In this content, created in collaboration with Lazo we discuss the U.S. tax system and explain it through five key concepts that help Latin American startups understand how taxes work in the United States.
First, we’ll look at how the U.S. tax system works. Then, we’ll explore the differences between direct and indirect taxes. Next, we’ll discuss business structures. In the fourth section, we’ll take a closer look at direct taxes, such as income tax, franchise tax, and property tax. Finally, we’ll cover indirect taxes, such as sales and use taxes.
Why do Latin American startups set up a company in the United States?
First, it’s important to keep in mind that Latin American startups often seek opportunities in the U.S. venture capital market, whether they’re looking for investment or customers. To do so, many set up a holding company in Delaware and link their investments to operating companies in Latin America.
Additionally, when a startup begins expanding globally and conducting international operations, it faces tax pressures in its home country, prompting it to seek a more competitive jurisdiction, such as the United States.
The most startup-friendly business structures for Latin American startups in the U.S.
When it comes to business structures, there are several legal options for incorporating a company in the United States. Some of the most common are LLCs (limited liability companies) and corporations. Each type of legal entity has its own tax obligations, which vary depending on the number of owners and their tax residency.
However, as a Latin American founder, you’re most likely to choose one of 2 options: a multi-member LLC with non-U.S. resident owners, or a C corporation with non-U.S. resident owners. We strongly recommend consulting with lawyers to understand which legal entity is best for your startup and investors, and to learn about your tax obligations in the United States.
How do taxes work in the United States?
The U.S. tax system is complex and has three levels of taxation: federal, state, and local. Each level of government has its own authority to levy taxes, which means the federal government cannot interfere with state taxes, and each state has a tax system separate from the others. In addition, there are more than 11,000 jurisdictions in the United States that can levy taxes, which can make the landscape complicated.
Types of taxes in the U.S.
There are 2 types of taxes in the United States: direct and indirect. Direct taxes are paid directly to the authority that levies them, such as income tax. Indirect taxes, on the other hand, are collected by businesses from their customers, who bear the economic cost, such as sales or use tax.
Direct taxes
In the United States, startups must comply with various direct taxes, which can vary depending on the company’s legal structure and geographic location. The most relevant direct taxes are income tax, franchise tax, and property tax.
Income tax: This tax is levied on a company’s profits. In the United States, income tax is imposed at both the federal and state levels, meaning that both the federal government and state governments can tax a company’s profits. Tax rates and filing requirements may vary depending on income level and the company’s location. It is important to file an accurate income tax return and meet all applicable tax obligations.
Franchise tax: Franchise tax is a state tax levied on corporations and certain other business entities. It is not related to franchises in the sense of business licenses; rather, it taxes a company’s right to exist and do business within a specific state jurisdiction. The amount of franchise tax can vary according to each state’s tax rules and may be based on various factors, such as the company’s assets or share capital.
Property tax: Property tax is levied on real estate and, in some cases, certain high-value personal property. This tax is used to fund infrastructure and public services in localities, counties, or states. The amount of property tax is based on the property’s fair market value and may vary by geographic location. Businesses must pay this tax on any property they own, such as land, buildings, or equipment.
It is important to note that direct taxes may be subject to specific rules and requirements depending on the state and the company’s legal structure. Some states may have higher tax rates than others, and companies must ensure they meet all applicable tax obligations in each jurisdiction where they operate. Specialized tax advice is essential to properly understand and comply with direct taxes.
Indirect taxes
Finally, when it comes to indirect taxes, we’ll focus on sales tax and use tax. Sales tax applies to transactions between retailers and end consumers, and varies according to each state’s tax rules. Use tax is similar, but in this case the end consumer pays the tax directly to the relevant jurisdiction.
Sales tax: Sales tax is a state tax levied on the sale of tangible goods and, in some cases, specific services. Unlike the value-added tax (VAT) used in many Latin American countries, U.S. sales tax applies only to the transaction between the retailer and the end consumer. Each state has its own rules and tax rates, which can make sales tax compliance complex for businesses operating in multiple states. The retailer is responsible for collecting sales tax from the end consumer and remitting it to the relevant jurisdiction.
Use tax: Use tax is a tax that complements sales tax. It applies when the retailer does not act as an intermediary in collecting sales tax, and the end consumer must pay the tax directly to the relevant jurisdiction. Use tax applies when an end consumer uses or consumes a tangible good or service in a specific jurisdiction without having previously paid the applicable sales tax. The economic burden falls on the end consumer, who must remit the tax to the relevant jurisdiction.
Conclusion
Remember that while you don’t need to become a tax expert, it is essential to seek specialized advice to ensure you meet all your tax obligations. We also recommend watching the video, which explains in greater detail and with visuals how taxes work for Latin American startups in the United States.