Foreign Investors in S-Corporations

Pursuant to Internal Revenue Code § 1361, there are certain restrictions to qualify for S-Corporation status; one of which is that a shareholder cannot be a nonresident alien.  If a nonresident alien were to become a shareholder of an S-Corporation already in existence, the entity’s S-Corporation election is immediately terminated and the entity’s classification becomes that of a C-Corporation.  There are a couple of options available for a nonresident alien who wants to become a shareholder in a business currently setup as an S-Corporation but each come with inherent risks or drawbacks.

The first option would be for the nonresident alien to become a resident alien.  This can be both advantageous and disadvantageous to the individual as it exposes his or her income and assets to U.S. taxation.  Unlike nonresident aliens, resident aliens are allowed to be shareholders in an S-Corporation.  To become a resident alien, an individual can acquire a green card or they can be considered a resident alien for U.S. tax purposes by meeting the Substantial Presence Test.

The second option would be to restructure.  By dropping the assets from the S-Corporation into a Limited Liability Company, a foreign investor who is a nonresident alien can be a shareholder in the business without subjecting the nonresident alien to U.S. taxation on his or her worldwide income; this also allows the business to remain a flow through entity for tax purposes.  It is important to note that tax treaties in effect between the United States and the nonresident alien’s country of origin may affect how the business or individual are taxed.