure is treated as a corporation that works to “block” taxable income at the corporate level for U.S. federal, state, and local income tax purposes. The corporate status of the blocker allows all earnings to be taxed at the corporate level rather than at the investor level, until the corporate blocker makes distributions to the investor. Furthermore, a U.S. blocker pays a flat 21% tax on all its income, regardless of the source of the earnings. Additionally, blocker corporations usually pay the U.S. tax themselves, so investors won’t have to.
There are key reasons why specific investors want to invest through a blocker. Without a blocker, certain income is distributed directly to them. For foreign investors, this income is treated as effectively connected income (ECI) with a U.S. trade or business, and as unrelated business taxable income (UBTI) for U.S. tax-exempt investors. Foreign investors want to steer clear of ECI to avoid filing U.S. tax returns and paying extra taxes. For tax-exempt investors, they want to avoid UBTI, as that income would make them liable for U.S. taxes they normally wouldn’t have to pay. Therefore, foreign and tax-exempt investors generally try to avoid owning direct equity in a U.S. partnership, as the pass-through income system can cause unfavorable tax consequences. Instead, these investors prefer to use a corporation as a “blocker” to absorb the income at the corporate level.
Overall, a blocker structure prevents the flow-through of income to the investor. This system protects foreign investors from having to file a U.S. tax return and being taxed directly in the United States. However, the blocker corporation is still subject to U.S. corporate income tax, and any dividends are further subject to U.S. withholding tax. Therefore, while the blocker may spare the investor from effectively connected income, the combined corporate and withholding taxes may end up being the same or more than the taxation that would have been faced by the investor if no blocker were used.
A corporate entity that conducts business outside the United States, but is controlled by U.S. shareholders, is referred to as a controlled foreign corporation (CFC). In the U.S., a CFC is classified as a foreign corporation when it is more than 50% owned by U.S. shareholders, with each owning a stake of at least 10%. With a CFC comes specific anti-deferral rules, as the U.S. implemented these preventative measures to help protect against tax evasion. These rules were designed to prevent U.S. taxpayers from evading U.S. taxation by enforcing domestic tax, overall blocking investors from deliberately routing income through foreign corporations in low-tax jurisdictions. Additionally, there are critical information reporting requirements for these corporations in the U.S. that are mostly connected to the IRS, with possible disclosure requirements to other agencies for special circumstances.
Any U.S. stakeholder that owns more than 50% of a foreign corporation is responsible for filing Form 5471 annually with the IRS. U.S. stakeholders who own 10% of a foreign company’s stock must file this form each year or only in certain years with their tax return. Form 5471 asks for the U.S. shareholders’ share of income from the CFC and their particular share of earnings that are invested in U.S. property. CFC shareholders may also be required to include the foreign corporation’s profits on their personal U.S. tax return within the year the income is earned, whether or not they’ve received any of its distributions. Failure to file Form 5471 may result in a $10,000 fine, and then a continuation penalty for each additional month the form remains un-filed after an IRS notice is received. Additionally, foreign tax credits may be reduced, and the IRS may audit and assess taxes on the foreign corporation’s income at any time, with no designated time limit.
Subpart F Income provisions were created to counter passive income and transitions between related parties that were intended to shift profits to low-tax jurisdictions. Under Subpart F, income is taxed to U.S. shareholders immediately, even if the profits remain within the CFC and dividends aren’t distributed. This rule is to discourage companies from using offshore companies to delay paying taxes.
Subpart F was established in 1962, which has led to various loopholes being found. Thus, Global Intangible Low-Taxed Income (GILTI) was introduced in 2017 to capture any income that wasn’t taxed by Subpart F. GILTI calculates CFC income to capture any income that isn’t explicitly exempted or taxed in another way. The GILTI provision was meant to target intangible assets, although it broadly affects most undistributed income held in a CFC. Its goal is to capture income that multinational corporations might shift into lower-taxed foreign countries. While Subpart F targets specific types of income like passive income or related party income, GILTI focuses on the remaining CFCs’ earnings that might have avoided taxes under Subpart F.
A controlled foreign corporation is a designation under U.S. tax law administered by the IRS; therefore, its most common reporting requirements are with this agency. However, when a U.S. public company qualifies as a U.S. shareholder of a CFC, it must incorporate the CFC’s financial information in its Securities and Exchange Commission (SEC) filings. This information must additionally be prepared in accordance with the U.S. Generally Accepted Accounting Principles (GAAP). Public traded companies must disclose material financial information from their foreign operations, including CFCs, in their periodic reports. These reports include the annual Form 10-K and the quarterly Form 10-Q.
While the Committee on Foreign Investment in the United States (CFIUS) does not regulate CFCs based on their tax status, it instead focuses on their specific U.S. activities and ownership structure. It has the authority to review its investments if there are covered transactions that give a foreign person control or specific rights in a U.S. business. A CFC is not exempt from a CFIUS review even though it is considered a foreign entity, especially if its transactions involve sensitive U.S. business activities.
The Department of Defense’s (DOD) Counterintelligence and Security Agency is responsible for managing potential risks that may come from foreign investment or foreign ties to contractors. A CFC is usually not required to hold or seek contracts with the DOD, unless it creates concerns regarding its potential foreign ownership, control, or influence (FOCI). A subject contractor is considered under FOCI when a foreign interest has the power—whether it is exercised or not—to influence the operations of a company in a way that creates a potential risk to national security, compromises sensitive data, or otherwise affects its ability to perform.
Dividends are a way for a company to distribute profits to shareholders in the form of cash or additional stock. Companies may choose to pay dividends if their stock is overvalued, or to secure shareholders’ investment in the company while still receiving a consistent source of income. Those who receive dividends generally pay a tax rate between zero and 23.8%, depending on their income tax bracket. High-income earners may also be subject to an additional net investment income tax of 3.8%.
A dividend paid by a U.S. corporation to a foreign shareholder is subject to a withholding tax, with the dividend tax rate usually being 30%. The withholding tax amount depends on tax treaties between the U.S. and the foreign shareholder’s country, and how much the foreign shareholder owns of the U.S. corporation. However, exemptions include if the dividends are paid by foreign companies, are interest-related dividends, or short-term capital gain dividends.
A return of capital is the payment a company pays back to an investor as part of their original investment. Since it simply returns the investor’s own money, it is not considered a taxable event, and it is not taxed as income. This return of capital lowers the amount of an investor’s original investment, or cost basis. Once an investor’s cost basis reaches zero, any additional return of capital received is taxed as a capital gain. In comparison, a return of capital is taken from its paid-in capital or shareholders’ equity, while a dividend is paid from the company’s earnings.
Shareholders in many foreign companies who have invested capital in a corporation may designate a distribution as a return of capital. This distribution allows shareholders to receive it tax-free in many jurisdictions. Even if a corporation has available earnings to distribute, it still has the possibility to make a return of capital distribution. The general notion is that a shareholder’s capital invested in a company should be returned first, if they so choose.
When a shareholder lends real money to a company through a bona fide loan, the amount they loaned becomes their debt basis within the company. Thus, the shareholder is able to receive repayments up to the amount of their debt basis without any tax consequences. When a company pays interest on a shareholder loan, the shareholder must note that interest as taxable income on their personal return. Simultaneously, the company usually has the opportunity to deduct the interest expense, which lowers its taxable income. Therefore, a loan may be beneficial for both the shareholder and the company.
When a U.S. individual or corporation receives a loan from a foreign person or entity, they are responsible for adhering to the specific tax withholding and reporting requirements associated with repaying that debt. When a U.S. individual pays interest to a foreign individual, a 30% withholding tax applies unless a tax treaty between the U.S. and the foreign country permits a lower tax rate or exemption. IRS Forms 1042 and 1042-S must be filed annually to report withholdings and to inform the IRS and the foreign recipient of the interest paid and the tax withheld. Form 1042 is sent to the IRS to report the total withholdings, while Form 1042-S is provided to both the IRS and the foreign recipient to show the amount of income paid and tax withheld. Any interest a U.S. individual pays to a foreigner is treated as U.S. source income for tax purposes. Overall, all loan interest payments are generally subject to a 30% U.S. withholding rate and annual IRS reporting requirements, unless a tax treaty states otherwise.
The absence of a tax treaty between the U.S. and certain places like Hong Kong impacts withholding rates and tax treatment. For dividends, individuals from locations without a tax treaty are subject to a federal withholding tax on U.S.-source income at a standard flat rate of 30%, with no way to reduce or eliminate this rate without a treaty. In contrast, a return of capital is not tied to U.S. tax or withholding if it doesn’t surpass the shareholder’s cost basis. Any excess is considered capital gain, which is generally not taxed by the U.S. unless it relates to real property interests. Therefore, foreign investors are treated similarly to U.S. citizens in this matter. Yet, most foreigners won’t be taxed on U.S.-source capital gains, often escaping U.S. tax entirely. Notably, the repayment of loan principal is not taxable in the U.S., and there is no withholding. This applies regardless of the receiver’s place of residence. However, interest paid on a loan to a Hong Kong resident is subject to the full 30% U.S. withholding tax, since there is no treaty to reduce this rate for Hong Kong.
The United States and China have several International Tax Treaties with each other, which impact dividends, returns of capital, and loan repayments. Dividends are subject to a reduced U.S. withholding tax of 10% instead of 30% for most payments to Chinese residents. Yet, it is the Chinese resident’s responsibility to file for eligibility, usually through IRS Form W-8BEN, to claim this reduced rate. Additionally, the U.S. and China have agreed to allow investors to claim foreign tax credits on dividend income to avoid double taxation. Although the standard 10% treaty rate has exceptions for cases when the shareholder is more than just an investor. Returns of capital remain tax-free up to the recipient’s cost basis and aren’t liable to U.S. withholding. Any excess is treated as capital gain; the capital gains of Chinese residents are generally not taxed. The treaty between the U.S. and China doesn’t change any rules for the returns of capital. Repayment of the loan principal to a Chinese lender is not subject to U.S. tax. Under the U.S.-China tax treaty, the withholding tax on interest paid to Chinese residents is reduced from 30% to 10%. Similar to dividends, Chinese residents can usually claim a foreign tax credit in China for U.S. withholding taxes paid on interest income. This ensures the taxpayer is taxed on the income once and not twice.
The tax treaty between the U.S. and South Korea provides significant reductions and clarifications for U.S. withholding rates for dividends, but does not generally affect returns of capital or loan principal repayments. The standard dividend tax is a 15% maximum withholding on dividends paid to a South Korean resident. However, there is also a reduced rate of 10% maximum withholding if the recipient owns at least 10% of the voting stock of the U.S. corporation for part of the current year, and the previous year if applicable. As per usual, the South Korean recipient must file IRS Form W-8BEN to claim this treaty rate. The treaty does not affect the returns of capital, as it remains as a non-taxable income without U.S. withholding for South Korean residents. Any amount that exceeds the recipient’s cost basis must be treated as U.S. source capital gains, which is also generally not taxed or withheld. Although the repayment of loan principal is not taxable and does not trigger U.S. withholding, interest payments are subject to a withholding rate. Yet, the treaty lowers the U.S. withholding tax on interest payments to 12% as long as Form W-8BEN is filled out.
With a tax treaty between the United States and Japan, there are notable reductions in the U.S. withholding rates and tax treatment. Dividends paid by a U.S. corporation to a Japanese resident are subject to a 5% withholding rate if the Japanese recipient owns at least 10% of the voting stock of the company paying the dividends. Otherwise, they are subject to a 10% withholding rate. To claim these rates, Japanese recipients must fill out IRS Form W-8BEN. As usual, returns of capital distributions are not considered to be taxable income and are not liable for U.S. withholding up to the point of the shareholder’s basis. Any amount given above the investment basis is considered a capital gain, which is generally not taxed by the U.S. for Japanese residents. Thus, the treaty does not alter these standard U.S. rules. Furthermore, the repayment of loan principal also remains protected from U.S. tax or withholding for Japanese lenders. However, as of 2019, the treaty has now provided Japanese residents with a 0% U.S. withholding tax rate for most interest payments.
This series provides U.S. business owners and investors with a practical framework for structuring ownership to manage risk, improve tax outcomes, and maintain long-term flexibility. Each article reinforces a central point: ownership structure is a strategic decision, not a formality. Choices made at formation or during growth directly affect liability exposure, investor alignment, and exit options. As businesses expand across state lines or internationally, tools such as blocker corporations and controlled foreign corporations can play a critical role in isolating risk and preserving value. For decision-makers navigating growth, investment, or restructuring, understanding these ownership structures helps prevent costly mistakes and supports sustainable operations.