A Canadian manufacturing client calls you on a Tuesday. They've just landed a major US contract—their biggest deal ever. They're ecstatic. They ask a simple question: "Do we need to set up a US company?"
You give them advice based on what you think you know about US tax law.
Three years later, they receive a notice from California's Franchise Tax Board. They owe six figures in back taxes, penalties, and interest for a nexus obligation they never knew existed. The state caught them because they had inventory sitting in a third-party warehouse in Los Angeles.
Meanwhile, they've also been filing US federal tax returns they didn't actually need to file, paying thousands in unnecessary compliance costs.
This scenario plays out repeatedly across Canada. Why? Because Canadian tax professionals operate with what experts call "dangerous half-knowledge" of US tax matters. And US tax professionals? Most have spent their entire careers in the world's largest domestic market and have zero experience with international tax or the Canada-US Treaty.
This comprehensive guide will help you navigate the critical tax implications when Canadian businesses operate in the United States. You'll learn when US tax applies, how to choose the right structure, and how to avoid the systematic errors that cost clients thousands while creating malpractice exposure for advisors.
What Does "Doing Business in the US" Mean for Tax Purposes?
For tax purposes, "doing business in the US" isn't a binary yes-or-no question. It exists on a spectrum of five distinct levels of activity, each with dramatically different tax consequences.
The Five Levels of US Business Activity
Level A: Employee Services in the US
A Canadian employee of a Canadian corporation travels to the US to meet customers, visit prospects, or provide services. The Canadian corporation has no other US presence.
Level B: Representative or Owner Visits
An owner or independent representative (not an employee) conducts business activities in the US—networking, attending trade shows, meeting potential clients.
Level C: Business Activity Through Third Parties
The Canadian business has goods stored in a 3PL (third-party logistics) warehouse in the US, uses a fulfillment center, or has an independent contractor taking orders.
Level D: Fixed Place of Business
The Canadian company establishes an office, factory, or company-owned warehouse in the US—a physical presence under direct control.
Level E: US Entity Formation
The business establishes a formal US legal entity: Corporation (C-Corp), S-Corporation, Limited Liability Company (LLC), or partnership.
Each level triggers different tax obligations at both the federal and state levels. Understanding where your client sits on this spectrum is the critical first step.
Federal Tax vs State Tax: Two Different Worlds
One of the most dangerous misconceptions Canadian advisors hold is assuming that federal and state tax obligations align. They don't.
Federal taxation is triggered by creating a "permanent establishment" under the Canada-US Tax Treaty—generally requiring a fixed place of business in the US or an agent habitually concluding contracts on behalf of the Canadian company.
State taxation is triggered by "nexus"—a connection to a specific state that can be created with far less activity than required for federal PE. Each of the 50 states (plus the District of Columbia) defines nexus separately under its own rules.
This means a Canadian business can have:
- State tax obligations with NO federal tax obligations
- Tax obligations in multiple states even without a physical presence
- Completely different filing requirements in different states
A Canadian company could be exempt from US federal tax under the Treaty but still owe income tax, sales tax, and franchise tax to California, New York, Texas, and five other states.
When US Taxation Applies: The Canada-US Tax Treaty Employment Exemption
The Canada-US Tax Treaty contains a powerful exemption that protects most routine employee visits to the US from taxation. Understanding these rules can save significant compliance burden and tax for clients with cross-border workers.
The Three-Part Test for Employment Income Exemption
Employment income earned by a Canadian resident for services performed in the US is exempt from US taxation if ALL three conditions are met:
1. The Time Test: The individual is present in the US for 183 days or less in any 12-month period beginning or ending in the tax year.
2. The Compensation Test: The total employment income is $10,000 USD or less for the calendar year.
3. The Deduction Test: The salary expense is NOT deducted against the income of a US entity (corporation, LLC, or branch of the Canadian company).
If even one condition fails, the exemption doesn't apply and US taxation kicks in.
Practical Applications of the Treaty Exemption
Example 1: Sales Representative Visiting US Customers
A Canadian employee visits US customers 40 days per year, earning $80,000 annual salary (approximately $10,000 allocable to US work). The Canadian corporation has no US entity and doesn't deduct the salary against US source income.
Result: Exempt from US taxation. All three conditions are met.
Example 2: Executive Spending Extended Time in US
A Canadian corporate executive spends 200 days in the US overseeing a major project, earning $150,000 annual salary ($82,000 allocable to US work). The company has no US entity.
Result: Fails the 183-day test. The executive has US tax filing obligations and the Canadian company may have withholding obligations.
Example 3: Employee Working at US Branch
A Canadian employee is assigned to work at the US branch of a Canadian corporation for 120 days, earning $60,000 annual salary ($19,000 allocable to US work). The salary reduces the branch's US taxable income.
Result: Fails the deduction test. US taxation applies because the salary expense reduces US source income.
What About Representatives and Business Owners?
Individuals who aren't employees—business owners visiting customers, independent representatives, consultants—don't benefit from the employment income exemption. However, casual visits for general business development typically won't create permanent establishment.
The line gets crossed when representatives begin:
- Habitually concluding contracts on behalf of the Canadian company
- Maintaining stock of goods for delivery
- Operating from a fixed location
These activities can create permanent establishment and trigger US federal taxation, even without a formal US entity.
State Nexus: The Hidden Tax Trap for Canadian Businesses
State nexus is where Canadian businesses get blindsided. The rules are complex, constantly evolving, and differ dramatically from state to state.
What Creates Nexus?
Historically, nexus required "physical presence"—an office, warehouse, employee, or inventory in the state. That changed dramatically with the US Supreme Court's decision in South Dakota v. Wayfair (2018).
Post-Wayfair, states can now impose economic nexus based solely on sales volume, even with zero physical presence:
Typical Economic Nexus Thresholds:
- $100,000 in annual sales to customers in the state, OR
- 200 separate transactions with customers in the state
Both income tax and sales/use tax can be triggered by economic nexus.
Physical Nexus Still Matters
Despite economic nexus, traditional physical presence remains the broadest nexus creator:
Activities Creating Physical Nexus:
- Inventory stored in the state (including 3PL warehouses, Amazon FBA)
- Employees working in the state (even remotely)
- Independent contractors soliciting business
- Company-owned or leased office, warehouse, or property
- Attending trade shows (some states create nexus after a certain number of days)
- Having an agent conclude contracts on your behalf
State vs Federal: Why They Don't Align
Example: 3PL Warehouse Scenario
A Canadian e-commerce company sells products in the US. They store inventory at a third-party warehouse in California. They have no employees in the US and no US entity.
Federal tax result: No permanent establishment. The warehouse is operated by an independent contractor and doesn't create PE under the Treaty.
State tax result: California nexus is created immediately. The company must:
- Register with California Franchise Tax Board
- File California income tax returns (Form 100)
- Collect and remit California sales tax
- Pay minimum franchise tax ($800 annually, even with zero income)
This is the "gotcha" that catches Canadian businesses off-guard. They correctly determine they have no US federal obligations but miss the state-level compliance entirely.
Multi-State Compliance Burden
A Canadian business selling into multiple US states could have filing obligations in 10, 20, or even all 51 jurisdictions. Each state has:
- Different registration requirements
- Different filing deadlines
- Different apportionment formulas
- Different tax rates
The compliance burden becomes substantial quickly, even if actual tax owed is minimal.
How to Choose the Right US Business Structure
When a Canadian business needs a formal US presence, the entity structure decision is critical. The choice affects taxation in both countries, liability protection, banking access, and operational flexibility.
The Four Main Options
1. US C-Corporation
A C-Corporation is a separate legal entity taxed at the corporate level. The current US federal corporate rate is 21%, plus state corporate tax (0% to 13% depending on state).
Tax treatment:
- Corporate income taxed at corporate level (21% federal + state)
- Dividends to Canadian parent corporation subject to 5% withholding (under Treaty)
- Dividends to Canadian individual shareholders subject to 15% withholding
- Canadian parent receives foreign tax credit for US taxes paid
Best for:
- Businesses planning to retain earnings in the US
- Operations requiring significant US banking relationships
- Businesses with US investors or eventual US sale planned
- Companies needing maximum credibility with US customers
Drawbacks:
- Double taxation (corporate + dividend)
- More complex and expensive to maintain
- State-level taxes in addition to federal
2. S-Corporation
An S-Corp is a pass-through entity where income flows through to shareholders and is taxed once at the individual level.
The problem for Canadians: Only US citizens and residents can be S-Corp shareholders. A Canadian cannot directly own an S-Corp.
Possible workaround: In limited circumstances, a Canadian might own an S-Corp through a US trust structure, but this is complex and requires specialized advice.
Best for: Generally not available to Canadian owners unless they become US residents.
3. Limited Liability Company (LLC)
An LLC is extremely flexible. For US tax purposes, it can be treated as:
- Disregarded entity (single-member LLC) - transparent for US tax
- Partnership (multi-member LLC) - flow-through for US tax
- Corporation (if you "check the box" to elect corporate treatment)
Tax treatment for Canadian owners: This is where it gets interesting. An LLC has different tax treatment in Canada vs the US:
In Canada:
- An LLC is ALWAYS treated as a corporation for Canadian tax purposes
- Canadian shareholder reports income only when distributed as dividends
- No flow-through of losses to Canadian shareholders
In the US (default treatment):
- Single-member LLC is disregarded (ignored for tax purposes)
- Multi-member LLC is taxed as partnership (flow-through)
- Income/losses flow through to owners annually
- Owners pay tax on their share whether distributed or not
Best for:
- Canadian businesses wanting US legal entity for banking/contracts
- Real estate holdings (allows FIRPTA planning)
- Businesses wanting flexibility to elect corporate treatment later
The Check-the-Box Election: A powerful tool. You can elect to have the LLC taxed as a corporation for US purposes. Interestingly, this election has NO Canadian tax consequence because Canada already treated it as a corporation before and after the election.
This allows you to:
- Start with flow-through treatment in the US
- Elect corporate treatment later without Canadian tax cost
- Match US and Canadian timing of income recognition
4. Branch of Canadian Corporation
The Canadian corporation operates directly in the US without forming a separate entity.
Tax treatment:
- US branch income taxed at 21% federal rate plus state tax
- Branch profits subject to additional 5% Branch Profits Tax (under Treaty)
- Full foreign tax credit available in Canada for US taxes paid
- Income reported on Canadian corporate return with foreign tax credit
Best for:
- Short-term projects or testing the US market
- Businesses comfortable with less liability protection
- Operations where flow-through of losses to Canada is valuable
- Avoiding complexity of separate entity
Drawbacks:
- Exposes entire Canadian corporation to US liability
- More difficult for US banking and contracting
- Some states impose additional taxes on branches
- Less attractive for eventual sale (buyers prefer clean US entity)
Decision Framework: Which Structure to Choose?
Ask these questions:
1. Will the business be profitable immediately or operate at a loss initially?
- Profitable immediately → C-Corp or branch (depending on liability concerns)
- Expect losses → LLC (possibly branch if losses valuable in Canada)
2. Will profits be retained in the US or distributed to Canada?
- Retained in US → C-Corp (avoid annual flow-through income)
- Distributed regularly → LLC or C-Corp with dividend planning
3. How important is US credibility and banking?
- Critical → C-Corp or LLC
- Not critical → Branch acceptable
4. Is this a real estate investment?
- Yes → LLC (FIRPTA planning opportunities)
- No → Any structure works
5. Is liability protection a major concern?
- Yes → C-Corp or LLC (never branch)
- No → All options available
Withholding Taxes: Understanding Treaty Rates
When income flows from a US entity to Canadian shareholders, US withholding tax applies. The Canada-US Treaty provides reduced rates, but understanding which rate applies is critical.
Standard Treaty Rates
Dividends:
- 5% withholding if paid to Canadian corporation owning 10%+ of voting stock
- 15% withholding if paid to Canadian corporation owning less than 10%
- 15% withholding if paid to Canadian individuals (any ownership percentage)
Interest:
- 0% withholding (in most cases)
- 15% withholding on certain contingent interest
Royalties:
- 0% withholding for copyright royalties (software, publishing)
- 10% withholding for industrial royalties (patents, know-how)
Capital Gains:
- 10% withholding on certain gains (FIRPTA applies to real estate)
- 0% withholding on most other capital gains
Claiming Treaty Benefits: The W-8BEN Form
To get treaty rates, the Canadian recipient must provide a W-8BEN (individuals) or W-8BEN-E (entities) to the US payer certifying:
- Canadian tax residency
- Treaty eligibility
- Beneficial ownership of the income
Without the proper W-8 form, the US payer must withhold at 30%—the non-treaty rate.
Branch Profits Tax
Branches of foreign corporations face a unique additional tax: the Branch Profits Tax.
After paying regular corporate income tax on branch earnings, any profits not reinvested in US assets are subject to an additional 5% tax (under the Treaty). This effectively treats the branch like a corporation paying a dividend.
Example:
A Canadian corporation has a US branch with $100,000 taxable income:
- US corporate tax: $21,000 (21% rate)
- After-tax earnings: $79,000
- Branch distributes $79,000 to Canadian parent
- Branch Profits Tax: $3,950 (5% of $79,000)
- Net to Canada: $75,050
The branch profits tax makes branches slightly less attractive than subsidiaries for businesses planning to remove cash from the US annually.
Section 899: Proposed Legislation That Could Increase Withholding
As of June 2025, a significant piece of legislation was moving through Congress that could impact Canadian businesses with US operations.
What is Section 899?
Section 899 of a proposed bill would increase withholding tax rates by 5% per year (starting in 2026) for countries identified as having tax regimes "anti-US" or discriminatory against US companies.
What triggers Section 899 designation?
For Canada, two specific provisions are being targeted:
- Digital Services Tax (DST) - Impacting Google, Amazon, Facebook, and other large US tech companies
- Corporate Minimum Tax - The 15% global minimum tax
The Withholding Tax Escalation
If Section 899 applies to Canada:
2026 Rates:
- Individual dividend withholding: 20% (up from 15%)
- Corporate dividend withholding: 10% (up from 5%)
2027 Rates:
- Individual dividend withholding: 25% (up from 15%)
- Corporate dividend withholding: 15% (up from 5%)
And so on... The rate increases 5% annually until the offending tax regime is repealed.
Will Section 899 Actually Pass?
As of the seminar delivery, the assessment was:
- Likelihood: Better than 50/50 that it passes
- Primary target: Digital Services Tax (especially impacts major campaign contributors)
- Expectation: Significant pressure on Canada to repeal DST
- Probable outcome: Some negotiated settlement before full implementation
For Canadian businesses with US operations, this creates planning uncertainty. Structures that minimize withholding become more valuable if Section 899 is enacted.
Filing Requirements: Federal vs State
Understanding who must file what, where, and when is critical to avoiding penalties and interest.
US Federal Filing Requirements
Form 1120-F: US Income Tax Return of Foreign Corporation
A Canadian corporation must file Form 1120-F if:
- It has income "effectively connected" with a US trade or business
- It has a permanent establishment in the US
- It operates a US branch
- It has income subject to withholding but needs to file for a refund
Due date: 15th day of the 6th month after tax year end (June 15 for calendar year)
Extension: Available with Form 7004 (extends to 15th day of 9th month - September 15)
Form 1040-NR: US Nonresident Alien Income Tax Return
Canadian individuals must file Form 1040-NR if:
- They have US source income not subject to withholding
- They need to claim treaty benefits or refunds
- They were engaged in a US trade or business
- They were present in US 183+ days (even if exempt under treaty)
Form 5472: Information Return of 25% Foreign-Owned US Corporation
Required when:
- A US corporation is 25%+ owned by foreign persons
- Reportable transactions occurred with related foreign persons
- Penalty for non-filing: $25,000 per return
State Filing Requirements
State filing requirements vary enormously. Common requirements:
Income Tax Returns:
- Required when nexus exists in state
- Even if no tax is owed (many states have minimum tax)
- Due dates vary by state (most are April 15 for calendar year)
- Extensions generally follow federal extension
Franchise Tax Returns:
- Required in states with franchise tax (California, Texas, Delaware, etc.)
- Often based on net worth or capital, not just income
- Minimum taxes apply even with losses
Sales and Use Tax:
- Monthly, quarterly, or annual filings depending on volume
- Required when economic or physical nexus exists
- Penalties for late filing can be severe
Annual Reports:
- Required to maintain good standing
- Not tax returns (corporate housekeeping)
- Late filing can result in administrative dissolution
The Compliance Burden Reality
A Canadian business with nexus in 10 states could face:
- 10 state income tax returns
- 10 franchise tax or privilege tax returns
- 10 sales tax registrations and filings
- 10 annual reports
- Various local city/county business licenses
- Worker's compensation registrations
- Unemployment insurance registrations
This is why many Canadian businesses operating in the US engage specialized cross-border tax firms or multi-state compliance providers.
Common Mistakes and How to Avoid Them
Drawing from decades of cross-border tax experience, these are the errors that create the biggest problems for Canadian businesses in the US:
Mistake #1: The "Dangerous Half-Knowledge" Problem
The mistake: Canadian advisors provide US tax advice based on partial knowledge, Canadian analogy, or outdated information.
Why it's costly: When systematic errors are made across multiple clients over multiple years, unwinding the damage becomes extremely expensive. Some mistakes can't be fully corrected.
How to avoid it:
- Recognize the limits of your expertise
- Engage US tax specialists for anything beyond basic treaty exemptions
- Don't assume Canadian concepts translate to US tax
- Stay current on US tax changes (they happen frequently)
Mistake #2: Ignoring State Nexus
The mistake: Correctly determining no federal permanent establishment exists but failing to consider state nexus obligations.
Why it's costly:
- States aggressively pursue nexus
- Penalties and interest compound quickly
- Multi-year exposure creates massive liabilities
- States share information and can trigger audits in other states
How to avoid it:
- Separately analyze federal PE and state nexus
- Review activities in each state where sales, inventory, or employees exist
- Register proactively when nexus is created
- Don't assume "they'll never find us"
Red flags that state nexus likely exists:
- ✗ Inventory in Amazon FBA warehouses
- ✗ 3PL or fulfillment center usage
- ✗ Employees working remotely from home in various states
- ✗ Attending trade shows (threshold varies by state)
- ✗ Sales exceeding $100,000 in a state
- ✗ Using sales representatives (even independent contractors)
Mistake #3: Creating Ownership "Loops"
The mistake: Structuring ownership in a way that creates an inversion or circular ownership when a principal moves to the US.
Example:
- Canadian individuals own Canadian Corp
- Canadian Corp owns US Corp
- One Canadian individual moves permanently to US
- Now: US individual → Canadian Corp → US Corp (loop)
Why it's costly: Loops create enormous tax complexity and can trigger:
- Controlled Foreign Corporation (CFC) rules
- Subpart F income
- Potential inversion penalties
- Complex tracking and reporting requirements
How to avoid it: If an owner plans to move to the US within a few years:
- Freeze the Canadian company
- Issue separate classes to individuals
- Consider US trust structures for Canadian company shares
- Restructure ownership before the move, not after
Mistake #4: Mismatching Income Recognition Timing
The mistake: LLC distributions or income recognized in different years for US vs Canadian purposes, causing foreign tax credit mismatches.
Example:
- LLC has capital gain in December 2025
- Canadian individual shareholder doesn't take distribution until January 2026
- US: Capital gain in 2025 (flow-through)
- Canada: Capital gain in 2026 (dividend/distribution)
- Foreign tax credit from 2025 US tax payment can't be used against 2026 Canadian tax
Why it's costly: Foreign tax credits for individuals don't carry forward or back. The tax paid to the US is lost and can't reduce Canadian tax.
How to avoid it:
- Coordinate distributions in the same calendar year as US income recognition
- Consider checking the box to elect corporate treatment for LLC
- Plan year-end transactions carefully
- Document tax years clearly
Mistake #5: Not Understanding LLC Tax Treatment Differences
The mistake: Assuming LLC has the same tax treatment in Canada and the US.
The reality:
- Canada: Always treats LLC as a corporation
- US: Treats LLC as flow-through (unless you check the box)
Why it's problematic:
- Creates timing differences
- Flow-through losses don't benefit Canadian owner
- Annual US personal tax return required even if no distributions
- Can trigger US state income tax in multiple states
How to avoid it:
- Understand check-the-box election options
- Consider electing corporate treatment for US purposes
- Note: Checking the box has NO Canadian tax consequence
- Plan for the complexity from day one
Mistake #6: Overlooking FIRPTA
The mistake: Canadian owner sells US real property without understanding Foreign Investment in Real Property Tax Act (FIRPTA) withholding.
What happens:
- 15% of gross sales price must be withheld by buyer
- Withheld amount sent to IRS
- Even if actual tax is lower, withholding still applies
- Getting refund requires filing US tax return
Example: Sell US property for $1,000,000:
- FIRPTA withholding: $150,000
- Actual tax on $200,000 gain at 20% capital gains rate: $40,000
- Refund needed: $110,000 (requires Form 1040-NR)
How to avoid it:
- Plan for withholding in closing documents
- File for withholding certificate if appropriate
- Ensure buyer withholds and remits (or you're still liable for tax)
- Structure through LLC to manage FIRPTA (won't eliminate, but provides options)
Mistake #7: Assuming US Taxes Are Always Lower
The mistake: Believing incorporating in the US automatically reduces overall tax burden.
The reality: When you factor in:
- US federal corporate tax (21%)
- State corporate tax (0-13%)
- Dividend withholding (5-15%)
- Canadian corporate tax on dividends received
- Loss of small business deduction in Canada
The overall tax burden is often similar or even higher than operating through a Canadian corporation with foreign tax credits.
When US structure does save tax:
- Very high-income states for services businesses
- Businesses retaining significant earnings in US
- Situations where Canadian corporate tax rate is particularly high
- Access to US deductions/credits not available in Canada
How to avoid it: Don't set up a US entity for tax reasons. Set it up for:
- Limited liability protection
- US banking and credit cards
- Customer preference for dealing with US entities
- Ease of contracting with US businesses
- Permanent US expansion plans
Let the entity structure follow business needs, not tax optimization.
Mistake #8: Inadequate Record-Keeping
The mistake: Not maintaining contemporaneous documentation of:
- Days present in US (for treaty exemption tracking)
- Source of income (US vs Canadian)
- Related party transactions
- Expense allocations between Canada and US
Why it's costly:
- Burden of proof is on taxpayer in US audits
- Reconstructing records years later is difficult/impossible
- Aggressive treatment without documentation gets disallowed
- Penalties apply when adequate records don't exist
How to avoid it:
- Track employee days in US (simple calendar or app)
- Maintain transfer pricing documentation for related party transactions
- Keep detailed books for US operations separate from Canadian
- Document business purpose for expenses
- Retain all filing documentation
Advanced Considerations: Complex Scenarios
Beyond the basics, several complex scenarios require specialized planning:
Controlled Foreign Affiliate (CFA) Rules
When a Canadian resident owns 10%+ of a foreign corporation (including a US corporation), CFA rules may apply:
Reporting requirements:
- Form T1134: Information Return Relating to Controlled and Non-Controlled Foreign Affiliates
- Detailed disclosure of foreign affiliate's income, assets, and activities
- Penalties for late filing can be substantial
FAPI (Foreign Accrual Property Income): If the US corporation earns certain passive income (investment income, not active business), it may be taxable in Canada annually even if not distributed.
Active business exemption: Income from active business in the US generally accumulates tax-deferred until repatriated to Canada.
Planning consideration: Structure to ensure US subsidiary is engaged in active business, not passive investment holding.
Transfer Pricing Between Canadian and US Entities
When a Canadian corporation and its US subsidiary transact:
- Pricing must be at arm's length
- Both IRS and CRA scrutinize related-party transactions
- Documentation is required (contemporaneous is best)
- Penalties for transfer pricing adjustments are severe
Common transactions requiring transfer pricing analysis:
- Management fees charged by Canadian parent
- Intercompany loans and interest rates
- Royalties for IP licensed to US subsidiary
- Cost allocations for shared services
- Purchase/sale of goods between entities
Planning consideration: Engage transfer pricing specialists before establishing significant intercompany transactions. Fixing problems after the fact is expensive.
US Estate Tax Exposure for Canadians
Canadian residents with US situs assets face potential US estate tax:
US situs assets include:
- US real property
- Shares of US corporations
- Tangible personal property located in US
Exemption amounts:
- US citizens/residents: $13.61 million (2024)
- Non-residents: $60,000 (but pro-rated based on worldwide estate)
Treaty relief: Canada-US Treaty provides credit for US estate tax paid against Canadian taxes.
Planning strategies:
- Hold US real estate through Canadian corporation (loses preferred capital gains treatment but avoids estate tax)
- Life insurance to cover estate tax liability
- Consider holding US property through LLC (doesn't avoid estate tax but provides flexibility)
S-Corporation Limitations for Canadians
S-Corporations offer attractive single-level taxation but are generally unavailable to Canadians:
Eligibility requirements:
- Must be US citizen or resident
- No foreign shareholders allowed
- Certain trusts can be shareholders
Workaround (limited circumstances): A Canadian might own S-Corp shares through a Qualified Subchapter S Trust (QSST) if they become a US resident, but this is complex and rarely used.
Planning consideration: Don't count on S-Corp treatment if you're Canadian. Focus on LLC or C-Corp structures.
Sale or Exit Planning
When it's time to sell the US operations or wind down:
Considerations:
- US buyers strongly prefer to buy US entities (not Canadian corporation owning US entity)
- Asset sales trigger recapture and higher taxes
- Stock sales generally more favorable but create issues if buyer wants step-up
- Earnouts and seller financing create withholding complications
- Timing of sale vs repatriation of funds matters for tax
Planning consideration: Work with cross-border M&A specialists well before sale. Structure from inception with eventual exit in mind.
US Business Expansion Checklist
Before your Canadian client crosses the border into US operations, ensure these critical questions are answered:
Pre-Expansion Planning
✓ Have you clearly identified the business activity level? (A through E framework)
✓ Will employees work in the US? If so:
- Track days present to stay under 183-day treaty threshold
- Ensure compensation stays under $10,000 if relying on treaty exemption
- Document business purpose of visits
✓ Which states will you have activity in?
- Where are customers located?
- Where will inventory be stored?
- Where will employees work (even remotely)?
- Where will trade shows/events be attended?
✓ What level of liability protection is needed?
- Professional liability exposure?
- Product liability concerns?
- Contractual risk tolerance?
✓ How important is US banking and credit?
- Will you need US business accounts?
- Are US credit cards needed?
- Will you need US borrowing capacity?
✓ What are the cash flow expectations?
- Profits retained in US or distributed to Canada?
- How quickly will the operation be profitable?
- Will there be initial losses?
Entity Structure Decisions
✓ Have you compared all entity options?
- C-Corporation
- LLC (with analysis of check-the-box options)
- Branch of Canadian corporation
- Partnership structure
✓ Have you modeled the total tax burden?
- US federal + state + withholding + Canadian = total tax
- Compare to operating through Canadian corp with foreign tax credits
- Don't assume US is automatically lower
✓ Have you identified which state to incorporate in?
- Delaware (favorable corporate law, but pay tax where you operate anyway)
- State of operations (simpler administration)
- Wyoming/Nevada (privacy, but limited practical benefit)
✓ Have you planned for eventual exit?
- How will you sell the business?
- Asset sale vs stock sale implications?
- Buyer preference for US entities
Compliance Framework
✓ Have you identified all filing obligations?
- US federal income tax
- Each state income tax where nexus exists
- Sales/use tax registrations
- Franchise tax or privilege tax
- Annual reports and corporate maintenance
- Canadian foreign affiliate reporting (Form T1134)
✓ Have you established record-keeping systems?
- Separate books for US operations
- Day tracking for employees in US
- Transfer pricing documentation for related party transactions
- Expense allocation methodology
✓ Have you engaged qualified professionals?
- Cross-border tax specialist (not just general US or Canadian tax)
- US legal counsel for formation documents
- Multi-state compliance provider (if nexus in multiple states)
- Canadian accountant familiar with foreign tax credits
✓ Have you implemented internal controls?
- Regular nexus reviews (quarterly or annually)
- Sales by state tracking for economic nexus monitoring
- Employee travel log maintenance
- Intercompany transaction approvals
Risk Management
✓ Have you addressed these specific risks?
- State nexus beyond where you know you operate
- FIRPTA withholding on real estate
- Branch profits tax if operating as branch
- Section 899 withholding increases (if enacted)
- Transfer pricing adjustments
- Withholding on payments to Canadian parent
✓ Have you planned for these owner transitions?
- What if an owner moves to the US permanently?
- What if an owner dies (US estate tax on US situs assets)?
- What if you add US investors?
- What if a non-Canadian investor joins?
✓ Have you stress-tested the structure?
- What if revenue is 3x projections?
- What if you're unprofitable for 3 years?
- What if you expand to 10 more states?
- What if US tax rates change?
