Owning US investments through a US LP or US C Corporation
To explore the C-corporation option, for illustrative purposes, we will use a hotel business in Florida that makes $1,000 of net income per year. Using this example, we will compare the US limited partnership (LP) structure to the C Corporation structure.
The US LP Structure
Canadians usually establish a US LP with a US LLC or a Canadian holdco as the general partner and the Canadian individual as the limited partner. Since the LP is a flow-through entity, the income is taxed in the individual’s hands. The individual is subject to US federal income tax at the top marginal tax rate of 37%. (There is no state income tax in Florida.)
The Canadian individual/limited partner is also subject to Canadian taxation. If the individual is an Ontario resident, for example, the Canadian limited partner will be taxed at the top marginal tax rate of 53.53%. Due to the US-Canada income tax treaty, the US tax paid will be used as a foreign tax credit in Canada; therefore, the combined US and Canadian tax on income from the Florida hotel business for an Ontario resident will be 53.53%
The US C Corporation Structure
A US C Corporation is set up with an Ontario holdco (Holdco) as a parent company, whose shareholder will be the Canadian individual. The income will be subject to a 21% US federal tax and a 5.5% Florida state tax. Since the state tax is still deductible for the federal tax return, the combined US federal and Florida tax rate will be 25.35%. The after-tax money of $746.50 will be distributed to Holdco as a dividend, which will be subject to the withholding tax of 5% ($37.32). The dividend net of withholding tax ($709.18) will be received by Holdco tax-free and may be distributed to the individual as an eligible dividend at the rate of 39.34% ($278.99). The after-tax total of $430.19 represents an effective overall tax rate of 56.9% (vs. 65% prior to the US corporate tax cut).
This C corporation tax rate of 56.9% is higher than the LP’s 53.53% overall tax rate. However, there is potentially a tax deferral opportunity available, where 27.9% of tax can be deferred in the C corporation structure if dividends aren’t paid to the shareholder in the same year in which they are earned.
You should speak to a cross-border advisor at a firm like MCA if you are a Canadian considering acquiring US investments.