If you’re an entrepreneur, you’re always looking for the next best idea for your business. Whether you have already registered your business in Canada or not, you probably have heard of limited liability companies or LLCs.
Touted for their flexibility, liability protection, and adjustable taxation treatment, you might be wondering if LLCs are offered in Canada. Unfortunately, they are not. But, there are some alternatives to consider, and you can use the LLC structure if you choose to operate in the US.
Here’s a roundup of all the details.
What is a Limited Liability Company (LLC)?
An LLC is a business structure available in the U.S. that allows the owners (known as “members”) to protect their personal assets should a lawsuit come their way. Because an LLC is considered a separate entity for legal purposes, any issues the business faces are dealt with within the company, not with the owners personally.
This can be a bit complex, so here’s an example. Let’s say you’re running a construction business, Don’s Contracting, LLC. One of your employees damages a customer’s home while on the job and the customer decides to sue. Even though you own the company, the customer cannot seize your personal assets like your truck, home, bank accounts, etc. They can only reach assets owned by the LLC, as the business is responsible for the damages. That’s quite an advantage.
Keep in mind that this asset/legal protection only lasts so long as the owners do not make any personal guarantees that will hold them personally liable – regardless of if they own an LLC or not.
How are LLCs taxed?
Unlike their legal status, LLCs are treated to be identical to their owners for tax purposes. In technical terms, they are taxed as flow-through entities. This means that any income generated by the business will be a part of the owner’s personal tax returns. Though the owners are the ones claiming the income, the LLC will still have a business bank account, credit card(s), and other assets in its name.
Additionally, LLC owners can choose how they want their business to be taxed. This topic is quite complex, but the essence is this: rather than be taxed like a sole proprietorship, LLCs can elect to be taxed as a corporation. This means they fall under corporate tax brackets rather than personal ones (to name one major difference).
On the other hand, if there are multiple owners in the company, they can elect to file their taxes as a partnership. This means that each owner will have income allocated to their personal return in accordance with their ownership in the company.
The taxation flexibility that comes with LLCs can be seen as a major boon for business owners. But is this business type even available to Canadians?
Are LLCs available in Canada?
LLCs, unlike corporations or partnerships, are not offered in Canada. The LLC business structure is not offered to Canadians. However, Canadian residents can register an LLC in the US – if they so choose.
What are the alternatives to LLCs in Canada?
Though this flexible business structure is not offered in Canada, there are some solid alternatives – depending on what your goals are. If you’re looking for asset protection with limited liability, a standard corporation will suffice. A corporation is a separate legal entity that will prevent your assets from being seized in the event of a lawsuit.
On the other hand, if you’re simply looking to start your first business, a sole proprietorship or partnership is a good fit. Similar to LLCs, they are taxed on a flow-through basis, meaning that the owners receive the income from the business – not the company.
However convenient these other options may be, they don’t quite match up to an LLC in terms of flexibility and asset protection. The closest business structure Canada can offer – both in name and structure – is a limited liability partnership (LLP).
Limited liability partnerships (LLPs): a similar counterpart
An LLP is a type of partnership that allows for limited liability protection like an LLC. Within this structure, there are partners of the business that are separate from the entity itself. This allows for some asset protection, as the partners in the business only have liability up to the amount they contribute to the business. Moreover, if the lawsuit is due to one partner’s negligence, only their assets are liable. The other partners are protected. Note that LLPs are governed by the legislation of the province they are created in. Some provinces offer more (or less) liability protection than others.
Additionally, LLPs are taxed similarly to general partnerships. Any income the business makes is part of the partner’s tax returns.
Though this business type is similar to LLCs in the US, there is a major caveat to keep in mind: in many provinces, they are only offered for certain types of businesses. In Alberta, for example, only licensed professionals such as lawyers or accountants can operate an LLP. This vastly shrinks the pool of individuals that can use such an entity.
Can you form an LLC in the US as a Canadian?
Yes, you can. Regardless of where you live in Canada, you can start an LLC in the US. Why wouldn’t you want to open a business in the US, especially if you don’t have to move?
There is one major pitfall to be aware of: double taxation.
Taxation issues for LLCs owned by Canadians
As mentioned previously, LLCs are flow-through entities, meaning that any income the business generates belongs to the owner – not the business. Though LLCs can elect to be treated as corporations, for simplicity’s sake we will only focus on flow-through taxation issues.
The problem with LLCs owned by Canadians is how the Canada Revenue Agency (CRA) views them. While the Internal Revenue Service (IRS) treats an LLC’s earnings as the earnings of the owners, the CRA is vastly different: it treats LLCs as corporations. What does this mean tax-wise?
If you opened an LLC in the US to take advantage of pass-through taxation benefits (i.e. not paying corporate taxes), this maneuver is no longer possible. Given the disparity between how the IRS and the CRA classify LLCs, you will be taxed multiple times.
First, the IRS will tax any income you make as personal income. Second, the CRA will tax the same income the business earned as corporate income, subject to corporate tax rates. Third, when you choose to withdraw the funds as dividends or a salary, this will be taxed again according to Canadian dividend rates or personal income rates. That’s three times you will be taxed if you operate a flow-through LLC in the US.
LLC taxation example
Taxation rules are quite complex, so here’s an example of the above.
Your business, Canadian Construction Co., LLC made $5,000 in 2022. The IRS takes $500 (10%) in personal tax from you the owner. The CRA then taxes that same $5,000 at a rate of 15% (we are assuming you are not a Canadian small business for simplicity) which subtracts $750 from the LLC’s earnings. So far, your business is left with $3,750.
When you decide to remove the $3,750 for your salary, through a withdrawal or dividend payment, you will pay another round of Canadian tax again. That’s an unnecessary amount of taxation that could have been avoided by using a different corporate structure.
What about the Canada-US Tax Convention?
In cases where Canadian residents could be taxed by the IRS and CRA on the same income, the US-Canada Tax Convention has provisions in place to prevent double taxation. For example, if you are an independent contractor earning income from the US, you can file a W8-BEN Form so the IRS will not tax your income, only the CRA will.
When it comes to LLCs electing to be treated as flow-through entities, these provisions generally do not apply. These “tie-breaker” rules only apply when a single entity’s income is subject to tax from both countries. Because a flow-through LLC’s income is classified as personal income in the US, but classified as corporate income in Canada, this clause does not apply.
In short, opening an LLC in the US is doable, but messy.
How to open an LLC in the US
Should you decide to open an LLC despite the tax complications, here are the steps you need to take. Note that these steps may vary slightly depending on where you decide to start your company.
Step 1: Choose a name
Your business name should reflect what services/products you will be offering. Think of a name as a handshake: it’s your first impression. Though choosing a name is a creative process, there are requirements to be aware of, set by the Secretary of State you will be incorporating with.
- Ensure the term “LLC”, “L.L.C.”, or “Limited Liability Company” are included.
- Take care to avoid terms that make your company appear to be a public servant (e.g. Department of State).
- Do not use terms like attorney, university, or bank, as these are restricted unless you have the proper paperwork – and meet the legal requirements.
Once you have chosen an appropriate name, you’ll also need to make sure it is not in use. To do so, simply search for the name on the Secretary of State’s website for the jurisdiction you are planning to incorporate in. If no results come up, you’re in the clear.
Given the ubiquitous use of business websites regardless of the type of services offered, you’ll likely want to check if a similar domain name is available. An online presence is key in this day and age.
Step 2: Find a registered agent (RA)
Any business that operates within the US needs a registered agent (RA). This is an individual (or business) that receives legal documents on behalf of the business and makes sure it is meeting compliance requirements.
The RA will need to be located within the state you are operating in, so having a contact in place before starting any business activities in the US is a huge plus. Alternatively, some states (e.g. New York) do allow for you to appoint the Secretary of State as your RA.
If you are choosing someone you know personally, such as a friend or family member, keep in mind that they will need to be available to the public five days per week. Their contact information will also need to be made public.
Step 3: Set up a mailing address
Though your registered agent will receive any formal correspondence (tax issues, lawsuits, legal documentation) your business is still required to have an address. As someone living in Canada, your best bet is to use a virtual mailing address service. Many businesses offer virtual mailing addresses that are secure and professional (unlike a simple PO box). Don’t worry, you’ll still be able to forward packages from the US to Canada with a virtual address.
Step 4: File organizational paperwork with the state
While each state has its nuances when it comes to filing organizational paperwork, there are some general guidelines to follow. The articles of organization (i.e. the documents that outline core features of the business) need to contain at least the following:
- Purpose of the LLC
- Name and address of the business
- Length of its existence, if specified
- Name and address of the registered agent
The articles need to be signed by the person forming the LLC, as well as the registered agent – in some cases.
Once completed, the articles will typically be filed with the Secretary of State.
Step 5: Draft an operating agreement
An LLC operating agreement is a document that states key operation, administration, and management details. Think of it as a roadmap – it defines what goals you wish to reach and how you want to achieve them.
Specifically, an operating agreement lays out points such as member responsibilities, allocation of profits and losses, how meetings will be held, voting rights for the members, and so on. Although they may not be mandatory to file with the state, they may still be required by state law. Not having one in place could open up the potential for disagreements among members due to scope creep. An operating agreement helps clearly define the roles of each involved party.
Step 6: Apply for an employer identification number (EIN)
An employee identification number (EIN) is like a social security number for your business. It is a way for the IRS to identify your business from a tax perspective.
Not only is it crucial to have it for tax purposes, but you’ll also need it if you plan on hiring employees.
Thankfully, the process is fully online and easy to complete. The IRS has an intuitive, fully-online process that is expedient.
Step 7: Apply for a US bank account
If you’re going to be operating in the US, you’ll need a US bank account. With all the documents completed and filed from the previous steps, you should have everything you need to get the ball rolling.
While opening an LLC in the US may appear to be an attractive option, doing so could open your business up to some severe tax consequences – unless you know what you’re doing. Unless you have an overriding reason to operate an LLC rather than a standard US corporation or partnership, we recommend leaving the LLC structure alone. It’s unduly complex for new and established business owners alike.
No, Canada does not offer the LLC business structure.
In terms of entity types that offer limited liability protection, limited liability partnerships (LLPs) come close. But for taxation purposes, Canada does not have entity structures that allow for flexible taxation like LLCs (allowing for either flow-through or corporate tax treatment). If you’re looking for a corporate structure that will protect your assets in the case of a lawsuit, a simple corporation will do.
In most cases, yes. Because the CRA treats LLCs as corporations and not flow-through entities, both the owners of the company and the company itself will be taxed.
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