Cross Border Taxes: How A Canadian Resident Reports a K-1 in the USA

We recently received a call from a client in Canada who invested in a California LLC and was issued a K-1 from the LLC. Our client is a Canadian resident and citizen only, is not a green card holder or in any way qualifies as a US taxpayer.

Never having seen a K-1 before, our client was perplexed on how to deal with it both in Canada and the US, especially since the K-1 showed our client incurred a loss for the first year of his investment in the LLC.

A K-1 represents each shareholder’s portion of the company’s profits, losses, deductions and tax liability for the year. The Internal Revenue Service (IRS) requires a partnership to issue a Schedule K-1 to all partners, even though a partner is not in any way connected to the US.

Much to our clients chagrin, we explained to him that even though he is not a US taxpayer and even though he incurred a loss, he was still obligated to file a 1040NR return and to obtain a US Individual Taxpayer Identification Number (ITIN). Moreover, our client was informed that he also needs to file a California 540NR return.

Simply put, even though our client is not a US taxpayer, he still needs to file a US return because he is considered to have effectively connected income as a result of the LLC’s business within the US. Under the tax code, because of our client’s ownership interest in the LLC, he is considered to be engaging in a business operated within the US.

Surely, not the answer our client was hoping to hear.

What about the tax consequences in Canada? Well, we’ll have to leave that to a future article because the tax rules in Canada with respect to a US LLC are fairly complex.

At Gedeon Law & CPA, we regularly advise domestic LLC’s, and its foreign members, with the tax reporting and compliance obligations involved with foreign ownership. Please call our office today to schedule a consultation on this subject or to discuss your specific situation.

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