Gregory T Bryant, CPA | Attorney at Law
Caroline White, Attorney at Law
General Information Only
DISCLAIMER: This article provides general information about certain tax structures and is not intended as tax or legal advice. Tax laws are complex and subject to change, and the application of tax laws depends on the specific facts and circumstances of each situation. Readers should not rely on this information as a substitute for professional advice and should consult with qualified tax and legal advisors before making any decisions regarding business structure or tax planning. The author and publisher assume no liability for actions taken based on the information contained herein.
Introduction
The rapid rise of global e-commerce has led many business owners to rely on flawed or incomplete advice about how to structure their U.S. operations—particularly through foreign-owned LLCs formed in places like the UAE or Hong Kong. As discussed in Structuring Your E-Commerce Business, these structures often rest on dangerous half-truths about LLC tax treatment and can expose owners to unexpected U.S. tax liabilities, aggressive enforcement actions, and significant penalties, especially with the IRS’s recent announcement to focus on e-commerce specifically. By examining how the IRS uses Form 1099-K data, information exchange agreements, and new compliance initiatives to target unreported income from foreign-owned LLCs, we highlight why proper structuring, timely filings, and transfer pricing compliance are not optional—they are essential in today’s e-commerce landscape.
The consequences of getting it wrong can be significant: income tax of 44.7% on gross revenue and penalties for failure to report form 5472, late filing and late payments.
As we explain in this article, there is a solution that significantly mitigates US tax risk and brings the company into full compliance with US income tax filings requirements. The solution is not complex, and can be implemented quickly.
Structuring Your E-Commerce Business
We frequently hear this: “I have been told that the best way to set up a business to sell products through e-commerce is to have a parent company in the United Arab Emirates (“UAE”), preferably Dubai, that owns a wholly owned limited liability company (“LLC”) because everybody knows limited liability companies are not taxed, and there’s zero tax in the United Arab Emirates.” There can be some variations on this theme, for example, using Hong Kong in place of UAE. There are many things wrong with this statement and we will unpack them in this article. This structuring and “planning” are promoted by people in the UAE who may not have expertise in US income tax law. And as we will soon learn, “a half-truth can be a great lie.”
Companies are often set up this way to access banks and credit card processors in the United States. A US company is typically required for these purposes. The US LLC will get a tax identification number from the IRS, or what is called an “employer identification number” and use that to open bank accounts and get credit card processors, or what are called “merchant processors” to process on-line sales for them. They will also, many times, register in states under the EIN for sales tax reporting and compliance.
Here is the problem. Although it is very true that LLCs are not subject to income tax, their owner(s) are, and this means the UAE company in our example is subject to tax in the United States. So, the first half-truth is that the LLC’s income is non-taxable. It is taxable, but to the owners, not the LLC. But that is not the end to the story. The way the UAE company is taxed is not what one might think. First, the UAE company, if it does not file a timely and complete US income tax return, Form 1120-F, may be subject to US corporate income tax on its gross revenue (not net income or profits, but its total turnover) because it would be denied deductions for expenses. This is because if the UAE company did not file a timely tax return, it is not allowed to deduct expenses against its income.
Second, the UAE company would be subject to “branch profits tax” which includes an additional 30% withholding tax on the income. So, this means the UAE company owning 100% of a US LLC could be taxed at an effective rate of approximately 44.7% of its gross revenue (21% corporate tax plus 30% branch profits tax on the remaining 79%), absent any applicable tax treaty provisions. The branch profits tax (“BPT”) treats the profits of a foreign company’s US branch as if they were sent back to the home office, just like a U.S. subsidiary’s dividends sent to a foreign parent and applies the same tax rate – 30% or a lower applicable treaty rate. The goal of the BPT is to prevent tax avoidance on repatriated earnings.
One might ask, “How would the IRS detect this structure?” Here is how. When a company uses Amazon, Shopify, and merchant processors, they will get a form 1099-K in February following each year. The 1099-K reports to the IRS the gross-dollar amount of transactions processed by that company for the LLC. It will have the LLC’s EIN and the IRS will be looking to match these values to a tax return. The IRS enforcement process can escalate over time, potentially leading to assessments, notices of intent to levy, jeopardy assessments, and ultimately collections actions including account garnishment and tax liens. The timeline and specific actions taken can vary based on individual circumstances and IRS procedures.
Here is a typical scenario. If the IRS does not find a tax return that correlates to the 1099-Ks in the system or if the gross turnover amounts reported on the tax return do not equal or exceed the total amounts reported to the IRS on the 1099-Ks, the IRS computer will issue correction notices starting a year later. These will come as CP2000 letters. These notices will continue and the penalties will escalate and over the next two-years the tone of the letters will get more hostile. Eventually, after about two and a half years, the IRS will issue an assessment and a notice of intent to levy. Six months later, the IRS may then generate a “jeopardy assessment” and start to impose collections. If the company does not respond to those letters within another year, accounts will be garnished and tax liens will start to be filed. This means the company will have a life cycle under the UAE/LLC structure of about three to four years before facing severe enforcement actions.
After the IRS issues a tax lien, enforcement shifts to collection and recovery. The lien gives the government a legal claim against the taxpayer’s property, both real and personal, within the U.S. The IRS can then seize bank accounts, intercept payments from third parties, and seize or sell physical assets such as real estate or equipment. The lien also attaches to after-acquired property, so future assets can be claimed until the liability is satisfied. Additionally, the Foreign Account Tax Compliance Act (“FATCA”) requires foreign financial institutions in countries that have a FACTA Intergovernmental Agreement with the US to report information about foreign accounts held by US taxpayers. Since enactment in 2010, the US has entered into FATCA agreements with 115 jurisdictions, including the UAE and Hong Kong.
There are also international exchange of information agreements that allow the US Treasury to go into the UAE and garnish foreign bank accounts and enforce criminal actions. Although Hong Kong suspended its mutual legal assistance treaty (“MLAT”) with the US in 2020, the US did enter into an MLAT with the UAE in 2022. This treaty provides for evidence sharing, cooperation between judiciaries, and investigation assistance between the countries. Additionally, in 2024, the US entered into a customs cooperation agreement with the UAE to exchange trade-related information and reduce customs violations in both countries. While these agreements primarily target criminal and customs cooperation, they enhance the IRS’s broader enforcement capabilities by facilitating access to financial and transactional information abroad.
One potential solution involves having the US LLC elect to be taxed as a C corporation. Under this structure, the US LLC would pay US income tax. If the US LLC functions primarily as a payment processor, with brand and product development, marketing, and capital expenditures occurring outside the United States, then under transfer pricing principles of “arm’s length pricing,” the US LLC may be allocated a “routine profit” which could range from 1%-2% of its turnover, depending on the specific facts and circumstances and applicable transfer pricing analyses. Any such transfer pricing arrangement must be supported by contemporaneous documentation and economic substance to withstand IRS scrutiny. This structuring may significantly reduce the risk of 45% taxation on gross sales, subject to proper implementation, documentation, and ongoing compliance with transfer pricing regulations. It also brings the entire structure into US tax compliance.
Here is why it works. By making the US LLC taxable as a corporation, the company’s tax footprint is “ring-fenced.” By this we mean the tax footprint for the company is now only the US LLC, which has elected to be taxed as a C Corporation (currently subject to a flat 21% federal corporate income tax rate on taxable income, subject to change by legislation). Transfer pricing becomes a vehicle to ensure the outcome is arms-length and in compliance with the tax law, and also to manage cashflow. However, transfer pricing arrangements must reflect genuine economic substance and cannot be used solely for tax avoidance purposes, as the IRS may challenge arrangements that lack business purpose or economic reality under the substance-over-form doctrine and IRC Section 482. This structure significantly reduces tax risk. By proactively structuring the US entity for corporate taxation and maintaining compliance, businesses can mitigate IRS enforcement actions and ensure long-term operational stability.
The IRS is Intensifying Focus on E-Commerce Tax Compliance
The IRS has become aware that there are significant sales and income from e-commerce that are going untaxed, and they are making plans to change that. There are two significant sources of what is called “tax gap” from e-commerce, estimated to be over $80b annually.[1] “Tax gap” means the fiscal revenue loss to the US treasury. The two primary sources of the tax gap are small, infrequent sales and payments for services through PayPal and other online payment platforms and income from sales through foreign owned limited liability companies that do not report any US income on hundreds of millions of sales of products and services. In this article, we will focus on foreign owned LLCs that do not report US taxable income.
We previously addressed foreign-owned LLCs in “Structuring Your Ecommerce Business” in November 2025. This article builds upon that discussion by examining how recent IRS enforcement initiatives specifically target unreported income from foreign-owned LLCs engaged in U.S. e-commerce activities. Foreign-owned LLCs are often structured to take advantage of the pass-through taxation treatment available to LLCs, but many foreign owners fail to understand that while the LLC itself may not be subject to entity-level taxation, the LLC’s income is still subject to U.S. taxation at the owner level, along with withholding tax obligations on distributions.
Two half-truths have been driving the structuring summarized above, using an US LLC that is owned by a UAE or HK company. The first misconception is that LLCs are not taxable entities. While it is true that LLCs are generally treated as pass-through entities for U.S. tax purposes, this does not mean the income escapes taxation. Rather, the LLC’s income is taxed at the owner level. This means foreign owned LLCs are subject to complex withholding tax rules and their owner(s) must file US nonresident tax returns (1120F for corporations and 1040-NR for individuals).
Pursuant to the Housing and Economic Recovery Act of 2008, IRS started requiring payment processors and on-line merchants to report on-line sales on forms 1099-K. The reporting requirements took effect for transactions in the 2011 tax year, with the first Forms 1099-K being issued in 2012. This reporting now creates a body of data on all on-line sales over $20,000, and 200 transactions (note: it was temporarily lowered to $600, but OBBBA repealed that rule).
Form 1099-Ks are issued to sellers or other persons/entities receiving payments. The form reports all gross amount received, and does not take returns, credits, fees, etc. into account. The threshold for 1099-K reporting had been scheduled to drop to $600 in 2026, but the One Big Beautiful Bill Act (“OBBBA”) reinstated the prior threshold of $20,000 and 200 transactions, effective for 2025 and subsequent years.[2]
The purpose of Form 1099-K is to collect data on online sales and ensure that reported amounts correspond to income reported on tax returns.[3] Problems begin when revenue (or “turnover”) reported on tax returns is less than the amounts reported to that taxpayer on Forms 1099-K. We have found that many foreign-owned LLCs are not reporting any of their sales and are not filing any income tax returns despite engaging in significant amounts of U.S. business activity, sometimes exceeding $100 million in annual sales. This is even in cases where the foreign owned LLC is paying sales tax in 47 states. These foreign-owned LLCs and their owners do not file income tax returns because they have been told that LLCs are tax-exempt. What they fail to understand is that the owner(s) of the LLC are subject to U.S. taxation on the LLC’s income and are also subject to withholding tax on all distributions. For owners in non-treaty countries such as Hong Kong and the United Arab Emirates, the withholding tax rate is 30%.
The tax on unreported income from any source creates the “tax gap,” which is the tax that should have been (but is not) collected on unreported income. The IRS estimates this could be $80 billion annually and accordingly IRS has recently announced that it is cracking down on the unreported income from e-commerce specifically and considers it a primary component of the tax gap.[4]
Although the OBBBA reinstatement of the higher threshold along with the simultaneous heightened IRS enforcement of digital sales seems somewhat contradictory, the third puzzle piece is the tighter reporting requirements for the platforms, like Amazon, Etsy, and payment platforms like Venmo or CashApp. The higher threshold shows a targeted approach toward merchants, whereas a $600 threshold could pick up individuals who had a one-time yard sale. The limit is high enough for a mismatched 1099-K to be worth looking into, and the stricter reporting requirements for the platforms give the IRS more information to analyze.
As previously mentioned, information matching is the main method the IRS uses to catch unreported 1099-K income. The taxpayer identification number on the 1099-K should also be on a tax return, and the amount reported on the return should “match.” It sounds easy enough, but this can even cause problems for the most compliant businesses, especially when the gross amount reported on the 1099-K is more than the actual income received by the business. For example, if a business makes a $100 sale that is reported on the 1099-K issued by Venmo, and Venmo charges a $3 fee, the $100 is reported on the 1099-K even though $100 was not received and tax is not due on the entire $100. This could cause a mismatch, even though no tax was evaded.
Form 1099-K is a key tool for the IRS to collect data on all e-commerce sales. It will now use that data to match to income tax filings.[5] There are off-the-shelf artificial intelligence (“AI”) tools available now to perform the matching task. The reinstated $20,000/200-transaction threshold, along with stricter platform reporting and enforcement amongst e-commerce business targets digital merchants specifically, and even compliant sellers can face issues when 1099-K amounts exceed actual income, highlighting the importance of careful record-keeping and accurate reporting. Heightened IRS scrutiny on e-commerce businesses also raises the question of the best way to structure an e-commerce business with US sales. For further discussion of this specifically, see our previous article “Structuring Your Ecommerce Business.” For discussion of the possible future use of AI by the IRS, including in 1099-K matching, see “The Future of the IRS: Leveraging AI for Efficiency and Effectiveness.”
Additionally, although a three-year statute of limitations tax assessment usually limits the IRS to assessing only the three most recent years’ activity, this does not apply when no return is filed (or when a fraudulent return is filed). If no return was ever filed, the statute never begins to run, so the IRS has an unlimited period to assess and collect taxes.[6] The three-year mark is not a safe haven for unfiled return years – there is indefinite exposure.
It is also worth noting that there can be additional penalties of $25,000 for failing to file Form 5472, “Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business” for any tax year. A foreign owned US LLC must file a form 5472 reporting its foreign ownership and all intercompany transactions.
Hiding is no longer an option for foreign owned e-commerce companies. They need to get their tax filings in order, or they could be subject to tax at up to 44.7% of gross revenue plus penalties for failing to file forms 5472s and for late filing and underpayment of tax. The solution is for the US LLC to incorporate and become a corporation for US tax purposes. Then it must develop transfer pricing principle with its non-US affiliate(s) and use transfer pricing to manage and comply with US income tax rules.
[1] https://www.gao.gov/products/gao-24-105281
[2] https://www.irs.gov/pub/taxpros/fs-2025-08.pdf
[3] https://www.irs.gov/businesses/understanding-your-form-1099-k
[4] https://www.usatoday.com/press-release/story/11793/irs-targeting-e-commerce-sellers-in-2025-clear-start-tax-warns-shopify-etsy-and-amazon-vendors-to-prepare/
[5] Id.
[6] See https://www.irs.gov/filing/statutes-of-limitations-for-assessing-collecting-and-refunding-tax.