It is the Age of Technology. Some people would argue that technology may be expanding too far—just ask the parent of a teenager if they wish Instagram were never created. But one thing is clear. The Internet has opened up a world of opportunities for entrepreneurs—literally. The business world is global and your physical location no longer determines where you can do business. So what if you want to live overseas? Can you still run your business as effectively as you would in the US? The answer is yes—and it may be even easier (and more financially rewarding) than working in the States. But before you pack your laptop and head for the beaches of Bali, you need to be aware of your tax responsibilities as a corporation or self-employed individual. Here are the top 5 tips for entrepreneurs looking to start their business overseas!
1. Choose your corporate structure wisely.
It’s important to think about how you will structure your company, as different structures trigger different tax filing requirements. One of the most popular business structures (for both companies in the US and abroad) is the Limited Liability Company or LLC. Domestic LLC’s are considered ‘disregarded’ for tax purposes. This means that the company’s reporting simply flows through the owner’s individual Federal Tax Return. Why is this advantageous? No separate corporate filing! With a foreign LLC you must elect this disregarded status by filing Form 8832. This form only has to be submitted once, but then you must file Form 8854 annually to retain your disregarded status. Those who select the foreign LLC structure generally use the disregarded status ongoing to prevent the IRS from treating the company as a corporation for tax purposes. If you are running a corporation, you would need to file the dreaded Form 5471, which is lengthy and oftentimes confusing. This form must be filed by anyone who owns 10% or more of a foreign corporation or makes a transfer to the corporation during the tax year.
2. Self-Employed Individuals Must Report, too!
If you are working for yourself abroad, you will have a different set of filing requirements. You will need to file a Schedule C (Profit or Loss from Business) along with your US expat tax return. If you have no deductions, you could file the Schedule C-EZ, but most of the time you will have deductions to lessen your US expat tax liability. The filing threshold for the self-employed is so low that it would difficult not to exceed it! If you earn only $400 in a tax year you must file.
In addition to your standard filing requirements as noted above, you have other taxes to consider, such as self-employment taxes. In 2014, the self-employment tax rate is 15.3%, which includes 12.4% for Social Security and 2.9% for Medicare. The first $117,000 of income is subject to these taxes. If you are a high-income earner you may be subject to the new Medicare tax of 0.9%. It’s important to consult a tax professional if you are unsure about your specific filing requirements.
3. Offshore Bank Account Reporting is Critical
FBAR, Foreign Bank Account Report, is one of those filing requirements you may not have heard about. It is part of the US initiative to snuff out tax evaders attempting to hide money in offshore accounts. If your business has a foreign account balance of $10,000 or more at any point during the tax year, you must file Form FinCEN 114 electronically each year by June 30th. Remember that this is an aggregate amount—meaning the threshold is the sum of all your foreign accounts. If you are running a corporation you will also need to file FBAR for your individual/personal account if it hits $10,000 even for one minute during the tax year. Penalties can be harsh if you fail to file and the IRS discovers your account, so it’s important to stay up on your FBAR filings each year.
4. Using US Deductions and Exclusions to Lower Tax Liability
While the US has several helpful deductions and credits in place to help avoid dual taxation, you need to be clear on the qualifying stipulations. To qualify for the Foreign Earned Income Exclusion, you need to either be outside the US for a full year (with no intentions of returning) or inside a foreign country for 330 days of any 365-day period. If you qualify, you can exclude $105,900 of your foreign income in 2019.
For self-employed individuals, it’s important to note that self-employment tax is calculated on your full foreign income—i.e. it is calculated on the income BEFORE you exclude it with the Foreign Earned Income Exclusion.
So, for example, let’s say you make $150,000 in 2019. You pay self-employment taxes on this amount, then exclude $105,900 with the Foreign Earned Income Exclusion. In this example you would have $44,100 of income ‘left over’ and available for US taxation. If you pay taxes to your host country, you may be able to take advantage of the Foreign Tax Credit (a dollar-for-dollar credit on the taxes you pay to a foreign country) or the Foreign Housing Exclusion (which allows for a deduction of some housing expenses that occur as a consequence of living abroad).
5. Don’t Forget About Money-Saving Expense Deductions!
Reasonable and ordinary expenses related to your business can be deducted from US tax liability. What is considered reasonable to you may be different than what the IRS deems reasonable but you are encouraged to use your best judgment. For example, a ride-on lawnmower would be reasonable for someone starting a landscaping business but not for a marketing consultant! (See? Common sense prevails.) Some of the expenses you can deduct on your Schedule C include:
• Contract labor
• Legal and professional services
• Car/truck expenses
• Rent (business space and equipment)
• Taxes and licenses
• Meals and entertainment
And last but not least, consider where you are going to live! There are no individual or corporate taxes if you move to the United Arab Emirates, but the tax rate in Japan is over 20% for corporations and the highest marginal tax rate for individuals is a whopping 45%. So think carefully about where you reside as that alone can have the biggest impact on your financial success abroad!
Want more information about starting a business abroad?
Download our free US tax guide for expat entrepreneurs and get an in-depth look at the corporate structures and taxes that may impact you.