German entrepreneurs looking to incorporate a US limited liability company (LLC) should familiarize themselves early on with the tax regulations in Germany and the US. This is because incorporating a US company does not automatically mean that you’re liable only for US tax.

In this article, you’ll learn how an LLC functions under US law, when German founders with a US LLC are liable for tax in Germany, which taxes might apply, and how LLCs are classified for German tax purposes. We’ll also explain the potential liabilities regarding income tax, corporate tax, and trade tax, as well as tax obligations in the US, and how to avoid or minimize double taxation.

Key takeaways

• A US LLC can be formed from Germany even without requiring a place of residence in the US.
  
• Whether and how a US LLC is taxed in Germany depends on the tax residency of its members, the German classification of the LLC, as well as the location of the company’s registered office, the place of actual management, and the location of any permanent establishments.
  
• In Germany, LLCs are classified for tax purposes as either corporations or partnerships, depending on their legal and factual structure.
  
• LLCs might incur taxes in both Germany and the US, although the double taxation agreement can reconcile taxation between the two countries.
  
• The tax implications of a US LLC can vary significantly depending on the structure, the US state in which it’s incorporated, and the ownership interests, so it’s a good idea to seek tax advice early.
  

How does an LLC function under US law?

An LLC (limited liability company) is a business entity in the US that combines elements of a corporation and a partnership. In principle, the members of an LLC are not personally responsible for the company’s liabilities. At the same time, LLCs have a flexible structure, making them suitable for a variety of different business models. The specific corporate laws governing LLCs vary depending on the US state in which the LLC is incorporated.

LLCs can be incorporated by one or more individuals or entities. German citizens and businesses registered in Germany can also form a US LLC; US residency or citizenship is not typically required. Depending on their structure, LLCs can be used for business in the US market, for international services, or for digital business models. LLCs remain legally independent entities with their own rights and obligations.

When are German business owners with a US LLC liable for tax in Germany?

A US LLC can trigger tax obligations in the US. The specific taxes due vary depending on, among other things, the structure of the LLC and its tax classification. An additional question for German business owners is whether and to what extent Germany can tax the income. The key factors in making that determination are the owners’ tax residency, the location of the company’s registered office, and the company’s place of actual management.

When does German income tax liability apply?

For individuals, the primary factor in determining whether German income tax obligations apply is the individual’s connection to Germany. According to Section 1, Paragraph 1 of the German Income Tax Act (EStG), individuals who have a domicile or permanent place of residence in Germany are, in principle, liable for income tax without limitation. It does not matter whether their income comes from Germany or overseas. Anyone who is tax-resident in Germany must generally pay tax on income from an LLC as well.

What role do the registered office and place of management of the LLC play?

Germany might also have taxation rights against the LLC itself. According to Section 1, Paragraph 1 of the German Corporation Tax Act (KStG), certain corporations, associations of persons, and estates are liable for corporation tax without limitation if their place of management or registered office is located in Germany. For US LLCs, this means determining whether their actual management is located in Germany.

According to Section 10 of the Fiscal Code of Germany (AO), the management is defined as the “center of senior business management.” Therefore, it’s not solely a matter of where the LLC was formally incorporated or registered; rather, what matters is the location from which key business decisions are made and day-to-day operations are managed. An LLC registered in the US might therefore be subject to taxation in Germany if management is actually carried out from Germany.

Whether an LLC incurs tax liabilities in Germany thus depends on several factors: the legal and tax classification of the company, the tax residency of the business owners, the location of the LLC’s registered office, the actual place of management, and the location of any permanent establishments.

How do the German tax authorities classify US LLCs?

The designation “limited liability company” is not a decisive factor in German taxation. Instead, the key factor is how the company is classified under German tax law. An LLC incorporated under US law might be treated as an independent corporation, a partnership, or a dependent branch of a member.

Classification is performed using a legal entity comparison. This involves examining, on a case-by-case basis, which German corporate form most closely corresponds to the LLC in terms of its legal structure and actual operation.

How does the legal entity classification work?

The legal entity comparison assesses whether the specific LLC is closer in form to a German corporation or a partnership. The key criteria are summarized in a Federal Ministry of Finance (BMF) communication from March 19, 2004:

• Type of management and representation
  
• Member liability
  
• Transferability of company shares
  
• Distribution of profits
  
• Raising of capital
  
• Company lifespan
  
• Formal requirements for incorporation
  

None of these criteria is sufficient on its own to produce a classification. Instead, an overall assessment of the legal and factual circumstances is required.

What are the implications of legal entity classification?

How an LLC is treated for tax purposes ultimately rests on the outcome of its entity classification. The “check-the-box” elections LLCs make in the US do not replace German entity classification.

If an LLC is classified in Germany as a corporation, then, in principle, it is considered an independent taxable entity. Its profits are therefore initially taxed at the company level.

If, however, it is classified in Germany as a partnership, its income is generally attributed to its members.

Regardless of its classification, an LLC’s activities might have tax implications in Germany if it maintains a permanent establishment there. In this case, any profits attributable to its German permanent establishment could be taxed in Germany.

What income taxes, corporate taxes, and trade taxes might apply to a US LLC?

If an LLC is classified as a partnership in Germany, the income is attributed to its members. If these members are individuals subject to taxation in Germany, this income might be subject to tax as income from a trade or business. Section 15, Paragraph 1, No. 2 of the EStG expressly covers profit shares derived by members who are to be considered partners of an enterprise.

If, on the other hand, an LLC is classified as a corporation, the company itself is the taxable entity. Profits are therefore taxed at the level of the company. For a company subject to taxation in Germany, corporate income tax is governed by the German Corporate Income Tax Act (Körperschaftsteuergesetz). Taxation of shareholders is generally handled separately from this, but might come into play in the event of a subsequent distribution.

When is trade tax due?

In addition to income tax or corporate tax, US LLCs might also be liable for trade tax. According to Section 2, Paragraph 1 of the German Trade Tax Act (GewStG), a business enterprise is subject to trade tax if it operates and maintains a permanent business establishment within Germany. For an LLC classified as a corporation, Section 2, Paragraph 2 of the GewStG generally deems the entire scope of its activities to constitute a commercial enterprise.

In the case of an LLC treated as a partnership, however, the decisive factor is whether any commercial activities are undertaken in Germany. Section 15, Paragraph 2 of the EStG defines the criteria according to which activities constitute a commercial enterprise. If an LLC meets these criteria and maintains a permanent establishment in Germany, it might be liable for trade tax. Trade income is derived from the company’s taxable profits and then adjusted for the applicable credits and deductions defined by law.

What is the relationship between income tax and trade tax?

German business owners could find themselves liable for both income tax and trade tax, especially if they have an LLC that has been classified as a partnership. The income generated by the LLC is attributed to its members, who might be liable for income tax on these earnings. At the same time, the business operation conducted in Germany could be subject to trade tax if the requirements of the Trade Tax Act are met.

However, trade tax can partially offset the income tax burden on individuals. Section 35 of the EStG provides for a tax reduction on business income. Therefore, the actual tax burden cannot be assessed based solely on the basis of the Income Tax Act or the Trade Tax Act.

What tax obligations does an LLC have in the US?

Anyone incorporating a US LLC from Germany must observe both German and US tax obligations. Due to the LLC structure, a German business owner might be subject to taxation in both the US and Germany. With respect to US federal income tax, the classification of an LLC depends primarily on the number of members and the chosen tax classification.

• Single-member LLC
  A single-member LLC is generally treated as a “disregarded entity.” This means that it is not treated as a separate taxable entity with respect to US federal income tax. Income and expenses are attributed to the sole member and are included in that member’s tax return.
  
• Partnership
  An LLC with multiple members is typically treated as a partnership. The LLC files a partnership tax return reporting its income and expenses. The respective shares of the profits are then allocated to the members and reported by them on their individual tax returns. In either case, the profit is taxed only at the member level and not additionally at the LLC level.
  
• Corporation
  An LLC can also opt to be taxed as a corporation. To do this, the company must file an application with the US Internal Revenue Service (IRS). This election does not affect the legal status of the LLC under the laws of the respective US state.
  

What regulations prevent the use of US LLCs for tax evasion purposes?

German entrepreneurs might be interested in setting up a US LLC for either legal or financial reasons. However, simply incorporating a company in the US does not mean that German taxes can be avoided. The decisive factors in determining which taxes apply to an LLC in Germany are the actual circumstances and the tax classification of the LLC.

Section 42 of the AO establishes a general principle: tax law cannot be circumvented through the abuse of legal structuring options. An abuse might be deemed to exist if an inappropriate arrangement results in a tax advantage not intended by law and there are no significant nontax reasons for the chosen structure.

When do controlled foreign company rules apply?

Certain foreign companies might also be subject to the rules on controlled foreign companies (CFCs). These rules are intended to prevent companies from permanently evading German taxation by attributing certain income to a foreign company located in a jurisdiction with lower taxation.

According to Section 7 of the German Foreign Tax Act (AStG), income from a foreign company can be attributed to a taxpayer subject to unlimited tax liability in Germany if that taxpayer controls the company and the entity qualifies as an intermediary company. Section 8 of the AStG defines which types of income this applies to. Criteria include the type of income and the level of actual taxation abroad.

Therefore, a US LLC does not automatically qualify as a CFC simply because it’s headquartered in the US. What matters is the LLC’s classification for German tax purposes, the ownership and control structures, the nature of its income, and the taxation applicable in the US.

How is double taxation prevented?

Anyone running a US LLC might find their income recorded by both the German and US tax authorities. However, the US–Germany double taxation Agreement (DTA) is intended to prevent double taxation. It allocates taxation rights between the two countries and establishes which country is entitled to tax certain types of income. The DTA does not create a right to tax for either country; rather, it limits existing taxation rights.

The DTA provides for different rules according to the type of income. To avoid double taxation, an exemption or a credit for the tax paid in the other country can be applied. The method used depends primarily on how the income is classified. Therefore, in the case of a US LLC, the first thing to do is to clarify how the company and its income are to be classified under German tax law and for DTA purposes.

When is it a good idea to seek professional tax advice for a US LLC?

With a US LLC, even small differences in structure can have significant tax implications. This is the case, for instance, when the company is classified differently in Germany than it is in the US. Questions regarding CFC rules or avoiding double taxation can also complicate the tax situation. Professional advice is therefore highly recommended, particularly for more complex structures.

This is particularly important given that tax rules for an LLC can vary from Florida to Delaware to any of the other US states. Therefore, anyone incorporating or already running a US LLC should review the tax implications in the US and Germany as early as possible. Consulting with professional tax advisors can help identify potential tax obligations and mitigate avoidable risks.

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