Check-the-box for a UK Ltd: choosing how the US sees your company

Can a UK limited company make a check-the-box election?

A UK private limited company can. The US entity classification regulations list the foreign entities that are always corporations, and the entry for the United Kingdom is the public limited company. A private limited company is not on that list, so it is an eligible entity and may choose its US classification on Form 8832 (opens the official IRS page in a new tab).

Without an election, a foreign eligible entity whose members all have limited liability is an association taxable as a corporation. That describes the ordinary UK company limited by shares, which is why a US founder files Form 5471 by default. The choices open on an election depend on the number of owners, because the regulations treat an entity with two or more members as either a corporation or a partnership, and only an entity with a single owner can be disregarded.

The form is filed with the IRS, and the company must hold a US employer identification number before it is filed. It is signed by every owner at the time of filing, or by an officer or member authorised to make the election, and a copy is attached to the owner's return for the year in which it takes effect. We deal with it as part of business incorporation work.

• UK public limited company: always a corporation, with no election available
• UK private limited company, no election: a corporation by default
• Private limited company with one owner, electing: a disregarded entity
• Private limited company with two or more owners, electing: a partnership

What does the election change on the US return?

The company stops being a foreign corporation in US eyes. Form 5471 and the controlled foreign corporation rules, meaning Subpart F and net CFC tested income, no longer apply from the effective date. The whole profit of the business is instead taxed on the owner's Form 1040 in the year it is earned.

Reporting is replaced, not removed. The owner of a foreign disregarded entity attaches Form 8858 (opens the official IRS page in a new tab) to the income tax return, and it is due when that return is due. Where the company has two or more owners and becomes a partnership, a US partner who controls it or meets one of the other filing tests reports on Form 8865 (opens the official IRS page in a new tab). Our pages on Form 8858 and Form 8865 set out who files each one.

The larger change is to the credit. Under the foreign tax credit regulations, a foreign tax charged on the income of a disregarded entity is treated as the liability of its owner. UK corporation tax, at the 19% small profits rate, the 25% main rate or an effective rate in between, therefore becomes potentially creditable by the founder on Form 1116 (opens the official IRS page in a new tab), subject to the limitation and category rules described on our Form 1116 page. Under the default, an individual gets no credit for the company's tax unless a further election is made, as our post on net CFC tested income explains.

• Falls away: Form 5471, Subpart F and the net CFC tested income computation
• Comes in: Form 8858 for one owner, or Form 8865 for a partnership
• Timing: all profit is taxed on the owner as it arises, including profit left in the company
• Credit: UK corporation tax is potentially creditable by the owner directly

Does the election change anything for UK tax?

No. The election is a US filing with US effect only. In UK law the company remains a company. It still pays Corporation Tax (opens the official GOV.UK page in a new tab) on its profits, still files accounts and a Company Tax Return (opens the official GOV.UK page in a new tab), still runs PAYE on the director's salary, and still pays dividends that are taxed on the shareholder.

The result is a hybrid entity: a company in one country and transparent, or absent, in the other. The two returns then describe the same year differently. The UK sees a company paying a salary and a dividend to a separate person. With a disregarded entity, the US sees one individual carrying on a business, so a salary or dividend paid by the company to its owner is a movement of the owner's own money and not income.

Dividends are the harder case. UK dividend tax arises on a payment the US does not recognise, so there may be no US income of the right kind in that year for the credit to be set against, which is a point to review before any dividend is declared. How the treaty applies to income of an entity that the two countries classify differently is another. Our post on salary or dividends for a US founder covers the default position these points should be compared with.

What happens when an established company elects?

The regulations treat the change as a liquidation. A company that elects to be disregarded is deemed to distribute all of its assets and liabilities to its single owner. One that elects to be a partnership is deemed to distribute them to its shareholders, who are then deemed to contribute them to a new partnership. The deemed steps occur immediately before the close of the day before the election takes effect.

A liquidation is a taxable event for a shareholder. Under the Code, what a shareholder receives in a complete liquidation is treated as payment in exchange for the shares, so the owner is taxed as if the shares had been sold for the value of what the company holds. For a company that has built up goodwill, client contracts or retained cash, that can mean a US gain measured against a low share basis. Nothing has happened in the UK, so there is no UK tax on a disposal to credit against it.

A newly formed company is in a different position. An election that takes effect on the date of formation applies before any value has accrued, and the regulations do not count it as a change of classification at all. An election for a company with some years of trading needs a valuation and a computation before the form is signed.

When does the election take effect, and can it be changed?

It takes effect on the date entered on the form, or on the filing date if none is entered. The date chosen can fall only within a window set by the regulations, which reaches back a limited number of days before the form is filed and forward up to a year after it. A date outside that window is moved to the nearest date the rules allow, so the form's instructions should be checked before a date is entered.

Late election relief exists and is requested on the form itself. Broadly, the only failure must be that the form was not filed on time, the returns already filed must be consistent with the classification intended, there must be reasonable cause, and the request must be made within the time limit the IRS sets, which runs from the intended effective date. Outside those conditions the route is a private letter ruling, for which the IRS charges a fee.

Once a company has changed its classification by election, it generally cannot change it by election again for a period of years from the effective date. The IRS may permit an earlier change where more than half of the ownership has passed to new owners. An election by a new company effective from formation does not start that period, because it is not treated as a change.

• No date entered: the election takes effect on the day it is filed
• Backdating: only within the limited window the regulations allow
• Forward dating: up to a year after filing
• Changing again: generally barred for a period of years after an elective change

Does a disregarded company bring US self-employment tax?

It can. The regulations state that the owner of a disregarded entity is subject to self-employment tax on self-employment income from the entity's activities. A founder who was an employee and shareholder of a corporation becomes, for US purposes, a self-employed individual, and the US charge is 15.3% before any relief.

Relief comes from the totalization agreement (opens the official SSA page in a new tab) between the two countries. Under it, a self-employed worker who resides in the United Kingdom is assigned to UK coverage, and one who resides in the United States to US coverage. The exemption from US contributions is established by a certificate of coverage requested from HMRC, and the Social Security Administration asks self-employed workers to attach a copy to the US return each year.

There is a point to review here as well. In the UK the founder is a director paying National Insurance through the company's payroll, and is not self-employed in UK terms, so the certificate application has to describe the arrangement as it is. We settle the certificate position as part of tax planning before an election is filed.

How should a founder decide whether to elect?

By comparing both classifications on both returns, using the company's own figures. Neither is the default answer. Keeping the corporation means Form 5471 and an annual inclusion, with a section 962 election and the high-tax exception as options to review. Electing means direct taxation, a direct credit and the social security question.

Take a US citizen in Leeds who is about to form a UK limited company for her software consultancy and will hold every share. Because the company is new, an election from formation has no deemed liquidation to pay for. She compares the two routes on her forecast: how much profit she will leave in the company, whether she will pay herself mainly by salary, and whether she expects to bring in investors or sell. If she keeps the corporation, the filing described in our post on Form 5471 for a one-person UK limited company applies every year.

A founder with an established company asks the same questions and adds the cost of the deemed liquidation. We prepare the comparison, and whichever of Form 5471 or Form 8858 follows from it, through our business tax returns service. For how the election sits beside the anti-deferral rules, pay planning and a later sale, return to the guide to US-UK tax for founders, fund managers and executives.