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Question 243: John, a U.S. citizen living overseas, forms a single-member LLC in the U.S. (no election to be treated as a corporation) in order to enter into a services agreement with an unrelated foreign company. The LLC invoices the foreign company, and then distributes out the revenue as salary to John. Would an employer/employee relationship between John and the foreign company under U.S. tax principles (e.g., Rev. Rul. 87-41) for the reason that the LLC is merely an invoicing entity? If John were actually (in form) an employee of the foreign company, then he would not be subject to FICA or SE tax.
Answer: It is certainly possible, but the answer should turn on the facts and a current analysis of the situation, not on whether John wants to pay FICA or SE tax.
Let's start with the concept that an LLC that does not elect to be taxed as a corporation is disregarded for tax purposes. (Q 1:7; all references are to the third edition of Who's the Employer and are clickable by subscribers to the web edition.) In other words, for tax purposes the LLC isn't an invoicing entity. For tax purposes, the LLC isn't an entity at all.
Strip that away, and what do you have? You have a worker providing services for a company. Is the worker an employee or an independent contractor? The form of the transaction matters very little in determining that. (Q 2:24.) Rather, we look at the substance of the transaction under common law rules. Some courts still use Rev. Rul. 87-41 (Q 2:30), but the IRS has all but abandoned it if favor of its audit guidelines, which are summarized in IRS Publication 15-A (and are discussed at length beginning at Q 2:10). Whether the employer is domestic or foreign makes no difference in that determination.
The situation would be different if the client were to incorporate formally, and use the corporation rather than the LLC. (Q 2:34.) In most circumstances, the IRS would regard the corporation as the employer.
You said "If John were actually (in form) an employee of the foreign company, then he would not be subject to FICA or SE tax." Let me put that more clearly. If, after analyzing the whole situation, we determine John is an employee of this foreign company, then he is not subject to self-employment tax, regardless of what the form of the transaction may be.
Of course, if you determine that John is not subject to self-employment tax, you have also determined that he is not entitled to set up a retirement plan for himself because he is not an employer and he is not a self-employed individual. (Q 1:9.)
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