Single Member Real Estate LLC Tax in Japan

I feel as if there is a misunderstanding in regards how this board and potentially how the NTA views and taxes Limited Liability Companies (NOT Corporations) (LLC), but please correct me if I am wrong.

U.S. LEGAL PERSPECTIVE

From a legal perspective the LLC members, which is the legal term for the LLC owners, limits the liability of the members, hence the name.  In this case it is viewed more like a corporation and protects the members personal assets from being sued whereas a more traditional sole-proprietor or partnership puts the owners personal assets at risk, which is the primary purpose of an LLC.

U.S. TAX PERSPECTIVE

However, the IRS DOES NOT take the view that the company is a corporation.  The default view of the IRS is this company is a sole-proprietor or partnership and is taxed in the same exact manner as a non-LLC.  You can opt-in to be considered a S-Corp or C-Corp, but you must take and affirmative action to do this. 

In my case I DID NOT take an affirmative action and elect to be taxed as a corporation.

DIVIDENDS

I read a comment that stated…

This is not true at lest in the U.S.  There is no stocks issued in an LLC, therefore there are no dividends in an LLC just distributions and distributions unless specifically addressed in the operating agreement are allocated by the percentage of ownership.

SALARY AND EMPLOYMENT TAXES

The member generally distributes the income and pays employment taxes on all distributions IF they Materially Participated in the business.

Most rental Real Estate LLC’s DO NOT Materially Participate in their business and the income is considered passive and is taxed just like interest would be taxed, an exception to this might be a real estate agent or property manager.

In my case I DID NOT Materially Participate, nor do I have any employees and therefore I pay no employment taxes.  I do however have a property Manager, but they are considered an independent contractor and not an employee.

DISTRIBUTIONS

For LLC’s distributions are NOT taxed, distributions and salaries, if any, are the only ways an LLC passes money to their members.

WHAT IS TAXED

You fill out a tax form that is best described as a profit and loss statement either as a sole-proprietor or partnership, the final number is added to your personal income taxes.

HOW TAXES ARE FILED IN THE US

In a sole-proprietor (NOT LLC) you fill out a Schedule E and put the final number on your personal tax form (1040).

In a Single Member LLC you fill out a Schedule E and put the final number on your personal tax form (1040).

That’s it, there are no other tax form to be filled out, no dividends and no employment tax forms if the Members did not materially participate and employed nobody else.  Just a profit and loss statement (Schedule E).

TAXES IN JAPAN

If there are no dividends and no employment taxes for a member that did not materially participate in a Single Member LLC in the U.S. how exactly would Japan tax this income? 

It seems logical to me that if the IRS treats this income as a sole-proprietorship why would the NTA treat this income any differently?  In fact I can’t even see a reason to mention that is in an LLC, it sounds to me I should just tell the NTA that it is either a sole-proprietorship or a partnership.

Given the Japan/U.S. Tax Treaty the U.S. taxes real estate income first and Japan gives a tax credit on this income.

This is where I have to make assumptions. I assume that when I file in Japan I would take the

1.      total income received in rent

2.      subtract all Japanese authorized expenses. 

3.      depreciate the property using the Japanese depreciation schedule and subtract that amount. 

4.      Credit the amount of taxes I paid to the U.S., however the U.S. is a progressive tax system just like Japan.  So I would assume I take             

a.      my total income received on my Schedule E and divide that by my total income to get the percentage of income I received from the LLC.

b.     Using the previous percentage multiply that by my total taxes paid in the U.S. and this would be the credit I receive in Japan

5.      Then determine the appropriate exchange rate to determine the Japanese Credit I receive.

COMPLICATING FACTORS OF MARRIAGE AND A SINGLE MEMBER LLC

In the U.S. a Single Member LLC is almost always 100% owned by a single person, however if you are a resident of a state that is considered a community property state a Single Member LLC can be owned by a married couple. 

When living in Japan we would still be considered a resident of a state that is a community property state and therefore taxed in the U.S. as a sole proprietor with joint income.

The only conclusion that I can draw from this is that in Japan we would be taxed as a partnership, where my Japanese wife would receive and be taxed on 50% of the income and I would be taxed on 50% of the remitted income to Japan in the first 5-years.  Would this make since when determining our taxes in Japan?

STATE TAXES

The properties we own are in 2-different states both of which have state income taxes, we however are residents of a third state that has no income taxes.

When I file in either of those 2 states the only income I declare is the rental income.  Therefore the only taxes paid are exclusively related to the rental income.

In this case it seems logical to me that I can credit 100% of the state taxes I pay when filing taxes in Japan.  Does that sound correct?