After piecing together advice from tax accountants for both US and JP without success, no one tax advisor will give me a straight answer so it's time for Reddit! I'm not cheap. I paid money for consults.
Consults so far:
If operations will encompass activities outside the scope of the Partner Company (other clients, other unrelated projects), the most flexible, economical, and commonly used business practice in this regard is to establish an LLC (合同会社) registered in Japan.
Please be aware that Jon as a U.S. Person and owner of 10% or more of the GK will need to file Form 5471 each year with his U.S. 1040 and disclose his officer, director, and member ownership of a foreign corporation (a Form 5471 “Category 2 filer”). Some additional reporting will be required if Jon owns more than 50% of this LLC. Note that 50% ownership is not a controlling interest, so the additional reporting will not be required in that case. What I am referring to here are various financial disclosures to the IRS, but a 50/50 arrangement as contemplated will entail minimal Form 5471 reporting on Jon's 1040. If you read a bit about IRS Form 5471 and the related instructions, you will understand what I mean.
If an LLC 50/50 is formed, IRS rules for your foreign LLC will classify taxation on whether the owner-members have unlimited liability. Under Regs. Sec. 301.7701-3(b)(2)(i)(B), a foreign eligible entity whose owner(s) all have limited liability will be considered a corporation. A multi-member foreign eligible entity that has at least one member with unlimited liability will be considered a foreign partnership under Regs.
Sec. 301.7701-3(b)(2)(i)(A). Note that if salaries are paid to each member that effectively distribute the LLC net income and therefore the entity reports breakeven operations generally and over multiple years, then treatment as a partnership or as a corporation will be moot for income tax purposes (aside from any Subpart F issues, but I need to know more about the nature of this business before I can advise you in this regard).
If neither partner nor Jon has unlimited liability and so the default classification is as a corporation, then the LLC may still elect to be treated as a partnership for U.S. purposes if the election is filed within 75 days of LLC establishment. Whether to make this election would depend on both of your intentions regarding how and when each year’s profits will be distributed to you both. If you intend to distribute net profits currently in some form (salaries, dividends, etc.), then it will not be needed. If you both intend for profits and the associated cash to remain in the LLC, it will be taxed by Japan, potentially generating a Foreign Tax Credit. Doing so will also subject the profit to double taxation: once paid as a corporation, and again when dividends are paid.
Consults so far:
- I have a JP accounting firm who is going to setup a GK for me tomorrow.
- I use Taxes for Expats for my US filing.
- I have access to a US tax attorney (see below) who has no idea about Japan corporate tax laws and is semi useless.
- A few "global tax firms" in Tokyo just completely ignored me even after multiple emails and calls over 4 months time. Clearly my account potential isn't great ROI for them.
- Perma residence in Japan.
- I'm in 40% tax bracket as employee for JP company.
- New side hustle:
- 1 US-based and 1 Mexico-based client
- Both will pay to my corp JP bank account.
- Doing consulting from Japan.
- Non-US citizen wife I don't jointly file with for US taxes.
- US-citizenship kids on US filing.
- I expect nearly 50M jpy in revenue for new side hustle by end of the year.
- Wife has years of experience in business area and will be helping me as I juggle my main job.
- I do plan on hiring more people to help out and scale to more clients.
- Low costs initially.
- Create 50/50 GK with wife to reduce IRS filing to just form 5471 and avoid "controlling interest."
- I'll be both Daihyo and Gyoumu roles. Wife is investor only.
- No salary taken myself.
- Pay wife salary for work.
- Write off a bunch of costs like office equivalent to mortgage payments, cars, parking, etc.
- I'm about to do the above tomorrow. Am I fucking up?
- Any better way to go about this?
- Because it's a GK I assume both wife and I have limited liability up to the amount invested. Which means I need to file Form 5471 only.
- Should I elect for this to be treated as a partnership or corporation for US purposes?
If operations will encompass activities outside the scope of the Partner Company (other clients, other unrelated projects), the most flexible, economical, and commonly used business practice in this regard is to establish an LLC (合同会社) registered in Japan.
Please be aware that Jon as a U.S. Person and owner of 10% or more of the GK will need to file Form 5471 each year with his U.S. 1040 and disclose his officer, director, and member ownership of a foreign corporation (a Form 5471 “Category 2 filer”). Some additional reporting will be required if Jon owns more than 50% of this LLC. Note that 50% ownership is not a controlling interest, so the additional reporting will not be required in that case. What I am referring to here are various financial disclosures to the IRS, but a 50/50 arrangement as contemplated will entail minimal Form 5471 reporting on Jon's 1040. If you read a bit about IRS Form 5471 and the related instructions, you will understand what I mean.
If an LLC 50/50 is formed, IRS rules for your foreign LLC will classify taxation on whether the owner-members have unlimited liability. Under Regs. Sec. 301.7701-3(b)(2)(i)(B), a foreign eligible entity whose owner(s) all have limited liability will be considered a corporation. A multi-member foreign eligible entity that has at least one member with unlimited liability will be considered a foreign partnership under Regs.
Sec. 301.7701-3(b)(2)(i)(A). Note that if salaries are paid to each member that effectively distribute the LLC net income and therefore the entity reports breakeven operations generally and over multiple years, then treatment as a partnership or as a corporation will be moot for income tax purposes (aside from any Subpart F issues, but I need to know more about the nature of this business before I can advise you in this regard).
If neither partner nor Jon has unlimited liability and so the default classification is as a corporation, then the LLC may still elect to be treated as a partnership for U.S. purposes if the election is filed within 75 days of LLC establishment. Whether to make this election would depend on both of your intentions regarding how and when each year’s profits will be distributed to you both. If you intend to distribute net profits currently in some form (salaries, dividends, etc.), then it will not be needed. If you both intend for profits and the associated cash to remain in the LLC, it will be taxed by Japan, potentially generating a Foreign Tax Credit. Doing so will also subject the profit to double taxation: once paid as a corporation, and again when dividends are paid.