U.S. Business Ownership After Deportation or Loss of Residency: Tax Rules Explained

Viktoriya Barsukova, EA, MBA
3 hours ago
4 min read

When an individual loses U.S. residency for tax purposes, they are classified as a nonresident alien (NRA) under federal law. This change has immediate consequences:

Worldwide income no longer applies: They are no longer taxed like a U.S. resident on global income.
Taxation is limited to U.S.-source income:
- Income that is effectively connected with a U.S. trade or business (ECI) is taxed at the same graduated rates that apply to U.S. residents, after allowable deductions.
- Passive income such as dividends, interest, or royalties is generally subject to a 30% flat withholding tax, unless reduced by an applicable tax treaty.
Nonresident aliens are still allowed to own and operate U.S. businesses. U.S. law places no restriction on foreign ownership of a limited liability company (LLC) or a corporation (C-corp). The key difference lies in how each entity is taxed once the owner is a nonresident.

The complication arises when an LLC has elected to be taxed as an S corporation. By statute, an S corporation cannot have a nonresident alien as a shareholder (IRC §1361(b)(1)(C)). Therefore, the moment the owner becomes an NRA, the S corporation election terminates automatically. The LLC continues to exist under state law, but its federal tax classification changes immediately.

Termination of S-Corp Status

Legal Basis: An S corporation cannot have a nonresident alien as a shareholder (IRC §1361(b)(1)(C)).
Automatic Termination: The S election ends immediately once a shareholder becomes a nonresident alien (IRC §1362(d)(2)).
State Law Impact: The LLC itself continues to exist under state law. Only the federal tax treatment changes.

Default Classification After Termination

Once the S election ends, the LLC does not revert to its original “check-the-box” default (disregarded entity or partnership).
Because the entity was already classified as a corporation to make the S election, it is automatically treated as a C corporation going forward (IRS Publication 3402).
No Form 8832 is required to be a C corporation — this is the legal default.

Electing a Different Classification

If the owner does not want C-corp taxation, the LLC can file Form 8832 (Entity Classification Election) to change its status:

Single-Member LLC: Elect disregarded entity status and report income on the owner’s Form 1040-NR (and sometimes Form 1120-F).
Multi-Member LLC: Elect partnership status, requiring Form 1065 and Schedule K-1s to owners.
Timing: Form 8832 can be made retroactive up to 75 days or prospective (generally within 12 months, subject to IRS rules).
If no election is filed: The LLC remains taxed as a C corporation by default.

Federal Filing Obligations

Final S-Corp Return: File Form 1120-S for the short tax year ending on the termination date.
New Return After Termination:
- C-corp (default) → File Form 1120.
- Disregarded Entity → Report directly on the owner’s Form 1040-NR.
- Partnership → File Form 1065.
Split-Year Reporting: In the year of termination, you must file a short-year S-corp return and another return under the new classification.

Withholding and Nonresident Rules

C-corp Default:
- The corporation pays federal income tax.
- Dividends to the NRA are U.S.-source income and subject to 30% withholding, unless reduced by treaty (IRC §871, Pub. 515).
Disregarded Entity/Partnership:
- NRA reports income directly on Form 1040-NR.
- Withholding under IRC §1446 applies to the NRA’s share of effectively connected income (ECI).
Other Considerations: If U.S. real property is sold, FIRPTA withholding applies.

State Filing Obligations

States may require:

A final state S-corp return.
Registration of the new entity classification.
Continued annual reports and franchise or minimum taxes (e.g., California’s $800 LLC tax).

Tax Treaty Benefits

Many NRAs qualify for reduced withholding rates under U.S. tax treaties.
To claim treaty benefits, the owner must submit Form W-8BEN to the withholding agent (bank, corporation, or payer).

Summary of Key Rules.