Spain tax guide
Christian Reeves

Spanish Tax Guide: Tax Implications of Living, Working and Investing in Spain

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Spanish Tax Guide – this is the first in our country tax guide series.

Spain emerged from five years of recession in mid-2013, and now is one of the hottest investment options around. Real estate and investment markets are still priced near the bottom, but are on the upswing, employment is improving, and the government’s austerity measures are growing the economy.

Spain’s economy, the fourth-largest in the EU after Germany, France and Italy, crashed in 2008 when a real-estate boom went bust, taking down much of its banking system and raising doubts about the country’s solvency. The gross domestic product, which briefly rebounded in 2010 and 2011, has shrunk 7.5% in the past five years.

Investing in Spain is still not for the faint of heart. Its tax system is one of the most complex in the world, still boasts one of the highest rates in Europe, faces staggering budget deficits which have resulting in “wealth taxes” for residents and nonresidents alike, and the economic rebuilding has just begun. In an interview with The Wall Street Journal, Spain’s Prime Minister Mariano Rajoy said “Spain is out of recession but not out of the crisis,” cautiously touting the effects of budgetary and structural overhauls that have been among the deepest in the euro zone. “The task now is to achieve a vigorous recovery that allows us to create jobs.”

There are strong signs of recovery, and thus opportunity for international investors. Labor costs have been reduced, exports are on the rise, and the current-account deficit, once 10% of GDP as cheap money poured in to fuel the building boom, has turned to surplus. However, GDP growth is expected to increase by .5% to 1% in 2014.

High corporate and personal taxes on your worldwide income, and possibly your worldwide assets, are a major issues for anyone moving to Spain. Unwilling to cut government spending, Mr. Rajoy’s right-leaning government chose to raise taxes. According to the Cato Institute, “Following the tax increase, Spanish individuals will be paying one of the highest personal income tax rates in Europe. For instance, from 2012 onwards, only Sweden and Belgium, with 56.4% and 53.7%, respectively, will have a higher top marginal income tax rate than Spain, which stands at 52%. However, if one takes into account local surcharges imposed by some Spanish regional governments, the top marginal rates rise further. In Catalonia, for example, the top tax rate is 56%.”

For just about any income, Spanish tax rates are higher than in France, Britain, Italy and Germany, they say, adding:

“All of those countries enjoy a considerably higher income per capita than Spain and thus can more easily withstand higher taxes than a poorer country. With Rajoy’s tax hike, Spain suffers from the worst of both worlds: very high taxes combined with decreasing income and employment levels. At 23%, Spain has the highest unemployment rate in the European Union.”

Spain’s immensely complex tax regime means that the well organized and researched resident entrepreneur might take advantage of a number of planning opportunities. While Spain has one of the highest tax rates in the EU, it has one of the lowest effective tax rates. The official corporate tax rate, for example, is 30% but large Spanish companies pay about 8% on average. This compares favorably to the US effective corporate rate of 12.6% for 2013.

  • There are few planning options available to non-residents…who basically pay a 21% flat tax without deductions.

Spanish Tax Primer

A resident of Spain is liable for tax on their worldwide income at scale rates after any available allowances and deductions. A non-resident of Spain is liable for Spanish income tax only on Spanish income, and possibly Spanish assets, generally at fixed rates with no allowances for deductions.

If you spend more than 183 days in Spain during the calendar year, or your “center of economic or vital interest” is in Spain, you are a resident for tax purposes. Depending on where you live, personal income tax on wage and business income will range from 24.35% to 56%.

  • “Vital interests” usually refers to someone whose spouse lives in Spain and they are not legally separated, and/or their dependent minor children live in Spain.

If you are a tax resident of Spain, income “derived from savings,” such as interest income and capital gains, are taxed at 21% to 27%. Specifically:

  • Up to €6,000: 21%
  • Excess from €6,000 up to €24,000: 25%
  • Excess from €24,000: 27%

By comparison, non-residents pay 21% on capital gains and 24.75% on investment income earned in Spain. Where residents are taxed on their worldwide income, nonresidents are taxed only on income earned in country.

As a tax resident, you might also get the joy of paying a wealth tax on your worldwide assets. This levy varies from year to year and has come and gone in various forms since 2008. In 2014, each person is generally allowed assets of €700,000 and a personal residence of €300,000, so a husband and wife might be able to hold up to €2 million before paying the wealth tax. If you are caught up in this toll, you will be required to pay a tax equal to 0.2% to 2.5% of your total assets.

Spain’s wealth tax is quite complicated, varies from region to region, has been repealed and brought back from the dead more than once, and might finally be eliminated in 2015. In some areas, allowances are reduced and, if you are fortunate enough to live in Madrid, you pay no wealth tax at all…I guess that’s where the politicians call home. If you are at risk of the wealth tax, you should contact a local expert.

Taxation of Real Estate for Residents and Non Residents

If you are a tax resident and own a rental property in Spain, net income earned is taxed at ordinary rates, which are 24.35% to 56% rate. You are allowed to deduct ordinary and necessary expenses, which include interest on loans used to acquire the property, repairs and maintenance, leasing fees, etc. Spain allows you to depreciate the value of the home or structure on the land at up to 2 – 3% of the purchase price, but you may not depreciate the value of the land. 3% results in a depreciation rate similar to the United States (33.3 years in Spain compared to 27.5 years in the US) and more “generous” that the 40 year depreciation schedule Americans are allowed for foreign property.

If you are not a tax resident and own rental properties in Spain, net income is taxed at a rate of 24.75%. If you are not a resident of the EU nor a resident of Spain (ie. you are a US resident for tax purposes), you may not deduct any expenses against your rental income.

If you are not a resident of Spain, you pay 21% in capital gains tax on the profits from the sale of your real estate and 24.75% on other types of investment income. But, be careful because local capital gains tax (which is levied by the town hall where the property is located and depends on local values) may also apply. This should be considered before making a purchase.

  • 3% of the gross sale price is held back by the buyer and paid over to the Spanish tax authorities. If 3% of the gross is more than 21% of the net (more than the total tax due), you can file a claim for refund.

In addition to the tax on net rental income, you will pay property tax at 1% to 2% per year based on the value of the property. This rate varies by municipality and you should take it in to account when considering properties from different areas. You should also look in to whether you must pay cantonal property tax in addition to the general property tax described above.

There is also a special assessment on real estate owned by non-residents. If you are not a tax resident of Spain, you will pay 3% per year on the value of the property for the right to own property in Spain.

When you go to sell the property, you will pay capital gains tax as described above. Because Spain’s capital gains rate is equal to or higher than the United States, you will probably not owe capital gains tax to Uncle Sam on the transaction. This is because, in most situations, the Foreign Tax Credit will come in and eliminate a double tax.

Spain will also hit you with a Stamp Duty on the transfer. In most cases, this is 0.5% rising to 1% in some autonomous regions and can reach up to 6%! It is paid by the buyer, but you should take it in to account when valuing your property. A property with a small duty might garner a higher price than one with a 6% toll.

Finally, if you own significant real estate in Spain, and you are not a tax resident, you may still get to pay the wealth tax on your assets in Spain. That’s right, if you own rental properties worth more than €700,000 in 2014, you are required to pay a tax based on their value. The levy starts at 0.2% and jumps to 2.5% quickly. It is uncertain whether this tax will apply after 2014.

Taxation of Rural Land

Many of these taxes do not apply to rural land (land primarily dedicated to farming). For example, transfers of rural land and used buildings on that land are exempt from the 21% tax described above. Used for this purpose means that the building is transferred for the second or subsequent time, except when the building is acquired for rehabilitation, and the property is classified as rural by the taxing authorizes.

In many cases, the transfer of rural land will be taxed at around 7% and property taxes will apply at 2% per year. Though, this is an estimate and can vary by region. You should seek the advice of a local attorney before purchasing rural land…and be aware that is extremely difficult to obtain a permit to build in land zoned as rural.

Tax Summary

As a resident living and working in Spain, you are facing personal income rates that cap at an astounding 57% and capital gains taxed at 21% to 27%. However, you can make use of a number of deductions and exclusions that may get your effective rate down to that of the UK and France…now, there’s something to aspire to in tax planning!

If you are a non-resident, you will enjoy a 21% to 24.75% flat tax with very few deductions (unless you are an EU resident). When you consider that owning rental properties in the US generally reduce your taxes (mortgage interest, expenses and accelerated depreciation often exceed rental income), rather than increasing them as is the case in Spain for a nonresident, one should think long and hard before buying a Spanish rental.

As a non-resident, you will also pay a special 3% tax per year, and a property tax of 1% to 2%. Therefore, a non-resident’s carrying costs may be as high as 5% of the assessed value each year.

When you purchase real estate in Spain, the buyer is responsible for a scaled transfer tax of 8 – 10%, and this usually jumps to 12% for new builds (property acquired from the builder / developer). When you sell the property, you pay 21% on the net gain plus an average stamp duty of 1.5%. Local and municipal taxes may also apply.

Finally, when a non-resident sells their property, a special 3% withholding on the total sale price must be held back by the buyer.

I hope you have found this tax review helpful. I’d like to end with an interesting caveat in the Spanish tax code:

  • Because of the extremely high transfer taxes, buyers and sellers might be incentivized to misreport the sale price, with the buyer giving cash on the side to the seller to make up the difference. Well, if the tax authority can prove that the transfer was reported at less than 50% of its fair market value, the government has the right to buy that property for the value reported in the sale.

I hope you find this article helpful. Please contact me at info@premieroffshore.com with any questions or article requests.

US Person for tax purposes
Christian Reeves

Who is a U.S. Person for Tax Purposes?

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Who must pay US taxes you ask? Who is a US person for tax purposes? Who is in the crosshairs of the IRS? The answer is not quite as simple as you may think…and something that confuses many people living and operating a business in the US.

Who is a U.S person for tax reporting purposes? Who are these unfortunate soles who must file an FBAR, report their foreign assets on IRS Form 8938, and pay tax on their worldwide income?

As those of you know who have met me at conferences or read my articles, I often ramble on about the many filing requirements for those living and working abroad. I won’t go in to them again here, but you can see my taxation page for more information.

First, a U.S. person is ANYONE with a U.S. passport. It doesn’t matter if you currently live in the United States, nor does it make a difference that you have never lived in the U.S. So long as you hold a passport from the U. S. of A., you are required to pay up and report everything.

That is the easy answer. But, what about those who were not blessed at birth with a blue passport and the honor of giving half of what they earn to the American machine?

For example, I recently had someone in my office that had been living in the United States for the five years on a Green Card. He had been filing his U.S. tax returns, and paying tax on his U.S. income, but had done nothing about his international obligations.

He was considering obtaining U.S. citizenship and was wondering what that would do to his tax situation. He had no idea that he was already screwed and a U.S. person for tax purposes.

A U.S. person for tax purpose includes any of the following: (see the IRS website):

  1. A U.S. Citizen, which is anyone with a U.S. passport,
  2. A green card holder (see: http://www.irs.gov/Individuals/International-Taxpayers/Alien-Residency—Green-Card-Test), or
  3. A U.S. resident for tax purposes – most commonly defined as someone who spends more than 183 days in the US under the Substantial Presence Test. A U.S. resident for tax purposes is commonly referred to as a resident alien.

Therefore, if you have a U.S. passport or green card, or are a resident alien for tax purposes, you must report income from all sources within and outside of the U.S. For more information, see Publication 525, Taxable and Nontaxable Income.

Also, if you are a U.S. citizen, green card holder, or resident alien, the rules for filing income, estate and gift tax returns and for paying estimated tax are generally the same whether you are living in the U.S. or abroad. See the IRS website for information on how to file as a resident alien abroad.

So, a U.S. person for tax purposes is just about anyone with immigration ties to the U.S., or spends most of their time here. If you want to enjoy the benefits of America, it’s going to cost you…and if you are unaware of these obligations, it can cost you big time!

I hope you find this brief article helpful. For additional information, or questions on your tax filing

Physical Gold
Christian Reeves

Do I Need to Report Gold to the IRS? FBAR and Form 8938

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Are you required to report gold to the IRS? Surprisingly, the answer is no. Gold you hold directly is not reportable on the FBAR or IRS Form 8938. But be careful…when you sell the gold, you have a reportable transaction.So, in most cases, you are not required to report gold to the IRS!

You hold gold directly if you own gold bars, gold bullion or coins and keep them in a vault. It doesn’t matter whether that vault is inside the U.S. or somewhere secure like Panama. You do not hold gold directly if you own a gold certificate, gold stocks, or a gold future contract. Only physical gold that you have direct access to is allowed to be private. For additional information, see the IRS website.

I note that your IRA can hold gold bullion directly, and that gold can be held in a foreign vault. Many of our clients form offshore IRA LLCs to hold this type of asset. In that case, your administrator must report the appreciation in the IRA account, but are not required to file an FBAR or IRS Form 8938.

The same holds true for tangible assets that you buy as investments. Examples of tangible assets include art, antiques, jewelry, cars and other collectibles. If you hold these assets outside of the United States, you are not required to report them on your FBAR or IRS Form 8938. Note that an IRA may not own art, antiques, jewelry, cars or any type of collectible

Finally, you are not required to report the existence of a safe deposit box at a foreign bank. A safe deposit box is not a foreign account and is thus not covered by these forms. If your safe deposit box has only gold and jewelry, then you have nothing to report.

Now, here’s the rub: If you sell your gold or tangible property to a foreign person, that sales contract is a reportable asset. According to the IRS, “The contract with the foreign person to sell assets held for investment is a specified foreign financial asset investment asset that you have to report on Form 8938, if the total value of all your specified foreign financial assets is greater than the reporting threshold that applies to you.”

Therefore, if you sell your gold and collectables to a U.S. person, no reporting is required. If you sell these same assets to a foreign person, and the total value is significant, you must report the transaction on IRS Form 8938.

I hope this helps. For a similar article on foreign real estate, see: Do I Need to Report my Offshore Real Estate on IRS Form 8938?

design

Industria în creștere a videoclipurilor porno

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Deși este dificil de cuantificat impactul economic al videoclipurilor porno, estimările sugerează că industria porno ar putea fi mai mare decât Netflix, care aduce 11,7 miliarde de dolari anual.

Acest număr de venituri este greu de identificat din cauza pirateriei rampante, a proprietății private și a discrepanțelor în studiile pornografice. Cu toate acestea, un lucru este cert: Pornhub domină în mod clar industria video porno online. De fapt, compania deține mai multe companii de producție care recoltează date de pe propriile site-uri porno. Aceste date sunt apoi folosite pentru a crea videoclipuri porno personalizate pentru utilizatori.

Deși studenții nu sunt familiarizați cu porno, nici ei nu sunt excluși. De fapt, studenții sunt al doilea cel mai mare număr de spectatori de videoclipuri porno, cu aproape o treime dintre ei cu vârsta cuprinsă între 18 și 24 de ani. Videoclipurile porno pot atrage spectatorii tineri, dar nu sunt sănătoși pentru sănătatea lor. În plus, porno este adesea degradant și violent, aproape 90% dintre scene prezintă violență. Ca rezultat, porno poate provoca boli cu transmitere sexuală la oameni.

De asemenea,  filmexxxgratis îți inundă creierul cu substanțe chimice care creează dependență, inclusiv dopamină. Această aprovizionare constantă face ca creierul să devină copleșit, ceea ce provoacă dependență. Utilizatorii de pornografie caută din ce în ce mai mult porno hardcore pentru a-și satisface dependența. Activitățile regulate și sănătoase, cum ar fi vizionarea la televizor, nu produc suficiente din aceste substanțe chimice, așa că atunci când nu vizionați porno, vă simțiți dezamăgiți. În cele din urmă, acesta nu este un lucru bun.

Industria porno există de secole, dar există câteva exemple recente care vă pot surprinde. De obicei, producția video porno durează cel puțin trei zile. Multe dintre aceste videoclipuri sunt foarte grafice și descriu viața sexuală a unui bărbat. Videoclipurile porno ar putea să nu fie pentru toată lumea, dar genul ar trebui să facă parte din lecțiile de alfabetizare media. Acest articol va oferi câteva date despre industria video porno. Să aruncăm o privire mai atentă asupra industriei și asupra modului în care este creat și consumat porno.

Există mai multe țări despre care se știe că sunt cei mai pasionați urmăritori de videoclipuri porno.

Aceste țări sunt în mare parte creștine, musulmane și mixte. Pornografia este, de asemenea, foarte populară în Japonia și Pakistan, iar conținutul videoclipurilor porno nu este limitat doar la aceste țări. Cei mai buni urmăritori de videoclipuri porno sunt enumerați mai jos. Nu există nicio îndoială că industria videoclipurilor porno este în creștere. Dar această industrie nu este lipsită de controverse. Este o sursă majoră de venituri pentru companiile care sunt interesate să-l monetizeze.

Una dintre cele mai mari preocupări este impactul pornografiei asupra creierului. Când ne uităm la videoclipuri porno, creierul produce o substanță chimică numită dopamină, care este responsabilă pentru crearea unei conexiuni între anumite acțiuni și dezirabilitatea percepută. Această substanță chimică promovează ulterior crearea de noi căi neuronale, legând pornografia cu plăcerea. Acest fenomen este responsabil în mare măsură de creșterea consumului de porno în rândul bărbaților. În consecință, vizionarea pornografiei poate avea un impact negativ asupra relației dintre bărbați și femei.

Dacă aveți o cască VR, puteți viziona porno VR folosind Samsung Gear VR.

Pentru a descărca aceste videoclipuri, creați mai întâi un dosar numit /MilkVR pe telefon. Apoi, descărcați aplicația Samsung VR și selectați canalul Sideload. Apoi, deschideți videoclipul în playerul VR. Dacă aveți o conexiune la internet, puteți viziona videoclipul. Cu toate acestea, dacă nu aveți acces la Internet, descărcarea conținutului este, de asemenea, o opțiune viabilă.

Unele filme au dus chiar pornografia la noi niveluri, cu exemple notabile, inclusiv The Bare Wench Project și The Blair Witch Project. Ambele filme au fost false ale unor filme mainstream și chiar au dat naștere unor sequele. Infamul Les Liaisons dangereuses a inspirat, de asemenea, mai multe filme și emisiuni TV. Pe lângă cele menționate mai sus, alte două filme care și-au făcut loc pe listă includ Legături periculoase și Intenții crude.

Popularitatea genului a crescut în anii 1970. În anii 1970, regizorul Bill Osco a început în industria filmelor porno producând Mona. Acest film urmărește o tânără în timp ce trăiește diverse situații sexuale. Epoca de aur a pornografiei a cunoscut, de asemenea, un val de creativitate în industria pornografiei. Filme precum Flesh Gordon din 1974 au fost un amestec de science-fiction și comedie.

Offshore Captive Insurance Company
Christian Reeves

Can I Invest in a Business with my IRA?

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Surprisingly, yes you can invest in an active business with your retirement account. There are a many caveats and limitations, but you can usually lend money to a business, purchase shares in a corporation or LLC, or buy in as a partner receiving a share of the profits (flow-through structures).

Now, let’s talk about those limitations:

First, if you are investing in a business in the United States, your IRA can’t own shares of an S-Corporation.  This is not an IRA rule, but rather a U.S. corporate statute which requires owners of S-Corps to be U.S. persons. In other words, no foreign person (for tax purposes), entity, or tax exempt /preferred structure may invest in a business structured as an S-Corp.

Next, you can’t invest in a business of which you are a highly compensated employee. Basically, the IRS wants to make it difficult for you to take money out of your retirement account as salary and thereby circumvent the distribution rules.

A highly compensated employee is an individual who:

  • Owned more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation that person earned or received, or
  • For the preceding year, received compensation from the business of more than $115,000 (if the preceding year is 2012 or 2013), and, if the employer so chooses, was in the top 20% of employees when ranked by compensation.

I note that, if you draw a salary from a business you invest in using your IRA, you open yourself up to audit on that issue. This is especially true if you also take expense reimbursements and other payments that could be categorized as salary. I always recommend clients not take a salary when investing through a retirement account. And, if you do take a salary, to keep very good accounting records on all transactions to ensure they are below the threshold.

Next, your retirement account is prohibited from investing in a business of which you own or control more than 50%, or which is owned or controlled by any “disqualified person.” The first part of this rule is simple enough: you may own up to 50% of a business or corporation through your retirement account. To put it another way, you can’t invest in an entity (corporation, partnership, trust or estate) owned or controlled more than 50 percent by you…straightforward enough.

Now, let’s talk about who else (other than you, the owner of the account) is a disqualified person. In this section, the IRS is attempting to limit any conflicts of interest involving your IRA and related parties and to ensure all transactions benefit the retirement account and not the IRA owner.

A “disqualified person” (IRC Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRA owner, any ancestors or lineal descendants of the IRA holder, and entities in which the IRA holder holds a controlling equity or management interest.

A disqualified person is defined as follows:

  • A fiduciary, which includes the IRA holder, participant, or person having authority over making IRA investments,
  • A person providing services to the plan such as the trustee or custodian,
  • The employer who created the plan or an employee organization any of whose members are covered by the plan,
  • A spouse, parents, grandparents, children, grandchildren, spouses of the fiduciary’s children and grandchildren of a disqualified person,
  • An entity (corporation, partnership, trust or estate) owned or controlled more than 50 percent by a disqualified person, and
  • A 10 percent owner, officer, director, partner, joint venture, or highly compensated employee of a disqualified person.

Note: brothers, sisters, aunts, uncles, cousins, step-brothers, step-sisters, and friends are NOT treated as “Disqualified Persons”.

What will happen if you (whether by accident or intentionally) break one of these many rules? If the IRS finds out, the consequences will be swift and severe. Specifically, if an IRA owner or his or her beneficiaries engage in a prohibited transaction at any time during the year, the account stops being an IRA as of the first day of that year and major penalties apply.

This means that the account is treated as distributing all its assets to the IRA owner at their fair market values on the first day of the year. If the total of those values is more than the basis in the IRA, the IRA owner will have a taxable gain that is includible in his or her income.

In addition, the IRA holder or beneficiary would be subject to a 15% penalty, as well as a 10% early distribution penalty, if the you are under the age of 59 1/2.

The prohibited transaction rules are extremely broad and the penalties harsh (immediate disqualification of entire IRA plus penalty). Thus, if you invest in an active business, you must be cautious when engaging in transactions that could be considered self-dealing or result in a direct or indirect personal benefit. Whenever you consider a complex transaction, it is important you consult with a qualified expert.

Let’s conclude with a few comments on the tax consequences of investing in an active business. If you purchase shares, and sell them for a capital gain, the profit flows in to your retirement account as any other investment – tax free to a ROTH or tax deferred in a traditional IRA. Likewise, if you lend money to a business, the interest earned passes up to your retirement account tax preferred.

If you invest in a joint venture, mutual fund, or partnership, such that you receive distributions of profits or income, rather than capital gains, your tax picture becomes more complex. Obviously, the IRS won’t let these profits go in to your retirement completely untaxed.

In other words, when you invest in a business by purchasing shares, the value of those shares go up or down based on the net income of the business. The business is earning money, paying corporate tax on its net profits, and then distributing out any after tax gains as dividends or stock appreciation. Thus, the IRS gets its cut first, then the investors benefit.

When a business operates as a partnership, untaxed net profits flow through to its members on Form K-1 to be taxed on the partner level rather than the partnership / entity level. If a retirement account were allowed to receive flow-through profits, then it would be possible to defer or eliminate tax on those profits all together.

Note: It is not possible to operate a business in the U.S. untaxed, but it is possible offshore.

To prevent this, the IRS invented “Unrelated Business Income Tax” or UBIT. In essence, UBIT is a tax at the corporate rate of 35% on profits in a retirement account on income which is not related to the accounts primary purpose of investing.  Income from an active business that is not capital gains, but ordinary income, mean the IRA is operating a business and are thus these profits are UBI and taxed at 35%.

So long as you can live with the tax consequences, your IRA may invest in partnerships, LLCs, and mutual funds (but not S-Corps). To prevent a reporting mess at the IRA level, you should form a U.S. UBIT Blocker corporation, make the investment and pay the tax from that entity, and pass through “related” income or investment returns to the retirement account.

If you invest in an offshore business, which is not taxable in the United States, then you can eliminate UBIT entirely by forming an offshore UBIT Blocker. This is where IRA tax law gets really interesting.

Let’s say you want to invest in a business partnership in Panama, will own 30% of that structure, and operating profits will be passed to you without being taxed by that country. If you form an offshore IRA LLC, an offshore UBIT Blocker corporation, and make the investment from this corporation, you can eliminate UBIT.

This is because the active business profits are earned by an offshore UBIT Blocker are free from corporate level tax. If that entity were a U.S. corporation, its profits would be taxed at 35%. Because it is an offshore corporation, formed in a country with no corporate tax (such as Belize or Nevis), no tax is due.

The UBIT Blocker now passes up these profits to the LLC as dividends. Because dividends are not unrelated income, but rather investment returns, they are not taxable…and UBIT has been effectively blocked.

To be clear, I am referring to an IRA making an investment in to a business that is outside of the United States, has no US source income, and is generating active business returns with an office and staff based in Panama. I am not taking about an offshore structure investing in a business or partnership located in the United States, or a business based in America that is utilizing a foreign holding company.

I hope you have found this article interesting. If you have questions on forming U.S. or offshore IRA LLCs and/or UBIT Blocker structures, please contact me at info@premieroffshore.com. I will be happy to work with you to design a structure that maximizes privacy and protection while still in compliance with IRS retirement account regulations.

 

UBIT Blocker
Christian Reeves

Eliminate Tax on Leverage in your IRA with UBIT Blocker

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If you want to use leverage / margin to increase your IRA’s investing power, then you need an offshore UBIT Blocker Corporation. There are major benefits available for the sophisticated investor offshore, and the most important is the ability to use leverage and avoiding US tax on that leverage.

Without a blocker, you will pay US tax on the profits generated by the loans in your retirement account. This is called Unrelated Business Income Tax, or UBIT for short, and can be a real killer at 35%. UBIT is taxed at the corporate rate and the United States has the highest nominal corporate tax in any of the world’s developed economies. There is no (long term) capital gains treatment available for UBI.

For example, if you want use your IRA to purchase a rental property in Belize, a local bank will give you a non-recourse loan for up to 50% of the value. So, your $50,000 IRA can purchase a $100,000 property…which sounds great. Well, if you are not structured properly, 50% of the net profits from the rental, and 50% of the gains when the property is sold, are attributed to leverage and thus UBIT. This means that half of your profits are taxable in the United States at 35%.

The same is true with leveraged brokerage accounts. Sophisticated investors might wish to trade their IRAs with 10 times leverage in the FX or commodities markets, but UBIT tax is so high that it makes the leverage worthless.

These investors can form an offshore IRA LLC, an offshore corporation as a UBIT Blocker, open a trading account onshore or offshore, and eliminate UBIT on leverage. A properly structured UBIT Blocker corporation will completely eliminate US tax on leverage!

For more information on UBIT and blocker corporations, please check out my Self Directed page. For further reading, here are a couple outside links:

Please contact me directly at info@premieroffshore.com for a confidential consultation on the use and benefits of offshore UBIT structures. I will be happy to answer your questions and assist you in taking your retirement account offshore.

Real Estate in an Offshore IRA
Christian Reeves

Do I Need to Report my Offshore Real Estate on IRS Form 8938?

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The general rule is that foreign real estate is not reportable to the IRS on Form 8938. Good news and an asset category that has been ignored by the IRS hawks trying to swoop in on as many international resources as possible.

But, read on! While the default rule is that foreign real estate is not reportable, about 95% of my clients do need to report their real estate holdings on IRS Form 8938. This is because foreign property is usually held in an offshore trust or foreign corporation and your shares in entity must be reported on Form 8938 and elsewhere.

Let’s take a step back: Form 8938 – Statement of Foreign Financial Assets was created in 2011 and must be filed by anyone with significant assets outside of the United States. If you qualify to file Form 8938, you are to report financial accounts maintained by a foreign financial institution.  Examples of financial accounts include: Savings, deposit, checking, and brokerage accounts held with a bank or broker-dealer.

Also, you are to report stock or securities issued by a foreign corporation (like the one that holds your foreign real estate), trust or other entity (such as an offshore LLC), and any financial instrument or contract held for investment with an issuer or counterparty that is not a U.S. person.  Examples of these assets include:

  • Stock or securities issued by a foreign corporation;
  • Stock or membership interests issued by a foreign limited liability company;
  • A note, bond or debenture issued by a foreign person;
  • An interest rate swap, currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap or similar agreement with a foreign counterparty;
  • An option or other derivative instrument with respect to any of these examples or with respect to any currency or commodity that is entered into with a foreign counterparty or issuer;
  • A partnership interest in a foreign partnership;
  • An interest in a foreign retirement plan or deferred compensation plan;
  • An interest in a foreign trust or estate;
  • Any interest in a foreign-issued insurance contract or annuity with a cash-surrender value.

Foreign real estate is not a foreign financial asset required to be reported on Form 8938.  So, a personal residence or a rental property outside of the United States does not need to be reported on this form.

However, if the real estate is held through a foreign entity, such as a corporation, partnership, or trust, then your interest in the entity is a specified foreign financial asset that might be reportable on Form 8938.  The value of the real estate held by the entity is used to determining the value of the shares to be reported on Form 8938, but the real estate itself is not separately reported on Form 8938.

All of this is to say that, if you purchase foreign real estate in your name, without an entity, you do not need to include that asset on Form 8938…but be careful, there are a number of traps for the uninitiated.

First all rental income must be reported on your personal return (Form 1040 and Schedule E), regardless of amount and regardless of whether you are required to file Form 8938. In most cases, reporting your rental property on Schedule E will create a loss, and thereby reduce your US taxes. For more information on this and taking depreciation on international real estate, check out my article US Tax Breaks for Foreign Real Estate.

Second, if you open a foreign bank account to facilitate the purchase of the property, or the receipt of rental income, and that account has more than $10,000 in it on any one day of the year, then you must report the bank account on US Treasury Form TD F 90-22.1, commonly referred to as the FBAR or Foreign Bank Account Report. I will discuss this form in more detail below.

Want to avoid filing the FBAR?

  • When you purchase the property, wire funds from your US account in to escrow. Don’t allow the purchase price to go through an offshore account.
  • Keep less than $10,000 in the operating account. You might need a foreign account to pay local expenses and receive rent, but you can avoid this form by maintaining a minimum balance.

What if you do not want to hold foreign real estate in your name? What if you, like most investing abroad, prefer the privacy, security and protection of a corporation?

Even if you purchase foreign real estate in a corporation, you might not need to file Form 8938. Remember that Form 8938 applies to those with “significant” assets outside of the United States. Here is how it works:

If you are living in the United States, are a married couple filing a joint tax return, and your reportable foreign assets on the last day of the year do not exceed $100,000, and are not more $150,000 on any day of the year, you don’t need to file Form 8938.

If you living in the United States, are single or married filing separate, and your reportable non-US assets on the last day of the year do not exceed $50,000, and are less than or equal to $75,000 on any day of the year, you don’t need to file Form 8938. For additional information, see the instructions to Form 8938.

If you are living abroad, are a married couple filing a joint tax return, and your reportable non-US assets on the last day of the year are not more than $400,000, and do not exceed $600,000 on any day of the year, you don’t need to file Form 8938.

If you living abroad, are single or married filing separate, and your reportable non-US assets on the last day of the year do not exceed $200,000, and are not more than $300,000 on any day of the year, you don’t need to file Form 8938. For additional information, see the instructions to Form 8938.

NOTE: Be careful when calculating the value of your foreign assets. You need to convert the value from your foreign currency to United States dollars each year. As the US dollar falls, the relative value of your assets increase. For an example, see my article Weak Dollar Crushing the Foreign Earned Income Exclusion.

Do you spend some time in the United States each year? Are you unsure if you are a US or international person for the purpose of Form 8938? The answer is simple: If you qualify for the Foreign Earned Income Exclusion (FEIE), then you are an international person. If you don’t qualify for the FEIE, you live in the US for tax purposes. Yes, even if you spend significant time abroad, you live in the US for the purpose of this form if you don’t qualify for the FEIE.

If you don’t know whether you qualify for the FEIE, or have no idea what the FEIE is, then you are probably a US person. Basically, if you are a resident of a foreign country for a full calendar year, you qualify for the FEIE. Alternatively, if you spend more than 330 days per year abroad out of any 365 day period, you qualify for the FEIE.

Note: This is a summary of a complex topic. For a detailed article on the FEIE, check out Foreign Earned Income Exclusion Basics.

If you decide to hold your foreign real estate in a company or trust, you will have filing obligations in addition to Form 8938.

The most critical offshore tax form is the FBAR. Anyone who is a signor or beneficial owner of a foreign bank or brokerage account with a value of more than $10,000 must disclose their account(s) to the U.S. Treasury.

The law imposes a civil penalty for failing to disclosing an offshore bank account or offshore credit card up to $25,000 or the greatest of 50% of the balance in the account at the time of the violation or $100,000. Criminal penalties for willful failure to file an FBAR can also apply in certain situations. Note that these penalties can be imposed for each year.

In addition to filing the Foreign Bank Account form, the offshore account must be disclosed on your personal income tax return, Form 1040, Schedule B.

Other international tax filing obligations include:

  • Form 5471 – Information Return of U.S. Persons with Respect to Certain Foreign Corporations.
  • A foreign corporation or limited liability company should review the default classifications in Form 8832, Entity Classification Election and decide whether to make an election to be treated as a corporation, partnership, or disregarded entity.
  • Form 8858 – Information Return of U.S. Persons with Respect to Foreign Disregarded Entities.
  • Form 3520 – Annual Return to Report Transactions with Foreign Trusts.
  • Form 3520-A – Annual Information Return of Foreign Trust.
  • Form 5472 – Information Return of a 25% Foreign-Owned U.S. Corporation.
  • Form 926 – Return by a U.S. Transferor of Property to a Foreign Corporation.

Once you begin to expand your investment options beyond the United States, your IRS picture will become more complex. But, don’t let big brother bully you in to keeping your money at home. Don’t let these forms dissuade you from diversifying outside of your comfort zone or achieving significantly higher returns than are available from your local bank.

You have two options: 1) get in line and keep your money at home or 2) break from the crowd, file your forms, and make some real money.

If you choose diversify abroad, I suggest you hire a tax preparer who is experienced in international investments and forms to handle your reporting. Your local guy probably has no idea what any of this means and the cost of making a mistake is just too great for you to take on the IRS alone.

U.S. Source Income
Christian Reeves

Tax Season’s Best Questions

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We get a lot of good questions from Expats around the globe during the April 15 and October 15 tax seasons. Here are a few from this go-round.

Moving to a High Tax Country

Q: “I’ve just moved to Australia in the last year.  I currently have very little assets in the US and am working for An Australia company building a saving account in Australia. I am planning on purchasing a home and or investment property in the next 12 months with the intention of having around 5 properties in a few years.  I’m trying to plan in advance to avoid long term capital gains and use smart tax strategies.  I am planning on buying in Australia and own no property in the US.  Will the US tax my income and capital gains?  If you have any suggestions on resources to utilize I’d be very appreciative.”

A: Unfortunately for you, US tax will not be an issue. This is because your tax rate in Australia is certain to be higher than it would be in the US. For example, your personal tax rate in Australia will start at 19%, and max out at 45% on income over $180,000. Your rate in the US on income over $180,000 should be 28% to 39.6%.

Making things worse, Australia does not have a capital gains rate…capital gains are taxed the same as your ordinary income. Therefore, long term gains in Australia might be taxed at 45% compared to 20% in the US.

When you move out of the US to a country with a higher tax rate, you should not expect to pay any tax to the US. You must still file your US tax returns each year, but the Foreign Tax Credit should eliminate any US tax on your Australian income.

The Cost of Compliance

Q:  “Thanks for the wonderful newsletter. I hope I get this email to you. I believe that someone from US would have a very hard time when opening up an IBC as it gets really expensive to file IBC paperwork with the CPAs. If also exiting the US with expatriation, it would cause problems with expatriation taxes. My CPA keeps on telling me that it would require $4,000-$5,000 dollars just to file all the forms needed. I was shocked at the costs…I am confused since they both told me there are a lot of people selling these offshore vehicles which can get me in a lot of requirements and problems. This is the same answer that I got from various tax attorneys in USA.”

A: I agree completely that there are a lot of promoters out there selling IBCs that can get Americans in to trouble. One of the quickest paths to disaster for an American is using an incorporator that does not provide US compliance. For more on this topic, checkout my article on offshore asset protection scams.

To avoid these issues, you should use a US tax expert to form your offshore structure. Companies such as mine will ensure you are in US tax compliance from day one.

Regarding the costs of compliance, offshore corporations and IBCs file Form 5471, which is a US corporate tax return designed to report ownership, control, and income from these types of structures. This return will require a profit and loss statement and balance sheet, but should be no more complex or costly than a typical US corporate return, Form 1120.

If someone is operating a large business with employees offshore, is retaining earnings offshore, or has a number of partners in the business, Form 5471 can become expensive…just as a complex Form 1120 can become costly.

If you are using an IBC for basic asset protection, filing your US return should not be a major expense. We typically charge $850 for Form 5471. If you are being quoted $3,000 to $4,000, you are either working with a major firm such Delloitte, or your CPA simply doesn’t want to handle the returns and is quoting a ridiculous rate to prevent you from setting up a structure.

State Tax Issues for Expats

Q: “I have heard that some people move to Texas or Florida before going offshore. Can you tell me why? When I moved from California to Panama, and become a resident of Panama, I had no problems.”

A: Right, if both H and W move out of California and become tax residents of a foreign country, then their State issues are eliminated. However, moving to Florida or Texas before going offshore reduces the risk of being audited on this issue by California.

First, I note that California doesn’t have a FEIE. So, if you move out of CA for two years and intend to return, 100% of your income earned abroad is taxable in California. You might avoid Federal income tax with the FEIE, but not CA income tax.

Second, for those using the 330 day test, State tax can be a real problem. This is especially true of they keep their old home and other ties to the State.

For example, I have had the case where Husband works offshore and qualifies for the FEIE using the 330 day test (military contractor) and the case where he lives offshore and qualifies under the residency test. Their wives lived in CA with the kids.

For the contractor, CA has no FEIE and thus 100% of his income is taxable in CA. You see this a lot with military contractors and oil field guys in hostile countries…obviously, H is not a resident of Iraq and intends to return to wife and kids when his contract is up.

For the person using the residency test, CA says half of H’s income is attributable to W because CA is a community property State. Therefore, 50% of H’s income is taxable in CA.

A more common example for non-contractors might be H and W have a small business netting $100,000 in Panama. H qualifies for the FEIE using the 330 day test, but W does not. She wants to spend more time visiting the kids / grandkids, while H is just done with the US.

They put all of their income under H and pay no Federal tax using his FEIE.

Then, CA comes along and says W is really a resident of CA, 50% of H’s income is attributable to W, and 50% of the income is taxable in CA.

One reason W might be a resident of CA is that she did not break off sufficient ties to the State and she intends to return there someday.

Do you disagree with CA’s determination? Legal fees will be at least $10,000.

Offshore Contractors and the FEIE

Q: “Christian, I am writing for my son who is in Afghanistan.  He works as a contractor there but need to find a tax person who understands the 35 days in country rule.  I’m sure you do but don’t know militarily if that is different.  Would like your recommendation if possible.”

A: Yes, I am familiar with this FEIE and have had many contractor clients…maybe around 100 over the years. Here are the rules for contractors abroad:

First, a contractor is someone paid by a US or foreign corporation and not directly by the US government.

Second, a contractor may take the FEIE (military personnel do not qualify). Contractors must use the 330 day test and not the residency test. Here is a detailed article on the 330 day test.

The reason he must take utilize the 330 day test is that a contractor is not a tax resident of Afghanistan because he does not intend to make that his home. His intention is to return to the US after his contract is up. So, he must use the 330 day test and not the residency test, and may spend no more than 35 days in the US.

This means that he should spend most of his vacation days somewhere other than America. Remember, he is not required to be in Afghanistan to qualify…he need only be outside of the US. So, if a contractor is on a 2 months on 1 month off rotation, he should vacation in Latin America or the Caribbean.

It is important to note that, if a contractor misses the FEIE even by one day, then he loses the FEIE completely and all of his income is taxable.

Third, if a contractor is paid by a US corporation, then he must receive a W-2 with Social Security and Medicare deducted. If paid by an offshore corporation, then the contractor is not liable for these taxes.

Fourth, there is a special component of the Foreign Housing Exclusion for contractors in war zones. In most cases, he (the temporary worker) may only deduct the cost of maintaining one home abroad. If your employer provides housing, that is his tax home.

However, if he maintains a second, separate household outside the United States for his spouse or dependents because living conditions near his primary home are dangerous, unhealthful, or otherwise adverse, he can exclude / deduct this second home using the Foreign Housing Exclusion.

In other words, if he is in a war zone, he may exclude the value of two homes outside of the US…one for himself and one for his family. If he is not in a war zone, he may only exclude his primary offshore home.

Adverse living conditions include:

  • A state of warfare or civil insurrection in the general area of your tax home, and
  • Conditions under which it is not feasible to provide family housing (for example, if you must live on a construction site or drilling rig)

Moving a Business Abroad

Q: Christian, I have moved to Costa Rica and just love it here. I have a business and a corporation in Florida and need some tax advice. Can you help?

Q: You indicate you are operating a business through an FL company while living offshore. This will certainly increase the amount of tax you pay to the United States.

If you will qualify for the FEIE, then you should add an offshore corporation to your structure. The offshore company will bill the US company and you will draw your salary from the offshore company. This will eliminate self-employment and all other related taxes…reducing your US taxes by at least 15%.

Such a company should be in a country other than where you are resident, and one that will not tax your income. Therefore, I recommend Belize. I also note it must be an IBC and not an LLC.

Puerto Rico Tax deal
Christian Reeves

Puerto Rico Tax Deals for Corporations

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Thinking about moving your business offshore? If you are a US citizen, and your profits exceed $400,000, I guarantee Puerto Rico has a better deal for you.

As I reported last month, a US citizen can move to Puerto Rico and pay zero capital gains tax on his or her passive income and investments. That’s right, no US Federal or State tax on capital gains tax from real estate, stocks, and/or other investments acquired after you move to and become a resident of Puerto Rico.

This time around, I am here to tell you that Puerto Rico has a deal for business owners and entrepreneurs…a deal you can’t find anywhere else in the world unless you turn in your US passport.

Puerto Rico is offering business owners a tax contract similar to the one Switzerland and Russia negotiates with high net worth Europeans. Yes, Snowden’s Russia is a tax haven. For example, the actor Gérard Depardieu, angry over a plan by the French government to raise taxes to 75 percent for the wealthy, accepted a Russian passport from President Vladimir V. Putin. Russia has a flat tax rate of 13 percent.

A tax contract with Puerto Rico will allow you to cut your total (worldwide) tax rate down to 10% or lower without the need for any complex planning or structuring. Once you enter in to a contract, it can’t be modified or revoked by the government until 2036. Of course, you can leave Puerto Rico, thereby opting out of the tax deal, at any time. You can also spend a few months a year in the United States.

To receive these benefits, you are required to move yourself and your business to Puerto Rico, spend at least 183 days a year on the island, become a legal resident of this territory, and enter in to a tax contract with the government. Once you have relocated, you have opted out of the US Federal and State tax systems and in to the Puerto Rico tax code…which trumps the Federal code.

  • As a US territory, Puerto Rico’s tax code takes precedent over the US Federal tax code. While US Expats are bound by Federal tax law, American’s in Puerto Rico need only follow local tax rules.

Such a contract is the inverse of the Foreign Earned Income Exclusion (FEIE) and allows you to pay all of your taxes now at a reduced rate without the need to lock earnings in to an offshore corporation, captive insurance company, or some other complex tax deferral mechanism.

Let me explain: If you qualify for the FEIE you can earn up to $97,600 in salary free of Federal income tax in 2013. If a husband and wife are both working in the business, they might take out $195,200 combined. That is a major tax break which allows a properly structured offshore business earning $195,200 to be completely free of US tax.

Well, what if your business earns significantly more than the FEIE amount? You can usually retain excess profits in to your corporation and thereby defer US tax until you distribute these profits as a dividend. Capital gains, interest income and other returns derived from these retained earnings are taxable (may not be deferred) and dividends are taxed as ordinary income.

While the FEIE works great for those with business profits near the exclusion amount, it is not so wonderful for those earning significantly more. If you net $1 million a year and want to take that money as income now, then you are stuck paying US tax on the amount over the FEIE at 39.6% in 2013. This comes to about $318,000 in Federal income tax assuming a husband and wife both qualified for the FEIE and no State tax is due (($1m – $195,000) x .396) = $318,000. If only one person qualifies for the FEIE, your tax bill will be about $357,350 (($1m – $97,600) x .396) = $357,350.

In Puerto Rico, you pay income tax on the first $250,000 (using a graduated rate of up to 33%) and 4% on income over $250,000. There is no need to retain earnings in an offshore corporation and no issues related to tax deferral. You are paying tax each year as the money is earned…at a lower rate compared to those of us in the States, but no deferral or retainer earnings to worry about.

For example, on $1 million of business profits, your tax bill in Puerto Rico will be about $105,000, significantly less than the same US owned business operating offshore using the FEIE. This equates to an effective tax rate of about 10% ((.30 x 250,000) + (.04 x 750,000)) = $105,000 or 10%.

As your net profits increase, the benefit of Puerto Rico’s tax system increase and your effective tax rate drops. For example, on net profits of $3 million, your tax is approximately $185,000, for an effective tax rate of 6.2% ((.30 x 250,000) + (.04 x 2,750,000)) = $185,000 or 6.2%.

As stated above, if your net profit is anywhere near the FEIE amount, then living and working abroad and operating through a foreign corporation will give you the best tax deal. If your profits are between $100,000 and $500,000, then you might need to run the numbers to determine whether Puerto Rico or the FEIE provides the better option. Such an analysis would take in to account how much you are willing to retain in to an offshore corporation, how long you can lock those profits away, and the deductions you have available on your US personal income tax return (itemized deductions such as mortgage interest, property tax, charitable contributions, etc.). I have not considered these issues in the examples provided.

What about those of us earning less than $1 million from our business? In Puerto Rico, you will be required to take salary of 1/3 of your net profits, up to a maximum salary of $250,000, and pay 4% on the remaining 2/3. So, if you earn $300,000 in total profits, your tax would be about $38,000 or 12.6% ((.3 x $100,000) + (.04 x $200,000)) = $38,000 or 12.6%.

If that same $300,000 was earned as salary by a US citizen using the FEIE and an offshore corporation, the first $97,600 would be tax free and the remaining $202,400 would be taxed at around 31% in 2013. This means your US Federal income tax will be about $62,644 (($300,000 – $97,600) x .31) = $62,644 for an effective rate of about 20%.

If a husband and wife are both working in that business with a net of $300,000, the FEIE amount becomes $195,200, and the balance is taxed at approximately 29%, for a total tax of $30,392. Therefore, at this income level it will be more efficient for a single person to operate in Puerto Rico and a married couple to be based offshore (($300,000 – $195,200) x .29) = $30,392 or about 10%.

When you combine these business tax incentives with the personal tax benefits of zero capital gains, you have a very strong contender in Puerto Rico. It is a deal that no country in the world can offer a US citizen.

So, why is Puerto Rico doing this? This island territory is in its 8th year of recession and is desperate to attract some wealth and prosperity. 4% tax on business profits is better than no business and no tax revenues.

How bad is the economy? Puerto Rican bonds are sold in the US with yield above 10%, which is extremely high. So high that Puerto Rico was forced to cut its offering this week the island’s Government Development Bank announced it would cut bond sales to between $500 million and $1.2 billion for the rest of the year. This yield compares to California municipal bonds at a current high of 3.13%, up from 2.17% at the end of 2012.

As the territory struggles with $70 billion in public debt and a 13.9% unemployment rate, higher than any U.S. state, it is searching for new ways to bring in capital, employment and investment. The government hopes to cut its $820 million budget deficit in half by 2015.

But, there is hope for Puerto Rico. While the US is completely out of control, Puerto Rico’s deficit has been reduced from $2.4 billion over the last couple of years. The island’s five-year economic plan calls for creating more than 90,000 jobs that would add as much as $7 billion to the economy by 2016, and another 130,000 jobs and as much as $12 billion of growth by 2018.

While these tough economic times might prevent a firm from building a large factory, or committing millions to the Island, they should not deter a high net-worth investor and business owner from picking up and moving. These tax incentives are guaranteed by the government until 2036 and can’t be withdrawn or amended. Even a law change would have no affect because your earnings are not locked in to the corporation, as they are with retained earnings in excess of the FEIE.

For more information, here are some links to other sites.

Links to Outside Resources

If you are considering moving your business  to Puerto Rico or abroad, please contact me for a confidential consultation. You can reach me directly at info@premieroffshore.com or (619) 483-1708.

Offshore IRA
Christian Reeves

Is Your IRA Confiscation Proof?

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Are you thinking of using your IRA to invest abroad? Do you want to move your retirement account out of the United States? There are two very different ways to accomplish these goals. First, you can use a simple self-directed IRA and allow your custodian to make whatever investments you need. Second, you can take control over your account by forming an offshore IRA LLC.

With a self-directed IRA, you can direct the custodian where to invest your money, but you don’t control the transaction. If your custodian is experienced in offshore deals, he will probably do as instructed. If he is not comfortable with a situation, then he can refuse to make the transfer.

With an offshore IRA LLC, you have complete control over your retirement account. Your custodian makes only one transfer…in to your offshore IRA LLC. From there, you are responsible for all transactions.

If your objective is to make a variety of investments, hold property in an offshore LLC, and gain complete control over your retirement account, then you need an offshore IRA LLC.

If you are making one investment, especially in to foreign real estate, then you might be satisfied with a self-directed IRA.

For small retirement accounts, or those with very few investments, the costs of an IRA LLC might outweigh the benefits. For example, a $40,000 account might be sufficient to buy in to a development in Belize, but you may not be willing to pay $3,000 to fully structure the transaction. Therefore, economics can dictate the investment be made in a self-directed IRA without the benefit of an LLC.

If your IRA is $150,000, you wish to purchase properties in various countries and invest the balance in stocks and bonds through an offshore brokerage, then an offshore IRA LLC is required. It is unlikely that a self-directed custodian will agree to handle multiple complex transactions, and he certainly will not allow you to trade your own funds in an offshore brokerage.

In other words, a self-directed IRA custodian will need to handle each and every trade, investment, and transaction, and he will charge you for each. If you have an active investment account, these fees will probably eat you out of house and home right quick.

By utilizing an offshore IRA LLC, you eliminate these transaction costs. The custodian makes only one investment – in to your IRA LLC.

The offshore IRA LLC also gives you complete control over your investments. If you are concerned with the US government taking over your retirement account, then you need an offshore IRA LLC.

  • There is approximately $18 trillion in US retirement accounts and the national debt is nearly $17 trillion and rising. Food for thought…

When you make an investment using a self-directed account, it is the custodian who is making that acquisition on behalf of your retirement account. If an order comes through demanding the funds be returned to the US for any reason, then your custodian will be forced to liquidate the investments for whatever he can get and pay over to Uncle Sam. As the signor on all accounts and investments, he will have the authority and ability to comply with such an order.

As I said above, if you have an offshore IRA LLC, the custodian invests in to that entity and you take it from there. This means that all investments and accounts are held in the name of your LLC and you are the only signor on these accounts and transactions. The custodian can request that you return the assets to his control, but it would be impossible for him to compel you to do so.

To put it another way, it would be impossible for the Custodian to go in to court in Belize and gain access to your bank or brokerage accounts there because he is not a signor to the accounts and has no power over them. He would have no standing or right to sue you or your LLC in a foreign country as his authority is limited to US retirement accounts and transactions where he is a signor.

  • This protection only applies to offshore IRA LLCs. If you are using a US LLC, rather than an offshore IRA LLC, and hold accounts the US, then the US government can simply issue a levy. The same is true of accounts and assets held in Canada, France and the UK. For more information on government takings, see: Can the Government Seize My IRA?

The above example is carrying things to the extreme and assumes you are willing to ignore the demand of the custodian to return your funds to his control. A more practical benefit of the offshore IRA LLC is that it creates a level of impossibility or impracticability in forcing the return of IRA assets. The US government, in its infinite wisdom, may decide to grandfather in these offshore IRA LLCs and block all future formations.

In fact, most experts, providers and IRA custodians agree on only one thing: that the offshore IRA LLC is not long for this world. This structure gives the average person to much control over his or her (possibly only) significant asset and allows them to move it out of the reach of Uncle Sam much too easily. If and when the US government decides to come after retirement accounts, their first attack will be against the offshore IRA LLC.

When this happens, those who have formed and funded their offshore structures will likely be left alone. The stigma and difficulty of going after a number of retirees will generate way to much fear and bad press. Can you imagine trying to criminalize and force the sale of foreign real estate? That would be very ugly.

Far more likely is that existing offshore IRA LLCs will be left alone and grandfathered in to a new law or rule. Forming and funding new offshore IRA LLCs will become an impermissible distribution that is taxable and a penalty will be imposed. Such a change would probably not even rate a blip on the national news cycle.

And this can be accomplished with a very simple change: investing in a single member entity / LLC can be added to the list of impermissible transactions (collectables, life insurance, businesses of which you own more than 50% or are a highly paid employee, etc.). Alternatively, managing an offshore IRA LLC can be deemed to be operating a business, and you own 100% of that business, so it is improper. Either way, future transfers to offshore IRA LLCs can be eliminated with the stroke of a pen, no act of congress, vote, or other law need be passed.

Therefore, the best and only way to ensure you are allowed to control your own finances, and make your retirement account confiscation proof, is to place it in to an offshore IRA LLC and invest outside of the United States before the tides change. By holding accounts at banks that have no branches in the US, in physical gold, foreign real estate, and in other assets not easily seized, you have the best protection available.

If you found this information helpful, I suggest you also read my article on Self Directed and Offshore IRAs. This is more detailed and focused on the legal requirements of these structures.

If you have any questions, please contact me at info@premieroffshore.com or at (619) 483-1708 for a confidential consultation.

Solo 401k for Expats
Christian Reeves

Solo 401k Retirement Plans for Expats

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I am often asked if an Expat can invest in a retirement plan. The simple answer is yes, there are retirement plans for Expats. Yes, if you are living and working offshore, you can use a retirement plan to reduce your taxes. Yes, the Expat can use a Solo 401k plan to save on taxes!

The US government treats all of its citizens the same. It doesn’t matter whether you are living in Panama City, Florida, or Panama City, Panama. So long as you carry a US passport, Uncle Sam wants his cut. Because you are taxed the same, Expats have access to all of the same deductions and tax savings plans as do people living in the US.

If you are living and working abroad, your first line of defense against the US tax man is the Foreign Earned Income Exclusion. With the FEIE, you can exclude up to $97,600 in 2013 of salary or business income from Federal income tax. This is the major tax advantage of living offshore…and the platform on which all other benefits, such as operating your business through an offshore corporation, are founded.

That is to say, if you are self-employed, or running a small business, and you qualify for the Foreign Earned Income Exclusion, you should be utilizing a foreign corporation. I have covered how to do this in great detail in various postings, so I won’t belabor the point here. For more information, see: Eliminate US Tax in 5 Steps with an Offshore Corporation.

Well, what can you do if your business has net profits in excess of FEIE, which is $97,600 (single) or $195,200 if a husband and wife are both working in the business? You can elect to retain the balance in to your corporation and defer US tax until you take it out. Though, you will pay US tax on all capital gains and interest income earned on those retained earnings.

A better solution might be to place that money in a US qualified retirement plan. When you put money in a retirement plan, you get the same benefits as someone working in the good old U.S. of A. You can select a traditional plan and take a tax deduction when you pay in, or setup a ROTH and pay no tax when you take the money is distributed to you.

Note: The Expat also gets to take a standard deduction, or all of the same itemized deductions as someone living in the US…including mortgage interest. You should only consider a retirement plan if your net income exceeds the FEIE and your allowed deductions. For example, it is unlikely that a retirement plan will be worthwhile for someone netting $110,000 from his or her business.

The best retirement plan vehicle for most self-employed Expats is the Solo 401(k). Qualified Expat small business owners can contribute much more on an annual basis than you can to a typical Individual Retirement Accounts, and even than to other small business plans such as the Simplified Employee Pension Individual Retirement Accounts. Also, with a Solo 401(k) you also have the option of making either tax-deferred (traditional) or tax-exempt (Roth) contributions.

  • For the high net worth individual, who wants to put away more than, say $50,000 per year, a defined benefit plan may be required.
  • For the very sophisticated entrepreneur, with up to $1.2 million to in excess profits, an offshore captive insurance company might be in order.

Solo 401(k) Retirement Plans for Expats

Your offshore corporation can establish a Solo 401(k) plan, provided that the only eligible plan participants are you (the business owner) and your U.S. spouse (if you have one). Generally this means you won’t be able to set up a Solo 401(k) if you have other U.S. employees. If you have US employees, you might consider segmenting them in to their own entity or converting them to independent contractors.

  • If those employees are offshore, converting them to independent contractors means you will need to provide IBCs for them so they are not caught in the web of paying self-employment tax.

Remember that this article is for the entrepreneur who is living and working abroad, qualifies for the Foreign Earned Income Exclusion, and is operating through an offshore IBC. As such, you have a lot more flexibility than someone living and working in the United States.

Contributing to a Solo 401(k) Plan

Similar to other 401(k) plans, Solo 401(k) plans allow contributions in the following ways:

  1. An employee contribution of up to $17,500 if younger than age 50, or $23,000 if age 50 or above in 2013
  2. An employer (or profit-sharing) contribution of:
    1. Up to 25% of net adjusted business profits for those not required to pay self-employment tax
    2. Up to 20% of net adjusted business profits for those who are required to pay self-employment tax

As an expat entrepreneurs, your salary is designated as the profit-sharing contribution. The maximum annual total limit for both types of contributions is $51,000, or $56,500 if age 50 or over for tax year 2013.

U.S. Tax Implications

Pretax option: Qualified contributions (employee and profit sharing) can be deducted from U.S. taxable earned income at the time of contribution. These contributions then grow on a tax-deferred basis until you begin to withdraw them after age 59½, at which time they will be taxed as ordinary income at your future U.S. marginal tax rate.

After-tax (Roth) option: If your 401(k) plan documents allow it, the employee contribution portion can also be made on an after-tax (nondeductible) basis, and contributed to a separate Roth 401(k) account that will growth free of U.S. tax. (Note that profit-sharing or employer contributions, which are not mandatory, cannot be made to Roth options at this time.)

Whether it’s better for you to make pretax or Roth contributions to a 401(k) plan will depend on your personal situation. If your taxable AGI will increase in future years, then you want to focus on Roth contributions. If your effective tax rate will decrease in the future (after retirement), then you want to focus on traditional plans.

Yes, it is possible for the Expat’s effective tax rate to increase after retirement. If most of your income was excluded by the FEIE, your effective rate might be near zero. After retirement, you might begin selling stocks, taking distributions, etc., all of which is taxable in the US. Therefore, an Expat’s effective tax rate will often rise after retirement.

Special Consideration for Expats: Unexcluded Earned Income Requirement

Note that your Solo 401(k) contribution must be made with unexcluded earned income (such as wages or self-employment income). If you either have no earned income or if you’re excluding all earned income from U.S. tax using the Foreign Earned Income Exclusion, you cannot contribute to a Solo 401(k).

This is one of the reasons I stated above that you should only consider a retirement plan if your income exceeds the Foreign Earned Income Exclusion. Another is that it makes no sense to lock money in to a retirement account if you can take it as salary tax free.

If you’re currently excluding all of your earned income using FEIE, but you could receive similar benefits by using the Foreign Tax Credit, rather than the FEIE, it could make sense to revoke using FEIE in order to contribute to a Solo 401(k) plan. In other words, if you pay a lot of local tax on your salary in the country you live, you may find that switching to using the foreign tax credit won’t leave you worse off in terms of U.S. tax and will allow you to invest in a Solo 401(k).

Note: If you make this switch and then change your mind within five years, you’ll need to apply for IRS approval to resume using FEIE by requesting a ruling from the IRS.

Summary

Solo 401(k)s can be a great way for a U.S. expat with an income from an offshore corporation of $200,000+ per person (husband and wife) to save money each year in a U.S. tax-advantaged account without locking that money in to their corporation as retained earnings.

Remember that retained earnings in an offshore corporation are usually distributed out as a non-qualified dividends. This means that these distributions will be taxed as ordinary income. You may be able to defer US tax for many years, but once you take out these profits, the tax hit will be significant.

I also note that passive income made by your offshore corporation will likely be taxable as earned. While a retirement account allows you to defer such tax, or pay zero capital gains (Roth), an offshore corporation usually has no such preferred tax status.

As you can see, there are a number of issues to consider when creating a retirement account and an offshore tax and business structure. If you are thinking about moving you and your business offshore, contact me at info@premieroffshore.com for a free confidential consultation. I will be happy to work with you to develop a plan that will reduce your worldwide tax burden.

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Puerto Rico Pic
Christian Reeves

Move to Puerto Rico and Pay Zero Capital Gains Tax

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Are you tired of paying in to the Obamanation? Is most of your income from capital gains taxed at 24% plus whatever your State grabs? You can eliminate tax on interest, dividends and capital gains by moving to Puerto Rico…immediately and legally.

Those of you who have been following me on  Live and Invest Overseas and PremierOffshore.com for a while know I am focused on showing business owners how they can move their operations offshore to eliminate or defer US tax using the Foreign Earned Income Exclusion. While this model works great for the entrepreneur or small business owner, it provides little benefit for retirees or those who make a living trading stocks and investing.

While the US is taxing and redistributing wealth as quick as it can, Puerto Rico has seized upon this opportunity (an Obamatunity if you will) to entice high net worth individuals to move to their happy islands. Puerto Rico has completely eliminated tax on capital gains, interest and dividends. Yes, that’s right, once you become a resident of PR, you can legally pay zero capital gains tax. No more Federal tax, no complex planning, and no fear of the US government finding your offshore account.

I am not talking about only cutting out your State tax…I am saying you can jettison ALL United States tax on interest, dividends, and capital gains. This is possible because Puerto Rico, while a commonwealth of the United States, is treated as separate for tax purposes. By moving to PR, you can opt out of the Federal tax system and in to the PR tax program. This is because, under the Internal Revenue Code (IRC), capital gains are sourced to your place of residence and the IRC has one section detailing Federal law and another specifying laws of the territories.

Retired? Puerto Rico does not tax social security or unemployment income.

I would like to note here that moving to a foreign country with a low capital gains tax rate does not reduce your effective tax rate on passive investments. This can only be accomplished by relocating to a tax friendly US territory. As a US citizen, you are taxed by the US IRC on your worldwide income no matter where you live. When you move abroad, you remain under the jurisdiction of the Federal Government. So, if your country of residence taxes your gains at 5%, and the US at 20%, then you pay 5% to your country and 15% to Uncle Sam for the right to carry his passport. But, when you move to Puerto Rico, you fall under a unique section of the US tax code for the Commonwealth which trumps Federal law. You are opting out of the IRC Federal system and opting in to the IRC commonwealth system.

In other words, once a U.S. citizen becomes a resident of Puerto Rico, any income derived by that person from sources within Puerto Rico is excluded from U.S. Federal income tax, and taxed under the Puerto Rican income tax code. However, any income derived from outside of PR remains taxed under the Federal law.

So, capital assets (such as land, stocks, bonds, etc.) acquired after moving to PR are tax free. As for property acquired prior to becoming a resident, special provisions can result in a 10% long term rate from the day you qualify and a 5% tax rate applies to property acquired prior to becoming a resident and held for at least 10 years thereafter. See details below.

Why is Puerto Rico Doing This?

While I could pontificate on how PR sees the error of our ways and is a bastion of freedom and capitalism, the truth is probably less grandiose. Puerto Rico’s per-capita income is around $15,200, half that of Mississippi, the poorest state in the nation. Puerto Rico has been battered by several years of recession and its unemployment rate is over 13 percent, well above the national rate, and its economy remains in a funk. Moody’s Investors Services rates the island’s debt one notch above junk status; and in a recent research note, Breckenridge Capital Advisors said the island was “flirting with insolvency.” The island has the weakest pension fund in America and by some estimates could run out of money as soon as 2014.

I also note that these tax breaks apply only to new residents and not those currently living in Puerto Rico. More specifically, they are available to individuals who have not been residents of Puerto Rico within in the last 15 years and who become residents of Puerto Rico on or before December 31, 2035. As such, PR is obviously attempting to bring in new money to revitalize their fledgling economy.

Qualifications

To qualify, you must become a tax resident of Puerto Rico, reside in PR for at least 183 days a year, and file an application for the exemption with the local tax authority. Once approved, the decree establishes the terms of the exemption and has the effect and force of a contract during the entire benefit period. Considering the weakness of the PR economy, and how frequently tax laws change, this contract status is a major benefit.

Incentives

The tax incentives available to individuals are as follows:

  • 100% tax exemption on interest and dividend income earned after the nonresident individual becomes a resident of Puerto Rico; also applies with respect to alternative minimum tax (AMT) up to tax year 2036
  • 100% tax exemption on interest, financial charges, dividends or distributive share on partnership income from international banking entities in Puerto Rico including AMT
  • 100% tax exemption on long-term capital gains realized and recognized after becoming a resident of Puerto Rico but before January 1, 2036
  • If not realized and recognized within the incentive timeframe, regular individual long-term capital gain applies (currently at 10%)
  • Applies to appreciation of property after becoming a resident of Puerto Rico
  • 5% tax on long-term capital gains realized before becoming a resident of Puerto Rico, but recognized after 10 years of becoming a resident of Puerto Rico, as long as recognized before January 1, 2036
  • This 5% long-term capital gain tax only applies to the portion of gain that relates to the appreciation of the property while the individual lived outside Puerto Rico
  • If the long-term capital gain is not recognized within these time periods, applicable individual long-term capital gain rate would apply on any Puerto Rico-source long-term capital gain

Puerto Rico also has great incentives for business owners, based around the tax breaks on dividend payments, which I will detail in a future article. If you are considering living and working abroad, give Puerto Rico a chance. Because of its status as a US territory, these islands can offer tax incentives to US citizens that are not available anywhere else in the world.

finance real estate overseas
Christian Reeves

US Tax Breaks for Offshore Real Estate

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Do you own property outside of the United States? Are you thinking about investing in offshore real estate? Are you an offshore real estate mogul looking to reduce or eliminate your US taxes? This article will cover all areas of US taxation of offshore real estate and provide insider tips and techniques to get your US tax bill under control.

So long as you carry a US passport, the IRS wants you pay tax when you sell offshore real estate. US citizens are taxed on their worldwide income and there are very few offshore tax breaks for capital gains and the passive income. Thus, it doesn’t matter whether you are living in the good ‘ole U S of A or abroad, passive income and capital gains are taxable as earned.

  • Active investors, real estate professionals, and those who buy in a retirement account are exceptions to the rule.

This means that offshore real estate is taxed the same as domestic real estate (with the exception of depreciation). The same tax rates apply, the same deductions for expenses are allowed, and the same credits are available. I will describe the best of these below.

In most cases, if buy a property in Panama and sell it after 3 years, you have a long term capital gain in the US, and owe tax at 20% to 23.8%. For the rest of this article, I will assume a long term US rate of 20%.

Offshore Real Estate and the Foreign Tax Credit

This doesn’t mean you must pay double tax, first in the country where the property is located and then again in the United States. The IRS allows you to deduct or take a dollar for dollar credit for any taxes paid to a foreign country…for every dollar paid to Panama your US bill should go down by one dollar. In practice, this never works out perfectly, but it does eliminate most double tax.

For example, let’s say you bought a property in Medellin, Colombia in 2005 for $100,000. In 2013, you received an offer you couldn’t refuse for $150,000, giving you a capital gain of $50,000. The capital gains tax rate in Colombia is 33%, so you pay $16,500 to Colombia.

The capital gains rate of Colombia is significantly higher than the United States at 20%, so you should not expect to pay any tax to the US. You will report the sale on Schedule D of your US personal return and deduct or take a credit for the $16,500 paid on Form 1116, leaving nothing for the IRS to leach on to.

Now let’s say you sell a property in Panama, where capital gains are taxed at 10%. In this case, you will pay 10% to Panama ($5,000) and 10% to the United States ($5,000), to get to the US 20% rate for long term capital gains.

If you had this same transaction in Argentina, Ecuador or Costa Rica, where real estate sales are not taxed, you will pay all of the “available” 20% to the United States.

Important Note: When deciding in which country to buy real estate, that country’s capital gains rate only comes in to play if it exceeds the US rate. If a country’s capital gains rate is 0% to 20%, you will pay 20% in total. If a country’s rate is more than 20%, then only the excess should be considered in your decision. For example, you are paying a 13% tax premium to buy property in Colombia because Colombia’s rate is 13% higher than the US’s capital gains rate.

Many clients look at a country like Costa Rica and think they are getting a deal or saving money by paying no capital gains tax when they sell their property. Well, these countries have other taxes and duties to make up for their zero capital gains rate, which might not deductible on your US return. In most cases, you are better off buying property in a country whose system mirrors that of the United States.

Cut Out the Tax Man – Offshore Real Estate in Your IRA

The exception to the rule above is offshore real estate held in an IRA LLC. By purchasing offshore real estate in your retirement account, you can defer or eliminate US tax on both rental profits and capital gains. If the country where your property is located doesn’t tax the sale, then you just might avoid the tax man all together. If the country taxes you at a relatively low rate, such as Panama at 10%, this might be the only tax you pay (ie. the IRA cut your total tax bill by half).

Let me explain: If you move your IRA or other type of retirement account away from your current custodian and in to an Offshore LLC, you can invest that account in foreign real estate. The LLC is owned by your retirement account and holds investments on behalf of that account. You buy the rental property in the name of the LLC, pay operating expenses from the LLC, and profits flow back in to the LLC and in to your retirement account.

I note that this structure is for investment or rental real estate and not property you want to occupy. If you later decide to live in the property, it must first be distributed out of the retirement account to you and taxes paid if applicable.

If you wish to purchase offshore real estate with funds from your IRA and a non-recourse loan, or you are in the active business of real estate, you can add a specially structured offshore corporation to eliminate US tax.

If you buy real estate with an IRA in the United States, you get the joy of paying tax on the gain attributed to the money you borrow (the mortgage). If 50% of the purchase price comes from your 401-K and 50% from a loan, half of the rental profits and half of the gain is taxable, with the other half flowing in to your retirement account.

Take this same transaction offshore and no US tax is due. Tax free leverage in a retirement account is one of the great offshore loopholes. Please check out this article for more information.

Offshore Real Estate and Depreciation

Owners of rental real estate in the United States get to utilize accelerated depreciation and deduct the value of the property over 27.5 years. If the property is offshore, you must use straight-line depreciation over 40 years and you get less bang for your depreciation buck.

On a $100,000 rental property, your annual depreciation deduction would be about $3,636 for US situated property vs. $2,500 if located outside the country. This means you would be paying a premium of $1,136 offshore real estate.

Don’t get to excited and cancel your offshore real estate deals just yet! The benefit of depreciation can be fool’s gold. The accelerated depreciation is great if you plan to hold the property for 20 years. However, if you plan on buying, improving and selling over a short period (a few years), then accelerated depreciation will cost you money, not save you money.

This is because depreciation is “recaptured” when you sell the property. Every dollar you were allowed to deduct over the years prior must be paid back, is added to your basis, and taxed at 25% rather than 20%. So, as a rough example, if you have a gain of $50,000, and took depreciation of $20,000, you owe tax at 20% of $50,000 for $10,000 plus 25% of $20,000 for $5,000. Therefore, you total tax due is $15,000.

The more depreciation you take, the more you must repay. If you hold a property for many years, taking a deduction today, and paying it back in the distant future, is a benefit. If you will sell the property in 3 or 5 years, taking the deduction now, and paying an additional 5% in tax later, is of little to no benefit.

I have had several clients over the years shocked at the size of their tax bills from the sale of a rental property. They had planned for a 15% rate (the previous long term rate), and ended up at 20% + recapture. In States like California, where values property values have gone down, it is possible to sell a rental at a loss and still have a big time tax bill from recapture.

This might lead some to think a good strategy is to not take depreciation, especially on property you plan to flip ASAP. Well, the IRS has a surprise for you: The tax law requires depreciation recapture to be calculated on depreciation that was “allowed or allowable” (Internal Revenue Code section 1250(b)(3)). This means you will pay tax on depreciation whether you take it or not.

All of this is to say that not being allowed accelerated depreciation on offshore real estate might be a good thing.

$250,000 / $500,000 Exclusion and Offshore Real Estate

As I said to begin this article, all of the same US tax rules apply to offshore real estate that apply to onshore properties. This holds true for the primary residence exclusion: If you qualify, you can exclude up to $250,000 single or $500,000 married filing joint, from the sale of your primary residence.

To qualify, you must own and occupy the home as your principal residence for at least two years before you sell it. Your “home” can be a house, apartment, condominium, stock-cooperative, or mobile home fixed to land anywhere in the world.

Tax Tip: You can take the $250,000/$500,000 exclusion any number of times. But you may not use it more than once every two years.

Have you owned and been renting out a property in Panama for a few years? You might consider kicking out those renters, moving to Panama, and occupying the property for two years before you sell.

Did you convert a home from your primary residence to a rental property? The rule is that you must have lived in the property for 2 of the last 5 years to qualify for the exclusion. Therefore, you can live in it for two years, rent it out for up to 3 years, and then sell and get the full exclusion.

To get the $500,000 exclusion, both a husband and wife must live in the home as their primary residence. It is possible for one spouse to qualify while the other does not. For example, husband is living in the United States and visiting his wife and family in Panama. On a joint return, only the wife may take the exclusion for $250,000 when they sell the home in Panama.

You don’t need to spend every minute in your home for it to be your principal residence. Short absences are permitted—for example, you can take a two month vacation and count that time as use. However, long absences are not permitted. For example, a professor who is away from home for a whole year while on sabbatical cannot count that year as use for purposes of the exclusion.

You can only have one principal residence at a time. If you have a home in California and a condo in Panama, the property you use the majority of the time during the year will be your principal residence for that year. So, it would be possible for Panama to be your primary resident for one year and California to be your primary residence the next. Before you sell, make sure you have spent at least 2 of the last 5 years in the property.

Like-Kind / 1031 Exchange with Foreign Property

Because you get the “benefit” of all US tax rules when it comes to offshore real estate, you can use like-kind exchanges (also called a Section 1031 exchange) to defer US tax. The only caveat is that you can’t exchange US property for foreign property – it must be a foreign property for foreign property transfer.

In a like-kind exchange, you defer paying taxes by swapping your property for a similar property owned by someone else. The property you receive is treated as if it were a continuation of the property you gave up. The benefit is that you defer paying taxes on any profit you would have received.

You may only exchange property for other similar property, called like-kind property by the IRS. Like-kind properties must have the same nature or character, even if they differ in grade or quality. All real estate owned for investment or business use in the United States is considered to be like kind with all other such real estate in the United States, no matter the type or location. For example, an apartment building in New York is like kind to an office building in California.

All real estate owned for investment or business use outside of the United States is considered to be like kind with all other such real estate outside of the United States. Therefore, you can exchange an office building in Panama City, Panama for an apartment building in Medellin, Colombia. You may not exchange a property in Panama with a property in New York.

In practice, it’s rare for two people to want to swap their properties with each other…especially offshore, where only US persons benefit from this loophole. Instead, one of the owners usually wants cash and the other (the gringo) wants to avoid tax on his gain. In this case, you can still qualify for a like-kind exchange by adding a licensed third party specialist to the deal, called a qualified intermediary or QI.

Let’s say your property in Panama is worth $300,000, and you have a capital gain of $100,000. You can defer paying tax on this sale if you can find someone in Colombia who wants to swap. Of course, no Colombian wants any part of a US 1031 exchange because they get no benefit…only an American living in Medellin would find the tax deal interesting. So, after you identify the property you want in Colombia, you need to hire a QI.

Essentially, the QI buys the property in Colombia and then enters in to a like-kind exchange with you. So long as you can identify the replacement property within 45 days after you sell the Panama property, and your replacement property purchase is completed within 180 days, you have a qualified 1031 exchange. Because of these time limits, it’s a good idea to have a replacement property lined up before you sell your property.

You should also note that this tax strategy is only advantageous in countries with low capital gains rates. If the country has a tax rate equal to or higher than the US, there is no reason to enter in to an exchange. It will not reduce your tax in the country where the property is located, only in the United States. If the Foreign Tax Credit will eliminate your US tax obligation, then an exchange is pointless.

By swapping a property in Panama with a property in Colombia, you are deferring US tax on 10% of the gain. This is because you pay 10% to Panama and nothing at this time to the United States. When you sell the property in Colombia, there is no reason to enter in to a like-kind exchange – unless you want to defer the gain from Panama a second time. The tax rate in Colombia is higher than in the United States, so no tax will be due to Uncle Sam on the gain from that property.

  • Let’s say you had a gain of $100,000 on the property you sold in Panama in 2011 and you will have another gain of $50,000 when you sell the property in Colombia in 2016 (very good for you by the way).
  • When you sold the property in Panama, you paid 10% to Panama and transferred the gain to the property in Colombia for US tax purposes.
  • When you sell the property in Colombia in 2016, you will pay 33% on the $50,000 to Colombia, leaving nothing for the US on this portion of the transaction.
  • You will also recognize the deferred capital gain on $100,000 from the Panama property. You already paid 10% to Panama, so you will pay 10% ($10,000) to the US in 2016 from the sale of the Panama property in 2011.

All of this planning and structuring allowed you to defer a 10% US capital gain for 5 years.

Combo Deal: Yes, you can combine a 1031 exchange with the $250,000 primary residence exclusion. To qualify for both, you must hold the property for more than five years and live in it for at least two of those five years. Then, you can use the exclusion to reduce or eliminate the capital gains, including tax carry-over from a like-kind exchange.

Offshore Rental Properties

Rental income and expense from offshore real estate is reported on your personal return, Schedule E, just as a US rental property would be. You must keep US quality books and records, including all expenses from management, improvements, repairs, and taxes paid. You must follow all US tax rules for these deductions and expenses, such as depreciating improvements and deducting repairs.

The IRS has a right to audit you offshore real estate, so be ready. It may be common to pay your bills in cash in Colombia, but you will have a tough time deducting any expenses without a receipt and proof of payment (such as a cancelled check).

An area of emphasis in an audit of offshore real estate is travel and other expenses associated with visiting the property. If you are flying to Panama five times a year, hanging out for a week, and then expensing these trips against your one rental unit on Schedule E, the deduction will not survive an audit. In fact, it is likely to be the cause of an IRS investigation.

I generally advise clients that they may visit their rental properties once a year for a couple of days. If they have no other business abroad, and are not using the getaway as a vacation, the entire trip may be deductible. If you have a large portfolio abroad, then you might get away with spending more time traveling, but one trip per year is a safe deduction.

When reporting your rental property, remember to take depreciation. As stated above, the only difference in offshore real estate is the allowed depreciation method. You must utilize straight-line depreciation over 40 years.

US Tax Filing Obligations for Offshore Real Estate

Your offshore real estate comes with a number of new and exciting US tax forms to file. It is important you master these forms or hire someone experienced in there preparation. Failure to file, or filing late, can result in outrageously high penalties.

  • These draconian penalties are aimed at Americans hiding money offshore. Unfortunately, regular folks, with simple offshore investments, often get caught in the crossfire.

The most critical offshore tax form is the Report of Foreign Bank and Financial Accounts, Form TD F 90-22.1, referred to as the FBAR. Anyone who is a signor or beneficial owner of a foreign bank or brokerage account with a value of more than $10,000 must disclose their account(s) to the U.S. Treasury.

For example, if you opened an offshore bank account to receive rent payments, and that account has more than $10,000 in it on any given day, then you must file an FBAR. If you send the funds to buy the property in to your offshore account, and then on to escrow, you must file this form. If you wired money from your US bank account directly in to escrow (which is a bank account you do not control), then the FBAR is not required.

The law imposes a civil penalty for failing to disclosing an offshore bank account of up to $25,000 or the greatest of 50% of the balance in the account at the time of the violation or $100,000. Criminal penalties for willful failure to file an FBAR can also apply in certain situations. Note that these penalties can be imposed for each year.

In addition to filing the FBAR, the offshore account must be disclosed on your personal income tax return, Form 1040, Schedule B.

Other international tax filing obligations for offshore real estate include:

  • If your property is held in a foreign corporation, you must file Form 5471 – Information Return of U.S. Persons with Respect to Certain Foreign Corporations.
  • If you hold your offshore real estate in a foreign LLC, you may need to file Form 8858 – Information Return of U.S. Persons with Respect to Foreign Disregarded Entities.
  • If your property is held in an international trust, a Panamanian foundation, or a Mexican Fideicomiso, you may need to file Form 3520-A – Annual Information Return of Foreign Trust and possibly Form 3520 – Annual Return to Report Transactions With Foreign Trusts.
  • If your foreign assets are significant, you must file Form 8938 – Statement of Foreign Financial Assets was new for tax year 2011. The filing requirements (who must file) for this form are too complex to list here, so please see the instructions before filing.

The Offshore Real Estate Professional

If you are living and working abroad and in the business of real estate, you can realize some great tax benefits. The following section is for those who spend a significant amount of time and effort working their offshore properties, and not those with only one or two apartment units.

The typical investor in offshore real estate may only deduct his losses against other passive income. If you do not have any other passive income, losses are carried forward until you can use them.

An exception to this rule applies to a) active participants and b) material participants in the management of offshore real estate.

As an active participant in offshore real estate, you can deduct up to $25,000 of passive losses against other income (like wages, self-employment, interest, and dividends) on your US tax return.  This allowance is phased out on a 50% ratio if your adjusted gross income is $100,000 or more.

As an active participant, you must share in the management, financial and operational decisions of the property and be knowledgeable in the day to day issues (usually by reviewing financial statements and other documents produced by the manager). This means you should be responsible for arranging for others to provide services like repairs, collect rents, etc. You may have a paid manager for the property and still be considered an active participant, so long as you manage that manager.

Besides the need to qualify as an active participant you must also meet these additional requirements:

  • You must own more than 10% of the property.
  • You cannot be a limited partner…you must be a general partner.
  • You must be an active participant in the year of the loss and the year that the loss is deducted. For example, if you are a passive investor in 2012, and active in 2013, you can’t deduct a loss from 2012 on your 2012 or 2013 return (because the 2012 loss was carried forward).

If you are a material participant in offshore real estate, you are much more involved and in control than an active participant. As a material participant (sometimes referred to as a real estate professional), you are in the active business of real estate and may deduct your expenses against any and all of your other income, without limitation or AGI phase-out.

It is relatively easy to qualify as an active participant. It is far more challenging to be classified as a material participant in offshore real estate. If you can meet the criterion, you will find that there are major international tax breaks and loopholes available to the real estate professional.

NOTE: The major benefit of being offshore and material participant / real estate professional is that you may draw a salary from an offshore corporation and qualify for the Foreign Earned Income Exclusion. This tax break is only available to offshore professionals and not those living or working in the United States.

To be classified as a material participant or real estate professional you must be active year-round in the operation of your offshore real estate business. You must work on a regular, continuous, and substantial basis, and offshore real estate should be your primary occupation. If you work a full time job and do real estate on the side, you are probably not a real estate professional.

According to the IRS, you materially participate in offshore real estate:

  • If (based on all of the facts and circumstances) you participate in the activity on a regular, continuous, and substantial basis during the year; or
  • If you participate in the activity for more than 500 hours during the year.

To meet the facts and circumstances test, offshore real estate should be your principal trade or business and you must have significant knowledge and expertise in that industry.

You can prove your level of involvement to meet the 500 hour test by any reasonable means. This includes calendars, appointment books, or narrative summaries identifying work performed and hours spent. Contemporaneous daily time reports or logs aren’t required but it is your responsibility to prove you meet the test, so any evidence you can muster will be a benefit. This is to say that the burden of proof is on you to demonstrate you qualify as a real estate professional.

In order to materially participate in offshore real estate, you should be living and working abroad. It would be near impossible to qualify as materially involved in properties in Colombia while living Texas. Therefore, you should also plan to qualify for the Foreign Earned Income Exclusion (FEIE). When the FEIE is combined with an eligible offshore real estate business, you can take out up to $97,600 in salary from that enterprise free of Federal income tax and make use of a number of other tax mitigation strategies.

In other words, a qualified offshore real estate professional can deduct his or her expenses against all other income, regardless of source and without limitation based on his or her AGI, and draw out up to $97,600 in profits free of Federal income tax. If a husband and wife both qualify as material participants and for the FEIE, they can each take out a salary of $97,600, for a total of $195,200 of tax free money.

To qualify for the FEIE, you must be out of the US for 330 out of 365 days or a resident of another country. If you are a resident of another country, preferably where your properties are located, then you can spend up to 4 months in the US each year.

The 330 day test is quite simple: you are either out of the US or you are not. The 365 days need not be in a calendar year (for example, May 2013 to May 2014 is fine) and there is no requirement to file for residency or spend a certain amount of time in particular country.

The residency test is more challenging. You must be a resident for a calendar year and move to a particular country with the intention of making that your home for the foreseeable future. You must submit a residency application to that country, file taxes, and generally become a member of the community.

The 330 day test is based on travel days and the residency test involves your intentions to move to a particular country and make that your home. It is always easier to prove how many days you are in the US. To put it another way, it can be a challenge to prove your “intent,” especially if your needs or intent changes after only a year or two.

For this reason, I suggest you qualify under the 330 day test in your first year abroad and then move to the residency test. This is the safest way to deal with the possibility of changes in circumstances.

If your offshore real estate business is focused in one country, you can obtain residency in that nation after a year and utilize the residency test to qualify for the FEIE. Utilizing the residency test in the long run is the best way to ensure you receive the benefits of the FEIE while being classified as a real estate professional.

If your offshore real estate business spans many countries, and you are on the road several months of the year, then you may need to utilize the 330 day test in year two and beyond. You may not be able to put down roots in one country, or you might not want to become a tax resident of any nation. In this case, you will need to watch your travel days to and from the US closely. If you miss the 330 days, even by one day, you lose the FEIE in its entirety and pay US tax on 100% of your salary.

If you qualify for the FEIE, you must operate your offshore real estate business through a foreign corporation. In order to minimize worldwide tax, you might consider a holding company in a jurisdiction that will not tax your income and subsidiaries in each country you do business to transact on behalf of your properties.

Whatever your structure, and wherever you decide to setup shop, you must incorporate outside of the United States. If you decide to skip this step, you will pay US self-employment tax on the salary. Even though you might pay nothing in Federal income tax, you will pay around $15,000 per person in SE tax. US SE tax is eliminated completely by the use of a properly structured foreign corporation.

The FEIE allows you to take out up to $195,200 (joint) free of Federal income tax, and a foreign corporation eradicates US SE tax. What if your profits are significantly more than $195,200?  You can retain earnings in to your foreign corporation to be taken out as salary subject to the FEIE in future years or as dividends whenever you choose. Withdraws that qualify as salary under the FEIE, are taken out tax free. If they come out as dividends, they are tax deferred for as long as you see fit to maintain the corporation…which can be decades, even if the business has long since been shuttered.

If you are able to combine material participation / active business status with the Foreign Earned Income Exclusion, and do so through a foreign corporation, you might just operate your offshore real estate business free of any and all US tax and keep Uncle Sam out of your pocket entirely. But, this is a major endeavor and one you should not take lightly.

You must be ready to defend your position in an audit and keep US quality books and records to support both positions. To succeed in an audit of your active business status, keep extensive files, to-do lists, home and mobile phone records, business plans, project descriptions and instructions to employees documenting your active involvement in day-to-day activities of the business.

In order to prove your FEIE, keep track of travel to and from the United States and have your credit card and other records available to support you claims of days out of the country. If you will use the residency test, file for residency and, if possible, a work permit. Also, file a tax return in your country of residence and put down as many roots in to that community as possible. You may be able to structure your affairs in such a way as you pay very little in tax to this country, but you should file a return.

Conclusion

The world of offshore real estate investing can be a complex maze of US tax compliance, deductions, credits and exclusions. If you are a professional, or you’re considering starting an offshore real estate business, you will need a solid plan to minimize your worldwide tax obligations. Such a plan must take in to account your US requirements and those of the country(s) where your property is located.

I can assist you by forming basic holding companies for the passive investor, creating a custom plan for the professional, placing your cash and properties behind appropriate barriers for asset protection, and keeping all of these constructs in US tax compliance.

Feel free to phone me at (619) 483-1708 or by email to info@premieroffshore.com with any questions and a confidential consultation.

December 2019 Update – we no longer offer 1031 exchange servies. I am not aware of any global firm that supports these transactions.

Offshore IRA Fees
Christian Reeves

Tax Benefits of Going Offshore

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The United States tax code is a hopelessly complex mess with as many loopholes for the wealthy as there are stars in the sky. There are many tax benefits of going offshore, and some of them can great for the “regular guy.”

Multinational corporations and billionaires spend big money on political campaigns and on lobbyists to ensure their interests are protected, and they expect a strong return on these “investments.” For example, a 2009 study found that each dollar put toward lobbying translated into $6 to $20 of tax benefits. Searching through these negotiated tax breaks leads you to a list of tax benefits of going offshore.

Just how ridiculous has the US tax code gotten? According to the IRS, taxpayers spent more than six billion hours in 2011 complying with the tax code – that’s enough to create an annual workforce of 3.4 million people. If that workforce was a city, it would be the third largest city in the United States. If that workforce was a company, it would employ more individuals than Walmart, IBM, and McDonalds, combined.

Even the mighty IRS seems overwhelmed by the complexity of the current tax laws. According to the National Taxpayer Advocate – part of the Internal Revenue Service – the Service cannot meet the needs of taxpayers.

Of the 115 million phone calls the IRS received in fiscal year 2012, it was only able to answer (actually pick-up) 68 percent of the calls. The IRS also failed to respond to almost half of all taxpayer letters within the agency’s own established time frame. And in 2011, the U.S.  Treasury Inspector General’s reported to Congress that most taxpayers who contact the IRS do not receive helpful responses.

Such complexity means that the well informed and well represented have a major advantage over the average citizen. While billionaires can afford hundreds of thousands of dollars a year in legal fees to structure their affairs to minimize tax, diversify their investments, and protect their assets, the average citizen is at a major disadvantage.

With this in mind, I spend my time researching and writing on the various ways the average person might utilize the tools designed for the Googles and Mitt Romneys of the world for their benefit. It is my hope that my website and articles will level the playing field just a bit.

Tax Benefits of Going Offshore

In the world of international tax planning, there are many regulations that can be utilized by anyone living, working, or investing abroad, to reduce your US tax bill. Some will eliminate tax on your salary, or allow you to opt out of the Social Security and Medicare taxes, while others, such as those that apply to IRA LLCs, can allow you to invest in just about anything offshore, with leverage, tax free.

The information provided below on the tax benefits of going offshore is a brief summary of a variety of complex tax rules. It is not meant as a complete analysis of these laws, nor is it tax or legal advice specific to your situation. Please contact me at info@premieroffshore.com or at (619) 483-1708 to discuss your situation in detail.

Foreign Earned Income Exclusion

The key to many of the offshore tax benefits of going offshore is the Foreign Earned Income Exclusion. This section of the tax code allows you to earn up to $97,600 from work, either as a self-employed person or as an employee. To qualify, you must be out of the US for 330 out of 365 days or a qualified resident of another country.

Anyone living and working abroad can qualify for this exclusion, so long as you meet the requirements of the 330 day test or the residency test, you are golden. The exclusion applies to Federal Income Tax, and not Self Employment tax, so additional planning may be required if you are running your own show.

I note that only those living in low tax countries will get much play from this exclusion. If you are based in a place with a tax rate that is about the same, or even higher, than the United States, then the Foreign Tax Credit will step in and prevent double taxation, without the need for the FEIE.

In other words, if your US Federal tax rate is 35%, and your rate in France is 40%, you have no need of the FEIE because you are already paying more in tax than you would in the United States. You can deduct your French tax on your US tax return without concerning yourself with qualifying for the FEIE.

Conversely, if you are living tax fee in Panama, drawing a salary of $100,000, and fail to qualify for the FEIE, then 100% of your income is taxable in the United States. Without the FEIE, there is no benefit to working abroad in a low tax country!

Take Your Retirement Account Offshore

By moving your IRA or other retirement account in to an offshore LLC, you can take control over your savings, invest in foreign real estate or projects, and hold cash outside of the United States in any currency you like. Even better, you can do all of this while maintaining the tax free or tax deferred status these accounts enjoy.

For the sophisticated investor, the tax benefits of going offshore can be enormous! I will list the in order of importance.

First, if your IRA invests in certain hedge funds (typically, the most profitable ones), the income generated is probably taxable to your IRA at the prevailing corporate tax rate, which is currently 15% to 39%. Most investors will pay about 34% on taxable income earned in their retirement account. In addition, you must file IRS Form 990-T to report that income and pay the tax.

–        Note that only very specific types of income, known as Unrelated Business Income (UBI), is taxable in a retirement account. This tax is called UBIT.

By moving your IRA in to an offshore LLC, and investing through a UBIT Blocker Corporation, you can completely eliminate UBIT. Your IRA can invest in a hedge fund, or any other UBI generating venture, and pay zero US tax.

This tax loophole was created for large pension funds, but is available to any tax exempt organization or charity, including offshore IRA LLCs. Hedge funds that wish to attract pension funds, retirement accounts, or non-US investors, must set up an offshore module of their fund (known as a Master/Feeder structure), whereby the tax exempt groups (your IRA) and foreign persons invest in the offshore division, while US persons invest in the US division. Then, these groups are combined in the master fund, from which investments are made and returns generated.

Offshore IRA LLCs have been used by the uber rich for years, and became big news during the previous presidential election. Many news outlets reported that Mr. Romney was able to grow his IRA LLC to over $100 million through the use of this type of international tax planning. To read more about his use of these structures, click here for the NY Times and here for a very partisan article on the Huffington Post.

Likewise, IRA LLCs that wish to invest in an active business will benefit from being offshore. Your IRA LLC can own up to 50% of any active business. The profits generated, especially if that business is structured as a partnership, are often Unrelated Business Income and taxable to the IRA.

If the company is offshore, then it may be operating free of US income tax. If you buy in through a specially designed offshore IRA LLC, profits paid out to you may also be tax free because your offshore structure effectively blocks the US from taxing those profits. For additional information, see the UBIT Blocker section of my website.

Those are the basics of taking your IRA offshore…child’s play, if you will. Here is the monster tax benefit of going offshore: You can eliminate UBIT on leverage by going offshore. Let me explain.

When you borrow money, or leverage up your IRA, the profits generated from that leverage are taxable (under the UBIT rules). So, if you buy a rental property for $100,000 with your IRA, paying $50,000 from your retirement account and get a non-recourse loan of $50,000 for the balance, when you receive rental payments, or sell the home, 50% of the net income will be taxable as UBI.

The same is true with brokerage and forex accounts. Your provider may be willing to give you 10 to 1, 30 to 1 or even 100 to 1 leverage on your deposit. But, if this is an onshore retirement account, the profits generated with that leverage are taxable.

By taking these transactions offshore, through a specialized offshore IRA LLC with UBIT Blocker Corporation, you can eliminate UBIT on borrowing and leverage. Tax free leverage is the key to generating big tax free profits in your retirement account.

For the “asset protection” benefits of moving your retirement account offshore, see my article: Can the Government Seize my IRA? If you are concerned with privacy or protecting your IRA from creditors and government appropriation, moving your IRA offshore, and in to a bank that does not have a branch in the US, is your best and only defense.

Stop Paying Social Taxes

Are you tired of supporting the Obamanation through social and medical taxes? Or, forgetting the political hyperbole, do you want to cut your US taxes? You can opt out of employment and social taxes by moving offshore. If you qualify for the Foreign Earned Income Exclusion, and are an employee of a company based outside of the US, then you need not pay Social Security, Medicare, or any other social taxes on your salary.

However, if you are an independent contractor, or are otherwise self-employed, then you must still pay Self Employment tax, at a rate of around 15%. So, assuming you qualify for the FEIE, on a salary of $97,000 you pay no Federal Income Tax but around $14,000 in SE tax. For a husband and wife, each drawing a salary, the SE tax will doubled to about $28,000.

The same is true if you are an employee of a US corporation while living abroad. You get the benefit of the FEIE, but must pay your share of social taxes (about 7.5%), as must your employer. All Social Security, Medicare, Obamacare, and related taxes still apply to the Expat and his employer, so long as you are employed by a US company.

Like the employee of a foreign company, you can eliminate SE tax by incorporating your business offshore and become an employee of that company. You can incorporate in any tax free country (such as Belize), and it does not matter where you are living or working, it does not matter if you are the owner and sole employee, nor does it matter if all of your clients are in the United States. So long you are living and working abroad, qualify for the FEIE, and are running an active business, you can eliminate SE tax by incorporating offshore. Your corporation should bill your clients and you can draw a salary from the net profits that entity of up to the FEIE amount (currently $97,600).

–        You might combine the offshore company with a US LLC if you wish to open accounts in the US and get paid by check, PayPal, or credit card.

Defer Tax with Offshore Mutual Funds

For the uninitiated, investing in an offshore mutual is a bad idea. Punitive rules (the opposite of loopholes) have been written in to the tax code by the US mutual fund industry which are quite hostile to investing in these types of products offshore.

In most cases, an offshore mutual fund investment is governed by the Passive Foreign Investment Company (PFIC) section of the code. Like a US mutual fund, you only pay tax when you cash out. But, unlike a US fund, the tax man is going to crush your profits. First, when tax is paid, all income and gains are taxed at the highest ordinary income rate (presently 39.6%).  There is no long-term capital gains treatment.  Second, losses are disallowed.  Third, you have to assume that all of the gains are earned ratably over the time the investment was held — even if the fund lost money the first few years and only made its gains in the last year when you cashed out.   Why is that bad?  Because of the final part of the quadruple whammy – interest charges, compounded annually.  Annually compounded interest at the underpayment interest rate (which is set by the Treasury Department each quarter and has been anywhere from 5% to 10% over the last several years) is charged on deferred tax.

And here is the loophole for the offshore professional: If the PFIC meets certain accounting and reporting requirements, a PFIC shareholder can elect to treat the PFIC as a qualified electing fund.  The effect is that the PFIC shares are taxed like U.S. shares.  The owner of a foreign mutual fund treated as a QEF may: 1) elect to pay tax on income as it is accrued in your account, or 2) choose to defer tax until money is received. If both the QEF and deferral elections are made, you pay tax on the profits plus 3% interest per year when you receive a distribution.

If your offshore mutual fund is returning profits greater than your interest rate of 3%, or the fund has profits some years and losses in others, the QEF with deferral elections are major tax benefits. This is especially important for a fund with losses, as these losses do not flow through to your tax return, so deferral can eliminate some quite harsh tax consequences of going offshore.

These elections allow the well-educated investor to access some of the high flying offshore mutual funds without the punitive taxes meant to keep the uninformed in the United States.

Eliminate Tax in Your Country of Residence

While the United States taxes you on your worldwide income, no matter where you live, and no matter where your clients are located, most countries do not charge you for foreign source income…which is to say, you pay no tax on income earned outside of their borders or, the majority of nations tax you only on income earned within their territory.

With this in mind, planning may eliminate tax from your country of residence. For example, if you are living in Panama, selling products or services to customers in the United States, and operating a through corporation in Belize, Panama may not tax you on the net profits of that Belize entity. Conversely, if you are living and working in Panama, operating through a Panama corporation and/or selling to people living in Panama, then Panama wants its cut.

By incorporating your business in a country other than where you reside, you may be able to legally avoid paying any tax to that country. When you combine a tax free country of incorporation (Belize), with a country with a territorial tax system (Panama), and the Foreign Earned Income Exclusion, it is possible to earn a significant amount of money from your business and pay zero income tax to any nation.

In the case of a business with employees and local expenses, you may form a corporation in Panama and bill your Belize corporation from that Panamanian entity. You should only bring in enough money to Panama to pay your bills, but draw your salary from the Belize company. In this way, the Panama company will break-even and no tax will be due.

I am often asked why countries like Panama allow this setup. It is because 1) you will pay employment and other taxes on your employees, and 2) you will spend money and indirectly contribute to the economy by living and basing your business in that country. A business that employees local workers is a major benefit to any efficiently run economy.

Retain Earnings Offshore

For the entrepreneur, qualifying for the FEIE and taking that salary through an offshore corporation is the first line of defense against the IRS. It allows you to take out $97,600 in salary free of Federal Income Tax. If a husband and wife are both involved in the day to day operation of the business, each may qualify for the exclusion, resulting in up to $195,200 in tax free salary.

So, what if your net profit is more than FEIE? If you take more than the Exclusion out of the corporation, you will pay tax on it as earned. If you leave it in the corporation, it will be classified as retained earnings and not taxable in the United States until it is distributed as a dividend or other payment.

–        This assumes you are incorporated in a country, such as Belize, that will not tax your corporate profits or retained earnings.

Two important caveats: 1) interest or capital gains derived from these retained earnings is taxable as earned, and 2) you may not borrow retained earnings from your corporation or use them for your personal benefit. They must remain in the corporation or be used for business expenses and expansion.

You might be wondering why large companies based in the US get offshore exclusions while you must make the drastic step of moving abroad to receive these benefits? In fact, multinationals must follow similar rules to qualify by having an active division with employees outside of the US in order to retain some earnings offshore.

To put it another way, a small business, that is owned and controlled by a US person, must move all of its operations outside of the US to gain these benefits. A large corporation can achieve the same by moving an autonomous division abroad.

For additional information on this topic, see my article: How to Manage Retained Earnings in an Offshore Corporation.

Conclusion

As you can see, there are a number of tax benefits for those offshore. If you are living, working, and/or investing abroad, you should consult with a professional to ensure you are taking advantage of these benefits. For the business owner who has a non-US partner, additional incentives may be available but are outside of the scope of this article.

I will end by pointing out that big tax breaks come with big tax reporting requirements. US tax compliance should be a primary component for anyone considering going abroad and is the foundation of an international tax or business strategy. Be sure to contact a licensed US representative, and do not rely on a foreign provider, whenever incorporating offshore.

Panama Foundation Scam
Christian Reeves

Is Panama the Next Singapore?

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Panama vs. Singapore by By Christian Reeves and Lief Simon (www.offshorelivingletter.com)

“Panama is the next Singapore,” declared a friend over lunch the other day. He wasn’t the first I’ve heard make the prediction.

Since finding its legs after the U.S. military handed over the canal, Panama’s economy has been on an uninterrupted upward trend. Even throughout the global recession of the past several years, Panama has racked up positive, albeit slower, growth.

Like Singapore, Panama is a shipping, banking, and corporate headquarter hub. Both countries are also tax havens. Where they diverge is gross domestic product (GDP) per capita and cost of real estate. Singapore’s GDP is about four times that of Panama, depending on the statistics you look at. The population of Singapore is about 50% greater than that of Panama, making this GDP figure even more stunning.

The average price per square meter for apartments in Singapore is eight times the current average cost in Panama City. (And we’ve been complaining about property values in Panama City!)

The point is that both of these statistics are being used as predictors for Panama’s potential. The consensus is that Panama is looking at at least another decade of continued tremendous growth rates.

I agree.

Panama has 100 times more land area than Singapore. As a result, there are different markets at work in this country. While real estate prices will continue to increase in Panama City as the country continues to mature and will, sooner or later, I believe, reach levels to qualify as “expensive” in a global context, prices in the interior of this country and in most of the beach areas will remain more affordable than those in comparable options in the United States. That will allow Panama to continue to attract retirees from North America and Europe.

Banking, shipping, business, tax benefits, and retirees: That is a dynamic combination for the Panamanian economy, which has grown at a rate of at least 7.2% per year every year since 2004, with the exception of 2009 (the “slow year”), when it grew at a rate of 3.9%. Unemployment is low, at 4.2%. In fact, the country is growing so quickly that it can’t educate and train its own citizens fast enough to keep up with the ever-expanding job market. The new “Specific Countries” residency visa, which comes with the possibility of a work permit for citizens of 47 countries, is one attempt to ease the strain the country is experiencing trying to find qualified workers for all the international companies relocating here, not to mention the local businesses and banks.

Global Banking Haven?

Historically, Panama has been generally acknowledged as a “banking haven.” No question, this is an international banking center; there are currently 78 banks licensed in this country. However, there is no longer any pretext of banking privacy or secrecy; not since November 2011 when Panama signed an exchange-of-information agreement with the United States.

Still, there are a lot of banks here and a lot of banking options. Like most offshore banking destinations, Panama offers two kinds of banking—local and international. Of the 78 banks licensed in Panama, 2 are state owned, 28 are international banks, and 48 are general licensed banks. International banks can only take clients from outside Panama, while general licensed banks can have both local clients and clients outside the country. The main difference from a practical point of view is that international banks don’t offer day-to-day banking services such as checking accounts or mortgage lending. These are places to keep investment, not operating, accounts.

You can see the full list of banks in Panama here. LINK TO http://www.superbancos.gob.pa/en/igee-general-information

The problem with most of the 48 general licensed banks in Panama is that, while they can take foreign (that is, non-resident) clients, in the current climate, they tend to not want to. That said, a colleague walked into Balboa Bank and was able to open an account as a non-resident foreigner with remarkably little hassle. He had his bank reference letter and his passport, which is all you need in theory. However, when it comes to banking overseas, the theory can be one thing, while the reality is something else.

While I’ve given up on identifying a local bank in Panama that will consistently open accounts for foreigners, ones to try in addition to Balboa Bank (which recently merged with Banco Trasatlantico and seems to be interested in growing its client base)include Banco General (one of the biggest banks in Panama in terms of number of branches), and Global Bank (where some I know have recently reported having good luck opening accounts).

All banks in Panama offer some level of internet banking, but check the details of this before investing the time in getting an account open to make sure you can initiate wire transfers online if that’s something you’ll need to do. Balboa Bank offers that service online, as well as an English-language version of their interface. This is notable, as many banks in this country don’t have English versions of their websites.

Many of the general licensed banks offer consumer as well as private or investment banking. If you’re a private banking client (meaning you’ve deposited US$250,000 or more), then you’ll generally have an easier time opening an operating or consumer account with one of those banks.

Again, the international banks operating in Panama deal only with foreign clients. Further, the minimum account balance required to open an account with one of these banks is US$1 million or more.

One exception is Banca Privada d’Andorra (BPA), which has a branch with an international license in Panama. BPA will open an account for you with a minimum account balance of US$100,000 (although they prefer US$250,000). Their online banking interface is in Spanish, French, Catalan, and English. You can contact Yariela Montenegro at y.montenegro@bpa.ad for more information about BPA’s services.

With the growing cost of the compliance required of any bank with American clients, many of the world’s international licensed banks are simply opting out of dealing with U.S. citizens, even those with the funds to open an account with US$1 million. Meantime, with everything going on in the global banking industry, banks are changing their policies and rules regularly. One bank that will open an account for a foreigner today may not next week and vice versa. We’ve watched this in Panama. Last year, for example, the executive committee of Unibank, a bank we’ve been recommending to readers since it opened in December 2010, decided that they would no longer take non-resident foreigners as clients except in their private banking division (US$250,000 minimum deposit). In December, they reversed that decision, but implemented a US$300 application fee for any foreigner wishing to open an account. Probably the back and forth and the new application fee are a reaction to the escalating cost of compliance when dealing with foreign clients.

Panama banks are generally solid, as the country’s Superintendent of Banking strictly monitors all bank activity. Currently, one bank is in “forced liquidation.” I’m not sure what that means, but banks don’t fail in Panama. When a problem does arise, the Superintendent takes action.

One specific occurrence a few years ago had to do with Stanford Bank in Antigua (the island, not the town in Guatemala). Stanford went bust because of malfeasance of the founder, and all related banks in different countries were affected. The Panama subsidiary of Stanford was closed, its assets frozen. The U.S. entities handling the case against Allen Stanford tried to seize the Panama assets, but the Panama Banking Superintendent wouldn’t allow that. After about 18 months, Stanford in Panama was sold to a group that reopened as Balboa Bank (still in operation today). All the Stanford Panama clients received the return of their funds.

It’s difficult to try to make a direct comparison of banking in Panama with that in Singapore. There are more banks and financial institutions in Singapore, which also offers more types of licenses. The number of banks in Panama has been relatively stable over the last 10 years, with new banks opening as other banks merge. Meantime, the volume of banking in Panama has increased, and I expect the number of banks to continue to increase as more international banks decide to open branches in this country.

Business And Taxation

One of the biggest advantages to Panama as a jurisdiction right now is that it is the best place in the world to run a business. Not a local business. I’d say that running a local business here in Panama would come with all the same challenges of running a local retail business anywhere in the world. In addition, though, the important thing to note about local trade in Panama is that much of it is restricted to foreigners. Most professions – doctors, lawyers, accountants, etc. – are restricted to Panamanian citizens, as are retail businesses. Most foreigners who want to be in business in the country focus on tourism-related opportunities or other service-related businesses…or restaurants.

If you’re looking for a place to launch or relocate an international business, however, you won’t find a better locale…

Except, perhaps, Singapore. I’d say these two countries are the top choices worldwide for where to base an Internet, consulting, or other laptop-based business. And, given the choice between Panama and Singapore, I’d choose Panama (as I did five years ago when my wife and I decided to relocate from Paris to Panama City to launch the Live and Invest Overseas business). Singapore is a far more expensive place to live and to do business. It’s also halfway around the world and many time zones away from your customer base if your customer base is based in North America.

One important reason Panama is as appealing as a doing-business choice as it is, is because it is a jurisdictional-based tax regime. That means any person or entity is taxed in Panama only if his, her, or its income is earned in Panama. Further, Panama doesn’t impose tax on interest income from deposits in Panamanian banks. Therefore, it’s possible, if you organize your life appropriately, for an individual to live in Panama free of any Panama income tax liability. Don’t earn any money in Panama, and you owe no tax in Panama. It’s as simple as that.

The easiest strategy for setting yourself up to be in Panama and in business without earning any income in Panama is to start a consulting or internet business based outside Panama. Create a non-Panamanian entity to house your non-Panamanian business, earn your income outside Panama (by consulting for a client in Costa Rica, for example), and have your clients pay your non-Panamanian company.

What you can’t do is set up a physical business in Panama with a non-Panamanian business providing the goods, and then have the non-Panamanian entity charge enough to the Panama company to keep it from showing any profit in Panama.

Panama has two rules that void that practice. One is simply an implied income tax on the gross revenue of a company if the company continually shows no profit. It’s essentially a minimum income tax charged at 1.168% of gross income for companies with gross revenue of US$1.5 million or more if the calculated tax on net income is less.

The other rule has to do with transfer pricing between affiliated companies. Panama passed a law last year specifically addressing this. A company with a Panama operation and a foreign subsidiary that provides products or services for local sales cannot charge above market prices for those products and services to the Panama entity in order to reduce the taxable income in Panama.

If you want to start a business in Panama for local trade, the tax rate is a flat 25% tax on net income. However, again, Panama places many restrictions on foreigners doing business locally.

To avoid this 25% tax on local business profits, you could consider basing your local business in either the free-trade zone in Colon or the Panama Pacifico “city” being developed at the former Howard Air Base outside Panama City. The free-trade zone in Colon is essentially a place to warehouse and modify goods to be shipped out of Panama. You can import and export goods to and from this zone with no tax implications, including no income tax. Any goods brought into Panama from this zone, however, are subject to import duties.

Panama Pacifico has been designated a tax-free zone for companies that qualify. The 13 categories of businesses that can operate here tax-exempt are:

 Distribution centers of multinational companies
 Back office operations
 Call centers
 Multimodal and logistics services
 High-tech product and process manufacturing
 Maintenance, repair, and overhauling of aircraft
 Sale of goods and services to the aviation industry
 Offshore services
 Film industry
 Data transmission, radio, TV, audio, and video
 Stock transfer between on-site companies
 Sale of goods and services to ships and their passengers
 Corporate headquarters

Another benefit of basing your business in Panama Pacifico is the opportunity that creates for you, as the business-owner/employer to be able to obtain work permits for foreign employees beyond the usual 90/10 rule. The 90/10 rule, which applies to all businesses operating in Panama outside Panama Pacifico, means that the business must employ nine Panamanians for every one non-Panamanian.

In recent history, again, the exception to this requirement that 90% of the employees for any business be Panamanian, has been to base yourself in Panama Pacifico. However, the new “Specific Country” residency permit means that this Panama Pacifico benefit isn’t as big a deal as it used to be. Now, any foreigner from any of the 47 countries included on the Specific Country visa list can obtain residency and a work permit, creating a chance for businesses to hire non-Panamanian labor without restriction. I believe this window of opportunity will continue only until President Martinelli is out of office. Martinelli created the new visa program through special Executive Order. The guy who follows him in office likely will repeal the order.

Unless the guy who follows Martinelli in office isn’t a guy at all but Mrs. Martinelli, as is lately being discussed.

Structures

Another important benefit of Panama as a jurisdiction includes the offshore services available here. In this way, too, Panama is very similar to Singapore. While Singapore has taken the offshore structures game to a next level, as it has been at this for much longer, Panama is working hard to catch up.

Panama offers corporations, trusts, and foundations. Again, Panama corporations pay no income tax in Panama if they don’t earn any money in Panama, making a Panama corporation a very appealing option for structuring business operations in other locations.

You can also use a Panama corporation to hold real estate in Panama or outside the country. Historically, this strategy provided important benefits to do with property and capital gains taxes. However, the rules for these things have changed recently, making this less of a no-brainer option. It can still make sense to hold Panama real estate in a Panama corporation, but not always.

Here’s how this used to work:

Once the Panama property was put into a Panama corporation, the “value” was locked into the public property registry. When the owner decided to sell, he sold not the property but the corporation holding the property. Ownership of the property didn’t change, and, therefore, the public registry value of the property didn’t change. As a result, the amount of property tax charged for the property didn’t change either. In other words, property values could increase, but property taxes (which are figured on property values) could be held constant this way.

Additionally, it used to be that, while Panama did charge capital gains tax on the transfer of property, it did not charge capital gains tax on the transfer of company shares, saving the seller 10% of the appreciation.

This changed in 2006. Now, sellers pay capital gains tax on both the transfer of property and the transfer of company shares.

Finally, Panama charges a 2% transfer fee on real estate. Selling the corporation rather than the property avoided that tax, as well.

Bottom line, today, with capital gains tax charged on the sale of shares and property values being reevaluated for the purposes of property tax, as I said, holding Panama real estate in a Panama corporation isn’t the no-brainer decision it was years ago. The cost of setting up a corporation runs from about US$1,000 to US$1,500, depending on the attorney. Maintaining the corporation runs US$530 a year without nominee directors, which should cost around another US$250.

On the other hand, using a Panama corporation to hold non-Panama real estate can be an excellent strategy, with estate planning and asset protection benefits. American readers should note, though, that a Panama corporation cannot be treated as a disregarded entity for tax purposes; they are treated like corporations. An American considering options for holding real estate in different countries should consider an LLC, a trust, or a foundation, which can be better choices depending on your circumstances overall.

Few people think of Panama as a trust jurisdiction; most look to the Cook Islands or perhaps Belize for this kind of structure. However, Panama does offer trusts (an odd thing for a civil law country).

Panama also offers foundations which is the civil law equivalent.

Foundations work very much like trusts and can be a good alternative to a trust depending on your needs. On the U.S. side, for tax purposes, a foundation can be treated like either a corporation or a trust. You want to make sure you set everything up so your foundation is treated like a trust. If you’re an American, have your Panama attorney work with a U.S. attorney who knows something about Panamanian foundations to be sure that the wording of the foundation documents is such that the entity will be treated as a trust by the IRS. Otherwise, you risk negative U.S. tax implications.

One other thing to keep in mind with a Panamanian foundation is that, while the name may suggest that it is a charitable organization, it is not. A Panamanian foundation is a tax-paying entity and can be liable for tax, both in Panama (if the foundation has any Panama based income) and in the United States (if the foundation has any income at all).

Pushing For First World Status

Panama’s President Martinelli has set an ambitious agenda. He has declared that he’s pushing Panama toward First World status. To that end, he’s taking all the revenues being thrown off by the Panama Canal (and then some) and investing them in infrastructure improvement projects across the country. You can’t drive more than a few blocks in any direction in Panama City without encountering some kind of construction—road expansion or repaving, digging for the new city metro, new building construction or old building renovation, electric and phone cables being moved underground, tunnels, bypasses, etc. Every main thoroughfare in the city is being improved in some way. The latest extension of the Cinta Costera, the new highway and pedestrian area that runs along the Bay of Panama, will take motorists around Casco Viejo and to the Bridge of the Americas, allowing drivers to avoid the current log jam trying to exit the city.

Around the country, roads are likewise being improved, expanded, and dug anew. Plus, new airports, new hospitals (including a big one in Santiago), new schools, and new shopping malls. The landscape of this country is being remade before our eyes.

The investment opportunities that all of this translates into are tremendous. Someday, people could be saying that Singapore is like Panama City.

 

Foreign Assets
Christian Reeves

Offshore Asset Protection Scams and How to Avoid Them

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If you are looking for the cheapest offshore asset protection, you are in the wrong place. If you are looking for an offshore asset protection and international structures founded in case history and reality, with guidance and US tax compliance, we can help.

The purpose of this article is to explain why you need quality representation when you go offshore and exposes the common schemes of online incorporators. The bottom line is that, if you can’t afford a quality offshore trust, don’t use a lesser structure which you can’t control. Instead, go with a simple offshore corporation to plant your flag offshore. If you don’t wish to pay for an offshore corporation from a reputable source, then you might not belong offshore.

Read the risks and costs of doing it wrong and then decide if the world of international banking and offshore asset protection are for you.

Offshore Asset Protection Scams

The internet is filled with scammers who promise to protect your assets for a few hundred dollars…a one size fits all document or company that will save your life. These online incorporators claim to have mastered the mysteries of US litigation and to have created some illusionary construct that no creditor can pierce. Well, I am here to tell you that no such construct exists and that most of the asset protection “gurus” are nothing but shysters.

These scams go by many names, such as “Self Managed Anonymous Offshore Trust” (just google this phrase for a list of purveyors) and Pure Trusts a/k/a Constitutional Trusts and Common Law Trust Organizations. For additional information, see Quatloos.

Then, there are the firms that charge low rates for an off-the-shelf, zero customized, offshore company formation with no support or tax compliance. These guys make up for their lack of quality and a low upfront price in volume (I may lose money on every sale, but I make up for it in volume). They will sell you four or five companies and a Panama Foundation when a Belize or Cook Island Trust was all that is required.

They convince you that all of these components add value, and, when they are done, the total fee is the about the same as a quality offshore asset protection trust, but with none of the supporting documentation, compliance, or guidance that a professional would include. They sell you a mini-monster that you have no idea how to take care of and won’t know what to do with when it grows out of control.

Why do online incorporators market like this? Because such a convoluted structure is more profitable to them in the long run. Because they can charge you a fortune in annual fees…they are betting on the residual income you will provide and selling you something you don’t need, and probably should not use, at break-even to lock you in.

Feed the Beast

Let’s go back to the mini-monster. Your new pet is comprised of a Panama foundation, one Nevis LLC, one Panama corporation, and four Belize IBCs, and you have paid $10,000 to take this bad boy home to cover your assets like a guard dog.

Well, this mini-monster must be fed.  Each year, your incorporator will send you a bill for about $1,200 per entity, for a total carrying cost of $8,400 per year. And, you can be sure there will be other costs…maybe you need a notary, a certificate of good standing, or you want to open a bank or brokerage account…this will cost you big time. Remember, they locked you in with a low price and are now going to get whatever they can.

Offshore Tax Issues

Now that this mini-monster is home, you will find that he is hungry. For example, every entity must file its own tax return with the US Internal Revenue Service, a fact that your offshore incorporator probably failed to mention when you signed up.

The Panama Foundation may need to file IRS forms 3520 and 3520-A, at a cost of about $1,700 per year. Also, each of the corporations must file IRS Form 5471, for which a qualified CPA will probably charge $1,100. This means your minimum US tax compliance bill to take care of this monster is $8,300 per year.

Finally, you will need to file a report with the US treasury of each bank account you have outside of the US is your cumulative balance during the year is more than $10,000. So, if you have four bank accounts outside of the US, each with $3,000, you have a total of $12,000 offshore and must file the FBAR.

So, you setup your structure and had no idea of these tax rules? Now the monster is angry!

The minimum fine for failure to file the FBAR is $25,000 per year per account, and up to $100,000 per year per account. And, don’t get me started on the possible criminal penalties…

The fine for failing to file Form 5471 for each corporation is $10,000 to $20,000, plus a reduction in the Foreign Tax Credit, if applicable. So, your annual penalty for failing to file for your various mini-monster’s corporate returns is $50,000 to $70,000 plus the foreign tax credit issue.

Failure to file the foundation or trust returns can result in penalties of $10,000 per year or 35% of the assets transferred offshore. This is a simplification and these penalties are more complex than I want to go in to here. Suffice it to say, not keeping a Panama Foundation in compliance can become very expensive very fast.

For additional information on your US filing obligations, see my article: US Tax Filing Obligations of ExPats.

Buy from a US Provider who Provides Tax Guidance

When dealing with an offshore incorporator, you must be cautious and take his answers to questions about your US obligations with a grain of salt. Many offshore incorporators phrase their claims and promises in such a way as to confuse you. Here is an example:

You call a firm in Nevis and inquire about forming an offshore IBC. You ask, “does this company need to pay tax?”

The sales guy will say something like, “as a Nevis IBC, there is no tax due and no tax return need be filed. Your corporation can earn money and never pay any tax to Nevis. It can also send money to you in the US, which you can report as income when received.”

This all happens to be true, and it is how so many US persons get in to trouble. You may have left that conversation with the impression that the Nevis IBC can retain earnings offshore and that you will only pay tax in the US when you repatriate that money.

What the sales guy really said is that Nevis will not tax your income and that you can wire from Nevis to the US. He made no comments about whether the US will tax your offshore company. And, from the perspective of Nevis, his statements are accurate.

But you, as a US citizen or resident, need to be concerned about the United States. It is great that Nevis will not tax your income, but that is a very small part of the offshore puzzle. The primary issue is how the big bad IRS will view your structure. If you do not live and work abroad, your corporation can’t retain earnings and all income is taxable in the US as earned.

For this reason, you must purchase your offshore asset protection plan or international corporation from a firm that provides US tax compliance and is capable of answering your US questions. Only US licensed experts can properly advise you on how to structure your business and keep you out of trouble.

Offshore Asset Protection is not Secrecy

Hiding assets is not a useful asset protection strategy.  If you have a judgment against you and you fail to disclose said assets, you might be found in contempt of court and end up in jail.  Hiding assets is not a valid tax reduction strategy.  If you hide assets and fail to report income from those assets, you might be found guilty of tax evasion.  Do things right and do things smart.

The quickest way to spot an offshore asset protection scam is look for those that focus on secrecy or privacy. While it may be helpful that your assets are hard to find in the beginning of a case, you must assume that a motivated creditor will find them.

A professional asset protection structure assumes the creditor has a roadmap to all of your dealings and, even in this extreme case, can’t break down your barriers and get to your assets. Your plan has moved your wealth out of the reach of the creditor and the US courts, placed them behind a few quality barriers, and provides the best protection available anywhere in the world.

Quality Offshore Asset Protection Plans

When done right, asset protection, which may be more properly termed risk management, places an appropriate number of barriers between you and your creditors making it difficult or impossible to reach your assets. How difficult it is to reach those assets will depend on the complexity and, most importantly, the quality of the plan. Always remember, it is about quality and preparation, not quantity. Quantity will get you nowhere with a judge!

For this reason, I will recommend a simple, easy to maintain offshore corporation to someone looking to protect $100,000 or less. The same is true for someone who just wants to plant that first flag offshore or to move their retirement account offshore. Keep it simple!

This single layer is cost effective to feed and keep in compliance, and moves the assets out of the reach of US creditors while placing one barrier between them and your money. While it is not perfect, it may be all that your situation requires.

  • And here is the key to this article: don’t be oversold! If one structure will suffice, don’t buy two…even if the price is right. Buy one and get one free is not a good idea when it comes to asset protection. It is a lot like TV ads selling cheap junk and promising a second unit at no additional cost – you will get a good deal but shipping and handling (carrying costs) will bury you.

If you have a much larger nest egg you wish to protect, a high risk of litigation, and/or wish to provide for estate planning and asset protection, than an offshore trust formed in Belize or Cook Islands is the place to start. The offshore trust is the foundation of any advanced asset protection plan and can be built up or expanded in a number of ways. For more information on offshore trusts, please see my International Trusts page.

No matter what structure you create to protect your assets, just remember that it must be maintained, that you need to be properly advised as to your US tax obligations, and that going offshore is a complex world fraught with challenges for the uninitiated. International asset protection is not for everyone!

Currency Transaction Report
Christian Reeves

How to Get an Offshore Merchant Account

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You read a lot of stories about how difficult it is for Americans to get an offshore bank account. Well, opening a low cost, efficient, offshore merchant account 10 times more difficult. Many of us are used to the extraordinarily low rates of the U.S., and have no idea what to expect when we venture offshore. I have more than a decade of experience in this arena, and can tell you an offshore merchant account is a whole different animal that you have experienced in the good ole U. S. of A.

If you are setting up an internet business offshore, you will need a corporation, a bank account, and a way to process credit card transactions in to that bank account…this is the offshore merchant account. Before I talk about rates and what to expect, I want to take some time to explain how the industry is different from the U.S., and how credit card processors view you, the potential client.

  • Definitions: This article will use quite a few industry terms, such as reserve, discount rate, high risk, etc. If you are new to the game, one of the better glossaries on the web can be found here.

How Offshore Merchant Account Processors Think

When a credit card processor opens a new account, they view it as extending some level of credit to their new customer. This is because the processor is liable for any refunds demanded by your customers, called chargebacks, if you, the merchant, is unable or unwilling to pay.

Let me explain: If the bank processes $10,000 a month for a merchant, and 5 months in finds out that their customer (you) has been selling a fraudulent product; the processor is on the hook for $50,000. The same is true if a new merchant account is opened and a batch of stolen credit cards is run through…the processor is responsible for 100% of the loss if the merchant has disappeared with the cash.

In the United States, the processor has a relatively easy time assessing risk and protecting against fraud.  They can check the credit score of the applicant (again, you) and review your banking history. If both of these indicators are clean, it is unlikely that any illegal activity will go through your account. And, if the processor is duped, American police departments are more than willing to step in and hall you off to jail.

But, what happens when you have a processor in Belize, the merchant’s corporation and bank account is in Panama, and the owner of the Panama entity is a citizen and/or resident of Costa Rica? There may be no easy way to validate the creditworthiness of the owner or perform proper due diligence on the account. Also, once the processor sends money to Panama, there is no effective way to get it back and it is unlikely that legal action will be successful…except in the gravest of cases. Basically, the international processor has no recourse in the case of fraud.

Of course, scammers get all the headlines, but fraud and theft are rare. More common is the case where a few customers have a problem with a merchant and chargeback their purchase(s). In the U.S. and Europe, the processor can debit the merchant’s account, withhold future processing to cover these expenses, ruin the owner’s credit, and sue for damages in extreme cases.

Offshore, the processor is limited to withholding future transactions and closing the account. If the merchant is a high volume low dollar account they will obviously pay the chargeback. If they are a low volume high dollar account they may be unwilling to pay…and simply open a new account elsewhere. Most sophisticated merchants will run two or more merchant accounts for this reason.

To protect against this risk, offshore account processors typically require a “rolling reserve” of 10% to 20% from new accounts. A rolling reserve is when the processor holds a percentage of each and every transaction, usually for 60 to 120 days, until the risk of chargebacks has past.

If you are considering moving offshore, you must be prepared for the rolling reserve. If your profit margin is such that the reserve is an issue, you will need sufficient operating capital, credit, or payment terms with your vendors, to support this cash flow “cost” of doing business abroad.

I note that strict rolling reserve rules will apply to new accounts. Once you have processed 6 to 12 months, and your chargeback rate is less than 1%, most processors will reduce or eliminate the reserve.

High Risk Offshore Merchant Accounts

Certain industries and business models have high chargeback rates and are thus termed “high risk” by credit card processors. Anyone in these trades is certain to pay a higher rate to process credit cards and to have a significant rolling reserve. The following are typically considered high risk:

Adult: Pornographic websites have high chargeback rates, especially on their recurring billing practices. Add to this the fact that most large processors don’t want to be associated with porn, and it is easy to see why adult sites get the shaft when it comes to fees.

Gambling: Because deposits in to gambling accounts are typically higher dollar and lower volume than adult, and because of the number of legal issues this industry has faced, internet gambling accounts are considered the highest of risk.

MOTO (Mail Order & Telephone Order) and Telemarketing: If your business accepts phone orders, or you market through outbound phone calls, you must code your transactions as MOTO and will be classified as a high risk account. You will also need a virtual terminal rather than an e-commerce shopping cart.

Pharmacy: If you are an internet pharmacy selling outside of your country of origin, you are considered high risk by the offshore merchant account providers. In most cases, an offshore merchant account will be your only option

Replicas and knock-offs: Most merchant account providers will not process transactions for sellers of replicas. Such products usually violate trademark and other laws.

Travel: A travel agent selling airline tickets or vacation packages over the internet is one of the highest risk accounts out there. The reason is simple: these transactions are for large dollar amounts, often sold months in advance, allegations of fraud are common (we all define a 5 star hotel differently), rights to refund are rare, and buyers love to chargeback…even after the trip has been completed.

Tobacco: If your business is related to cigars, cigarettes, or any type of tobacco, you are a high risk e-commerce client. If you are shipping worldwide, you will need an offshore merchant account.

Your Business Must Be Legal

We at Premier, and all reputable credit card processors, accept only clients operating legal businesses. It is the merchants responsibility to research, understand, and comply with all applicable laws and regulations related to the sale and use of their products and services.

If you are concerned that your product or services may be prohibited, here are some basic rules that apply:

–          Products or Services that violate any law, statue, ordinance or regulation

–          Donations or any configuration in which the value of the transaction is greater than the value of the product or service.

–          Products or services that are illegal, infringe upon the intellectual property rights of others, or can be used illegally.

–          Any product or service enabling consumers to circumvent locks, programming codes or to gain access to any service for which they have not expressly paid.

Higher Number of Rejections

When you process through a non-U.S. merchant account, you need to be prepared for a higher number of failed transactions. This is when the card / sale is declined by the customer’s bank (the issuer), for one reason or another.

When you are using a U.S. processor, just about the only time the issuing bank declines a transaction is when the customer has maxed out his credit. When you are using an international processor, a number of your transactions will be declined simply because you are offshore.

Basically, the bank who issued your customer’s card is concerned that a large transaction originating from, for example, Belize, is fraudulent, and has stopped it before any money has changed hands. When this happens, you can ask the customer to provide a different card, or ask him to phone his issuer and authorize the transaction. The bank will approve the transaction at the customer’s request and you can run the transaction a second time.

When building a website, you should have a system to easily communicate these issues to your customers…typically through a live chat pop-up, or a full service call center. Remember, being offshore means that you must take a proactive approach to each transaction.

Offshore Merchant Account Pricing and Reserves

A typical offshore merchant will pay 4% to 6% to process transactions and will have a rolling reserve of 20% for 60 days. High risk merchant accounts should expect to pay 5% to 10% and may be subject to a higher reserve.

If you are a brand new offshore merchant account, there will be little room to negotiate these fees and reserves. However, if you can bring in significant transactional volume, and have been operating a clean account for 6 to 12 months, providers will often cut deals to get you to move. If you are low risk and paying more than 5.25%, it is probably time to negotiate.

When selecting an offshore merchant account, there are a number of fees to keep in mind. In addition to the discount rate above, you have a per transaction fee (often $0.50 for offshore), a fee on each chargeback of $30 to $100, a dispute fee each time a buyer lodges a complaint, and a gateway fee, just to name a few. For high volume low dollar merchants the offshore transaction fees can be a killer.

Why a U.S. Social Security Number Helps

A U.S. Social Security Number is now a requirement for all merchant accounts in the U.S. The Patriot Act and similar laws of the land have scared processors in to demanding SSNs for all applicants (not ITINs).

While the Patriot Act does not specifically mandate that financial institutions must ask for a customer’s SSN in order to set up a merchant account, the regulations, which took effect in 2003 and were implemented in accordance with Section 326 of the Act, require that all financial institutions establish a Customer Identification Program (CIP), to verify the identity of any individual who wishes to conduct financial transactions through their businesses.

These regulations govern banks and trust companies, credit unions, mutual funds, savings associations, futures brokers, and other similar financial institutions, including institutions that offer merchant accounts to companies for the purpose of accepting credit cards. An institution’s CIP requires that it gather identifying information about any individual seeking to open an account in order to engage in financial transactions, and that it further (1) verify the identity of the individual creating the account such that the institution has reasonable certainty that it knows who the account holder is, (2) establish and keep records of the information used to verify the identity of the account holder, and (3) compare the identity of the account holder to lists provided by the government of known or suspected terrorists.

The “purpose” of these regulations is to allow the US government to work with financial institutions to prevent identity theft, money laundering, the financing of terrorist organizations and activities, and other types of fraud. A financial institution’s CIP is incorporated into its Bank Secrecy Act compliance program, which every US financial institution must have as a means of cooperating with the government to combat money laundering. Financial institutions are required to have procedures in place to ensure that they can verify a customer’s identity and establish that the customer does not appear on any government list of terrorists within a “reasonable time,” and to dictate under what circumstances the institution should refuse to open an account, close an account previously opened, or file a Suspicious Activity Report, based on its ability to successfully establish the identity of the customer.

Each financial institution develops its own CIP, which is then approved by its board of directors. As such, while the Patriot Act does not specifically require that a customer’s SSN must be provided in order to obtain a merchant account, most financial institutions consider a SSN to be a simple and reliable means of verifying identity, and may choose to deny service to a customer who does not wish to provide it. Using a SSN as a requirement for creating a merchant account has been demonstrated to be an effective means of discouraging criminal use of these accounts, and remains one of the easiest ways for financial institutions to comply with U.S. government regulations regarding the verification of customer identity and fraud prevention.

Onshore / Offshore Merchant Account Solutions

If you are a U.S. citizen living and operating a business abroad, or just looking to move some profits offshore for asset protection purposes, you may benefit from an onshore / offshore business structure. This solution may cut your processing costs in half and eliminate or reduce the rolling reserve.

We can setup a U.S. Limited Liability Company in Delaware, owned by an offshore corporation (typically Belize), and open a U.S. merchant account under the Delaware entity. In order to utilize this structure, you must be a U.S. citizen or resident with a valid Social Security Number, have good credit and provide the following:

  1. A U.S. mailing address,
  2. A U.S. utility bill reflecting that address and your name, and
  3. Be willing to travel to the U.S. to open a bank account (if necessary).

In order for this structure to have any tax benefit, you must be living and working outside of the United States, you may not have an office or employees in the US, you must qualify to retain earnings in your offshore corporation (click here for a detailed article), and the owners of the offshore company must qualify for the Foreign Earned Income Exclusion (click here for a detailed article on international taxation).

For additional information on offshore merchant accounts or to form an offshore corporation, please contact me directly at info@premieroffshore.com or call (619) 483-1708 for a confidential consultation.