One of the great things about owning your own business while living abroad is the flexibility it can provide. Nowadays, it’s fairly simple to operate a business from anywhere in the world, many thanks to technology. Something you’ll want to consider before moving or building a business abroad is the overseas small business taxes. Here are the top five things you should know about tax for expats before packing up your home office and moving it overseas.
Moving Business Overseas: How to Be Structured and How It Affects Expat Taxes
Before owning a business abroad or moving a business overseas, the first question you may ask is how the prospective business will be structured. Naturally, more than a few options are available.
- Sole Proprietorship – If you work for yourself with no formal business entity (for example, as a consultant or freelance worker), you generally file a Schedule C with your Form 1040. The Schedule C reports any profit or loss from your business, along with any deductions you may have. You’ll need to pay self-employment taxes to cover Social Security and Medicare; the current combined rate is 15.3%. If you’re overseas, it fundamentally works the same way, though you must be mindful that the foreign country may also tax the same income for their Social Security programs (see Totalization Agreements below).
- Partnership – By default, a business owned by two or more persons, corporations, or other partnerships, is a partnership, unless an entity structure (corporation, etc.) is created. If your partnership is foreign, you’ll file a Form 8865, which is similar to a US partnership tax return, along with Schedule K-1. The form also has schedules that explain the activities of the business and the inflows and outflows to and from the non-US Partnership and its partners.
- Limited Liability Company (LLC) – This is a popular option for companies around the globe. US LLCs are considered disregarded, and so the company’s reporting flows through the owner’s tax return and does not trigger additional reporting requirements. With a foreign LLC, you would elect the disregarded status by filing Form 8832. You’ll only need to file Form 8832 once, but you will need to file Form 8854 annually to retain disregarded status.
- Corporation – This structure would require you to file Form 5471, which is mandatory for anyone who owns 10% or more of a foreign corporation or makes a transfer to the corporation during the tax year.
As a Small Business Owner, Do I Get Any of the Tax Saving Opportunities Expats Who Work for Employers Receive?
The two major credits and exclusions that help with expat taxes for overseas businesses are the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit. Thankfully, self-employment is considered earned income, is eligible for the FEIE, and the Foreign Tax Credit is always available if you paid taxes to a foreign country. It is important to note that this does not include the self-employment tax, just the income tax.
Individuals and American Companies Abroad: Reporting Foreign Financial Accounts
Whether we’re talking about individuals or American companies abroad, reporting foreign financial accounts is a necessary aspect of US tax for expats responsibility.
- Foreign Bank Account Report (FBAR) – If your business has any foreign bank accounts that held more than $10,000 at any point during the year, you must file FinCEN Form 114 to report the accounts. This is an aggregate amount, so if you have $3,000 in one account and $9,000 in another, you’ll need to file FBAR. You can read more about FBAR for businesses here.
- FATCA Form 8938 – The Foreign Account Tax Compliance Act, enacted in 2010, requires individuals and businesses to file Form 8938 along with US taxes if certain filing thresholds are met.
Small Business Tax Guide: Use Deductions and Exclusions to Save
Fortunately, Americans living and working abroad are eligible for several big savings when it comes to US tax for expats. One, the Foreign Earned Income Exclusion (FEIE), requires you to be outside the US for a full year with no intentions of returning or inside a foreign country for 330 out of a 365-day period and allows you to exclude the first $101,300 of foreign earned income from your 2016 US taxes.
Don’t forget that business expenses can often be deducted from your tax for expats liability as well, so long as they’re considered ‘reasonable and ordinary,’ according to small business tax guides. For example, the following types of expenses may be written off, depending on the type of business you own:
- Legal and professional services
- Car/truck expenses
- Rent (business space and equipment)
- Taxes and licenses
- Meals and entertainment
It’s also a good idea to research the tax guidelines in your host country, as requirements differ from location to location. In any event, consulting with an expat tax pro can help you make smart decisions when it comes to operating your business abroad. Also, check out our tax guide for American expat entrepreneurs.
Working for yourself abroad as an independent contractor? You’ll have a different set of filing requirements – you must file Schedule C to report profit or loss from your business along with your tax for expats. In the case you have no deductions, you could file Schedule C-EZ; however, most self-employed individuals will want to report all deductions, as they lessen your US tax liability. Any self-employed person who earned $400 or more in the tax year must file.
If you aren’t a W2 employee, you’ll also need to pay your own self-employment taxes to cover Social Security and Medicare. The current rate is 15.3%, of which 12.4% goes to Social Security and 2.9% to Medicare. You can read more about self-employment tax here.
What Are Totalization Agreements?
If you’re an expat business owner working in the US or abroad, you are still liable for self-employment taxes in the US, as they are your Social Security and Medicare contributions. Unfortunately, many countries will also collect similar taxes. This can create a double taxation situation. However, if you’re located in one of the two dozen or so countries with which the US has a Social Security Totalization Agreement, the rules of that agreement will determine to which country you’ll pay the tax – it will only be one. Please note: this will depend on how your company is structured and where you are located. If you are a sole proprietorship (i.e., no business entity) or have a US-based business entity, you will most likely need to pay US FICA taxes. This is 15.3% of your income and would apply before you can use the Foreign Earned Income Exclusion, so you may have a cash expense.
If you have a foreign-based business entity, you will probably not be liable for US Social Security or FICA taxes. However, if you are in a country that has a tax treaty with the US, you need to consult the tax treaty to see how and to whom these taxes would apply. Generally, these payments would need to be made quarterly throughout the year.
What If the Country I’m in Doesn’t Have a Totalization Agreement With the US?
Unfortunately, for those who are self-employed and living in a country without a US totalization agreement, double taxation is quite common. This is because many must pay self-employment taxes to the US, even if they have already paid them to their host country.
Have More Questions About the Tax Implications of Owning a Business Overseas?
Our expat-expert CPAs and IRS Enrolled Agents have the knowledge you’re seeking in a tax professional – contact us today to discuss your expat tax questions related to overseas small business taxes.