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Optimal Business Structures for Expats

 
IJ Zemelman

 

Types of Business Structures and Key Aspects

Where and under what guidelines you establish your business will depend on how you see the future of your business. If you plan to live offshore permanently, you may decide to establish your company in the country in which you plan to stay. If your stint as an expat might be temporary, or if you plan to live in several countries over several years, it will probably make more sense to establish your company as an entity in the U.S. 

U.S. business entities are categorized as those in which the owner can be held liable and those in which the owner cannot.

 

 
Liability Protection
% Profits Taxed
Social Security & Medicare tax
Cost of Establishing/ Maintaining
Sole Proprietor
None
Individual Rate
Yes
Low
Partnership
None
Individual Rate
Yes - on the compensation for personal services
Low
S-Corp
Yes
Individual Rate
Yes - on the salary of the officers
Medium
Limited Liability Company (Partnership with the Liability Protection)
Yes
Individual Rate
Yes - on the salary of the officers or compensation for personal services
High
Corporation
Yes
Corporate Rate
1/2 of Social Security & Medicare tax on salaries paid by Corporation, 1/2 withheld from the employees' salaries
High


Note: As a U.S. expat, regardless of how you establish your company, you will be required to report the earnings from your business on your U.S. tax return. You will have some choice as to how this income is reported, however, depending on how you choose to structure  your business. 

Foreign Business Reporting Requirements

If you choose to establish your business overseas, you will be required to abide by your host country’s reporting guidelines. Each country has its own deadline for tax returns, which can pose a challenge if differing greatly from the U.S. June 15th deadline. Always check with a tax professional in your host country to be sure of the laws and guidelines. Certain country’s guidelines will require you to file U.S. taxes while filing in your host country as well.  Of course, if you are a U.S. citizen, you will always need to report your income to the IRS. But in which way you established your business will affect how you are required to report said income.

 

As a business owner, it is especially important that you remember that U.S. citizens with foreign bank accounts are required to report amounts over $10,000 USD (if this amount is reached at any point during the year) by June 30th each year. This rule also applies for those with signature authority over foreign bank accounts.

 

Should you choose the venue of incorporating in a foreign country, the U.S. taxation rules for corporate profits and Self-Employment income will be different from the rules for the U.S. entity. You will be required to file Form 5471 and attach it to your personal U.S. income tax return. We have written an extensive article - Preparation of IRS Form 5471 For a Foreign Corporation that explains this process.

Social Security and Medicare

Taxes on Medicare and social security and other state sponsored benefits also need be considered. U.S. expats are still required to pay taxes toward these services on their worldwide earned income. They will do so via their U.S. expat tax return. The U.S. is not the only country with a social security or equivalent program, however. The UK also required their residents to pay National Insurance on their worldwide income.

Double Taxation

To save money on your taxes, it is essential to eliminate as much double taxation as possible. To eliminate this penalty on social security equivalents, the U.S. has made agreements with twenty-four different countries (UK included, although in this case you will be required to opt out of Social Security to participate). Your international tax professional can explain these agreements (Totalization) and how they will affect your expat taxes. 

Payroll

Business owners should be aware of the tax requirements for themselves and their employees. Because U.S. employees are obligated to pay taxes on worldwide income, their employers must meet the reporting requirements of a U.S. business. While many employers choose to cease the withholding of income tax from their overseas employees under the belief that the majority of their income is going to be excluded, anyway, these wages must continue to be reported. Additionally, payroll taxes must continue to be paid on a quarterly basis. Employers can do their employees an enormous favor by staying on top of their reporting requirements so that their employees are not surprised by double taxation. The company itself will also receive a deduction as a result. To avoid the quarterly reporting and withholding requirements regarding payroll as an employer, you may choose to treat your U.S. employees as independent contractors. This will benefit you as you will not be required to withhold or pay taxes on the contractor and you will only be required to report annually instead of quarterly. Contractors are responsible for self-employment tax on their expat taxes and are usually required to make quarterly estimated payments. However, it must be weighed that contractors set their hours and work schedule, which may or may not work with your company’s schedule.

 

There is also a serious risk of the IRS reclassification of the contractors to employees. The IRS has a list of 20 factors by which they decide whether the employee can be treated as an independent contractor. If you simply change the employee classification for the convenience of payroll reporting and do not modify other conditions of their work agreement, you are at risk or the reverse classification by the IRS and the liability to pay retroactively your portion of Social Security and Medicare for the contractor whom the IRS reclassified to the employee.

Planning For Retirement

Business owners may be unwisely counting on their business as their retirement account. Small businesses, however, do not work well as investments because they normally rely heavily on their owner participation to thrive. Instead of relying on your business, the saving vehicles available to small business owners are a much wiser choice. Be wary of foreign retirement plans if they are not sponsored by larger corporations. This rule applies to the UK’s ISA  or Canadian RRSP accounts that are viewed as foreign trusts to the IRS. These accounts do not have tax deferred status in the US and annual IRS tax reporting is a hassle for the beneficiaries of these plans. As a US expatriate, you may be eligible to create a tax deductible  (for US tax purposes) retirement plan if you operate your own business abroad through your own sole proprietorship or by utilizing a US corporation or LLC.  The funds contributed are tax deductible and the earnings grow tax free until you withdraw the funds when you retire. IRS Explanation of the available plans can be found here.  When you plan the amounts to be contributed to the retirement plans, you should take into account the amount of foreign earned income exclusion that may bring your income from self-employment below the taxable level. Therefore, deduction to the retirement plan would not decrease it any further. 

Summary

American small business owners who live abroad must carefully consider the set up of their businesses from the onset. When things are set up right in the beginning, the business owner will be able to dedicate more time to the original intentions of his or her business... making and saving money and enjoying life as an expat.

Zemelman

I.J. Zemelman, EA is the founder of Taxes for Expats
She may be reached at: +1-646-397-2887
Email: questions@taxesforexpats.com
Web site: www.taxesforexpats.com