Offshore Corporations and Offshore LLCs

benefits of an offshore company
Christian Reeves

Benefits of an Offshore Company

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One of the most confusing areas of going offshore are the benefits of the offshore company. Will going offshore reduce your taxes? The answer is a qualified maybe. Will an international corporation or LLC structure protect you from creditors? The answer is a resounding yes.

In this article I will attempt to describe the benefits of an offshore company for those living in the United States and for those living and working abroad.

Offshore Company for Those Living in the U.S.

The benefits of an offshore company for those living in the United States are simple: it provides some of the best asset protection available and allows you to diversify your investments internationally. Moving your assets in to an offshore company should not increase or decrease your U.S. tax bill.

This is the say that there should be no tax benefit to going offshore if you are living in the United States. Offshore asset protection should be tax neutral.

So, your offshore company might invest in gold bullion held in Panama or Switzerland, real estate in Belize or Colombia, and hold a brokerage account at any number of quality firms. It will allow your assets to escape from America and plant that first flag offshore.

Protecting yourself with an offshore company will require you file a corporate tax return, IRS Form 5471, or a disregarded entity return, IRS Form 8858, and, if you move more than $10,000 out of the US, to report your international bank accounts  on the FBAR form. For additional information on tax reporting, click here.

Offshore Company for Those Living and Working Abroad

Let me begin by noting that U.S. citizens are taxed on their worldwide income no matter where they live. Operating a business through an offshore company may significantly reduce the amount you must hand over to Uncle Sam…so long as you file all of the necessary forms each year.

If you are living and working outside of the United States, the benefits of an offshore company can be significant. First, it allows you to protect your business assets, increases privacy, and offers an unparalleled level of asset protection.

Next, an offshore company allows you to maximize the Foreign Earned Income Exclusion. If you were to operate a business without a corporation, or with a US corporation, then you must pay Self Employment tax or FICA, Medicare, ObamaCare, etc. This basically amounts to a 15% tax on your net profits.

If you were to roll the dice and operate a business offshore without an offshore company, unprotected from litigation, you would report your income on Schedule C of your personal return. When this happens, expenses on Schedule C reduce the value of your Foreign Earned Income Exclusion.

For example, if your international business grosses $400,000, and your expenses are $200,000, your expenses are (obviously) 50% of your gross. When this is reported on Schedule C and Form 2555, your FEIE is reduced by 50% and you only get $49,000 tax free…not the full FEIE amount of $98,000.

– The FEIE is actually $99,200 for tax year 2014 and 2015 has not yet been released. I usually round down to $98,000 to make the math easier to follow.

If this same $400,000 in gross profit and 50% expense is reported in an offshore company, on IRS Form 5471 and 2555, then you get the full $98,000 FEIE. If the business is run by a husband and wife, each may take the exclusion, and you will get $196,000 tax free.

Finally, by operating your business through an offshore company, you may retain earnings that are in excess of the FEIE. So, if your net profit is $200,000, you might draw a salary of $98,000 and leave the rest of the money in the business. Thereby, you will pay zero US tax on your offshore business.

So, the tax benefits of an offshore company can be major. When planned and structured properly, your offshore company may pay zero U.S. tax…while remaining in compliance and following all of the applicable laws.

For more detailed information on the benefits of an offshore company, please check out my Expat Tax and Business Guide.

Why So Much Confusion on the Benefits of an Offshore Company?

So, why is there so much confusion about the benefit of an offshore company? Why do I receive calls nearly every day from people who are mixed up on the tax benefits? I think there are two answers:

First, promoters located offshore, and out of the reach of the IRS, often give false information to make sales. If you call an incorporator in Nevis and ask about taxes, they will say something like, “no, you don’t need to pay tax on your profits. You can leave them offshore as long as you like and no one will know about them until you bring them in to the U.S.”

Well, this is true from the perspective of someone in Nevis. That island will not attempt to tax your Nevis IBC, nor will they require you to file any tax returns or report your business. But that is not what is important here…as a U.S. citizen, you are concerned with the IRS knocking down your door and not what Nevis thinks.

This is why all U.S. persons must use a U.S. firm that offers tax and business consulting services to incorporate offshore. The risks and costs associated with failing to keep in compliance will certainly outweigh any premium you pay for quality representation. If you don’t choose Premier to create your offshore company, make sure you use another U.S. tax expert!

Second, you read all the time how big companies like Google and Apple have billions of tax free dollars offshore. Why can’t you, the average guy or gal, setup an offshore company and do the same thing?

These big guys have business units with employees and other assets that are working and producing sales outside of the U.S. They don’t just form an offshore company and run revenue through it. They build an offshore division that makes money…and it is these profits generated by their offshore units that retain earnings offshore.

  • Want to learn more about how big corporations operate? Read up on terms like “transfer pricing.” This is the foundation of the offshore corporate tax break for large firms.

Because small businesses can’t usually hire a bunch of employees in Panama and Ireland, and pay big money to tax lawyers to structure their worldwide affairs, we are left with the basics: the only way to emulate Apple and Google is to move you and your business offshore and qualify for the FEIE.

I hope you have enjoyed this article on the benefits of an offshore company. Feel free to contact me at info@premieroffshore.com for a confidential consultation, or post a question to this page in the comments.

Best Offshore Company Jurisdiction
Christian Reeves

Where to Incorporate Your Offshore Company

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Before forming an offshore company, give some thought to where you will incorporate that entity and where you will operate the business. Of course, these don’t need to be the same country…you may do better to incorporate in one jurisdiction and operate from another. The following article will help you select the best jurisdiction for your offshore company.

Offshore Company Tax Tip: If you are an American living and working abroad, the country where you form your company does not make difference. It should be somewhere that will not tax your business and will not require you to file any tax forms. To put it another way: your only reporting requirements should be to your home country of the United States and not to the country where you form your offshore company.

I have developed the following offshore company formation checklist based on my own experiences through the years of operating a number of businesses in five countries, as well as in structuring the affairs of a wide variety of clients around the world.  

The first list are business reasons to select your country of operation:

Offshore Company Tax Issues – Start your business in a country that will not tax your income. Of course, if you open a bar selling beer to the locals in Belize, they will tax you. I am referring to a business that sells a product or service to people outside of your country of operation…usually an internet based business. There are a number of countries that will not tax offshore company foreign sourced income in that case.

Time Zone – One of the most overlooked issues is the time zone. You should operate your business from the same time zone as your clients. If you are selling to the US, then you should be in South or Central America. I can’t tell you how many clients started up an internet business from Asia, only to give up the night shift and move to Panama after a few months.

Banking – Your offshore company can open an account at any number of international banks around the world. The account need not be in your country of incorporation. Of course, you will need a business account in your country of operation. To open that account, you may be able to use your offshore corporation from another jurisdiction, or you may be required to form a local corporation. Never put business income in a personal account…you must use an offshore company!

Tax Tip: I suggest that your offshore company bill your clients and receive payment outside of your country of operation. Then, you should only bring in funds necessary to operate your business, leaving the balance as retained earnings in the offshore structure.

For example, if you operate your business in Panama, bill your customers from a Belize corporation and send only the minimum necessary from Belize to Panama to avoid tax in Panama.

World Image – The way your country of incorporation is perceived by perspective clients might be relevant to some entrepreneurs. This is the country listed in contracts and other documents, so customers will see it. Your country of operation can be kept private, but your country of incorporation will be public knowledge.

Cost of Labor and Office Space – Of course, you will expect labor to be significantly cheaper offshore, but you might be surprised that office space is quite costly. Quality office space in Panama City costs about the same as in my home city of San Diego, California.

Availability of Labor – While cost of labor is low, the demand for English speakers is high. You may find it challenging to hire good people in certain countries. I also note that labor is rather transient in many countries. English speakers are in demand and often move from job to job in search of a dollar more an hour.

Availability of Professionals (CPAs & Lawyers) – One of the most overlooked aspects of starting a business offshore is the need for quality LOCAL counsel. You must have someone nearby who can advise you on leases, employment law, local taxation, and any number of issues. Going in blind, or expecting things to work as they do in the US, is a very common gringo mistake. Don’t be that guy or gal…find a few local experts on which you can rely. We at PremierOffshore.com can get you started, but there is no substitute for local knowledge.

Quality of Telecom and internet – Be sure your office has excellent internet and telecom facilities. You never want to sound like you are in a banana republic!

Availability of Computer Equipment – You might be surprised how expensive it is to import quality computer equipment in to some counties. I have had desktop systems, including monitors, stashed in my large checked cases on many occasions.

In addition to the business checklist above, careful consideration should be given to the quality of life offered in your country of operation. The following are the personal considerations of forming an offshore company and operating a business outside of the United States.

  • Can you learn the language?
  • Is there a community you will fit in to?
  • Can you adapt to the culture / speed of life?
  • Can you adapt to the weather?
  • Is the country accessible by air in 1 day?
  • Can you live with the security concerns?

Now, let’s apply these offshore company criterion to doing business in Panama City, Panama.

For myself and PremierOffshore.com, we decided to form an offshore company in Panama, operate from Panama, and form our offshore corporate billing entity in Belize. While the heat and humidity in Panama City is challenging for a San Diegan, the quality internet and low cost of labor won out. Also, escaping the heat to Medellin, Colombia is only a 30 minute flight!

I hope this article has been helpful and given you some ideas on how to select the jurisdiction for your offshore company and your offshore business. Please contact me at info@premieroffshore.com with any questions or to arrange for a confidential consultation.

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.

Retire Overseas Tax Free
Christian Reeves

How to Avoid Filing Offshore Tax Returns – IRS Form 5471 & FBAR

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Any offshore business owned and operated by a US citizen must file IRS Form 5471, an FBAR, and disclose all of its dealings to the US government. Here, you will learn how to legally reduce or eliminate these filing and disclosure obligations.

Most importantly, you must file US Treasury Form TD F 90.22.1 (generally referred to as the FBAR) if you have more than $10,000 in an offshore bank account or accounts, IRS Form 5471 if you operate your business through an offshore corporation, and IRS Form 926 if you transfer money or assets to an offshore corporation.

If you are a US citizen and the sole owner of the business with no non-US partners, then you are stuck filing these forms in their entirety. Basically, you must handle accounting and reporting of your offshore business just as you would if your business was in the United States.

As such, the IRS has the right to audit your offshore business and refuse to allow deductions for any expense you are unable to justify under the US tax code. It does not matter what the accounting and tax practices of your country of operation are…US citizens must report and pay tax in the US based on US tax an accounting standards.

If you do have partners who are neither US citizens nor US residents, then you have some planning options. First, if you have complete trust in your partner, then he or she can be the sole signer on the bank account, which means you are not required to file the FBAR.

The same is true of IRS Form 5471, the offshore corporation return. If the business is owned solely by a non-US person, and you are an employee, then the entity has no US reporting requirements.

It is important to note that I am talking about true ownership, not just some nominee director put in place to skirt the rules. This will not work and can land you in hot water with the Feds. The FBAR must be filed by anyone who has signatory rights or control over an offshore account and IRS Form 5471 must be filed by anyone with significant ownership, control, or voting rights in an offshore company.

With that said, unless your non-US partner is your spouse, it is probably impractical to give up complete control of a business just too avoid dealing with the IRS. But, there are varying levels of ownership and control that you can utilize to reduce the amount of information you must provide the US government.

For example, maybe you can structure a joint venture between an offshore corporation you own and your non-US partner’s corporation. In this way, you can bring in to your entity only what you wish to report to the IRS, possibly an amount which will match up with the Foreign Earned Income Exclusion.

Next, consider your filing obligations prior to completing your incorporation. Portions of IRS Form 5471 are required of any US person owning or controlling 10% or more of the stock and your reporting obligations increase as your ownership increases. For this purpose, a US person is a US citizen or resident and the 10% ownership requirement is defined as follows:

  1. 10% or more of the total value of the foreign corporation’s stock or
  2. 10% or more of the total combined voting power of all classes of stock with voting rights.

This is to say that US person or persons may own 9% of the company and have no IRS Form 5471 reporting obligation. If you find yourself in a partnership where you may choose to hold 15% or 9%, then it may be in your best interest to hold 9%. Also, you may benefit from the use of option purchase agreements, or other forms of contract, that do not impart ownership or control of the business.

If you own or control 10% or more of the stock of a foreign corporation, but not more than 50%, then you have reduced IRS Form 5471 reporting requirements and you may pay less in US taxes. Again, if you have the option of taking 50% or 51% of a venture, with the balance going to a non-US person, you might elect 50% to minimize your filing and paying obligations.

In the year you form the company, or acquire your 10%+ interest, you must file a full tax return for your offshore corporation on IRS Form 5471, reporting ownership, transfers, income, expense and a balance sheet. In subsequent years, you need only provide the following:

  1. The identifying information on page 1 of IRS Form 5471, not including Schedule A,
  2. Report special ownership interests the company may have, such as in trusts, other foreign entities, cost sharing arrangements, or other complex holdings reportable on Schedule G.
  3. IRS Form 5471 Schedule O, reporting the names of US officers, directors and shareholders, as well as transfers of stock.

In most cases, the Form 5471 return due for a company with US shareholders owning and controlling 50% or less is quite simple in year two and beyond. It should be a mere formality with no income and expense or balance sheet information required.

By contrast, the return due for a company which is controlled by US persons is quite complex and imparts filing obligations on everyone, including US shareholders who are not involved in the business.

When US persons own more than 50% of an offshore company, that entity is classified as a Controlled Foreign Corporation (CFC) by the IRS. As such, a full corporate tax return, with balance sheet, retained earnings statements, income and expense report, and a host of other information is required. The return consists of IRS Form 5471, as well as Schedules A, B, C, E, F, G, H, I, J and M. I won’t go in to each, so please take my word that preparing this monstrosity is a lot of work.

  • If you are a shareholder in a CFC, but not involved in the business,  you must file IRS Form 5471, along with Schedules G, H, I, and J. For additional information, see Category 5 filers.

More importantly, when an offshore company is classified as a CFC, it is unable to retain certain types of income. As such, these profits or transactions must be reported by the shareholders and taxed in the US, just as they would be with a US LLC or S-Corporation, regardless of whether any money is distributed.

CFC Income, or Subpart F income as it is commonly referred to, includes the following:

  1. Certain types of insurance income;
  2. “Foreign base company income,” which covers certain dividends, interest, rents, royalties, gains and notional principal contract income; income from certain sales involving related parties; income from certain services performed outside the CFC’s country of incorporation, for or on behalf of related parties; and certain oil related income;
  3. Income connected with certain sanctioned countries;
  4. Income from operations in which there is cooperation or participation in an international boycott of Israel; and
  5. Illegal payments made to a foreign government or agent.

Obviously, item two above is the one relevant to most business owners. The bottom line with this clause is that the shareholders of a CFC must pay tax in the US on passive income and related party transactions, where, had they been shareholders in a company with 50% or less US ownership, no such tax would have been due.

Finally, as a CFC, you may be limited in your ability to retain earnings and profits which result from loans or other debt obligations of US shareholders. This is true even if those profits are the result of an active business, rather than the passive income listed above. For additional information on this, and other CFC issues, see the IRS Audit Guide.

So long as you have US partners, there are a number of tax planning options for those operating a business offshore. We at Premier can assist you to structure such a business and keep it in compliance with US authorities. For additional information, and a free confidential consultation, please contact me at info@premieroffshore.com or call (619) 483-1708.

Offshore Corporation Taxation
Christian Reeves

Eliminate U.S. Tax in 5 Steps with an Offshore Corporation

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Yes, you, the offshore entrepreneur, can eliminate your US tax bill by forming an offshore corporation and following the five steps below.

As you are painfully aware, the United States taxes its citizens on their worldwide income. No matter where you live, or how much you make, America want’s its cut. Using an offshore corporation will level the playing field just a bit.

If you are a salaried employee in a high tax country, such as France or England, then the US tax system can’t get much, if anything, from you. You have already paid more in taxes to your host country than you would have to the US, so the Foreign Tax Credit steps in and prevents double taxation.

In other words, if the US tax rate is 30%, and you, as an American living in London, pay 35% to The Queen, there is nothing left for the US to take.

But, what if you want to structure your affairs to reduce or eliminate your worldwide tax bill? If form an offshore corporation, and you can follow these five steps, you will eradicate host country income tax, eliminate or defer US tax on your business profits and finally get Uncle Sam out of your pocket – legally and without risk.

Step 1 – Form an offshore corporation in a country that is business friendly

There are a number of tax efficient countries where you can structure your offshore company to pay zero local income tax. Most of these business friendly nations will tax only local source income, or sales to locals, and an internet based or international business will not pay tax on its profits.

To facilitate this, you may need to incorporate in an offshore jurisdiction, as well as in your country of residence, and bill your clients through your offshore entity. The offshore corporation is your “sales” unit and the corporation in your country of residence is your “operating” entity.

Cash flows to your sales entity and net profits are held there. Operating overhead, such as office and employees, are run through the operating entity, which bills the sales unit for these expenses. The operating entity should break-even at year end to avoid local taxation.

If you are marketing to the United States, the most business savvy country from which to operate your offshore company is Panama. It offers a well-qualified English speaking workforce at ¼ the cost of the US and is in the same time zone as America, a big benefit. Panama also has an excellent banking and professional sector, as well as decades of experience in shipping, technology, and production.

Where you incorporate your offshore sales unit doesn’t make much difference. So long as 1) it is different from your operating country, 2) does not tax your business, and 3) does not require you to provide annual reports or audited financial statements. In most cases I recommend a sales unit in Belize or Nevis to match up with a Panama operating company.

You might wonder why countries like Panama and Belize offer these types of structures and tax benefits…don’t they need tax revenue? First, these countries are relatively small and have nowhere near the military, spying, social programs, and other expenses related to running a superpower. Second, offering these incentives brings in investment, income from employment taxes, as well as employment, sales taxes, and other benefits. A small and efficient economy based on entrepreneurship can bring in sufficient proceeds to offer most of the benefits and few of the costs of America.

Step 2 – Live and Work Outside of the US

To realize tax benefits from your offshore corporation, you must live and work outside of the United States as well as qualify for the Foreign Earned Income Exclusion. If you do not qualify for the exclusion, all of the income in your offshore corporation will be taxable in the United States.

There are two ways to qualify for the Foreign Earned Income Exclusion:

The first is a simple math – be out of the US for 330 out of 365 days. If you can meet this requirement, known as the Physical Presence Test, you are guaranteed to qualify for the exclusion and should have no problems in an audit.

I also note that you can be out of the US for 330 out of any 365 day period. It does not need to be in a calendar year. For example, if you are out of the US from March 1, 2013 to March 30, 2014, and only visited the US for 20 days during that time, then you qualify for the Foreign Earned Income Exclusion.

If you have questions on the Foreign Earned Income Exclusion and how these days are calculated, please see my article: Changes to the FEIE Physical Presence Test Travel Days

The second is based on your intention to become a resident of another country for the foreseeable future and is more challenging to prove if you are audited. As a test based on your intentions, rather than travel days, it requires you to show you are a resident of a country, that you are a part of the community there, and that you have no intentions of returning to the United States in the foreseeable future.

To qualify as a resident, you must get a residency permit and file taxes in your new nation (hopefully, you will pay very little, if anything, but you must file). Also, you should think about applying for citizenship or securing some other long term work permit or enhanced residency status. Finally, you should break as many ties to the US as possible, including selling real estate, moving with your family or spouse, transferring some of your investments or retirement accounts, and have as few contacts with the US as possible. 

If you can qualify under the Residency Test, rather than the Physical Presence Test, you can spend much more time in the United States. While I don’t recommend spending more than 4 months, it is possible to spend just under 6 months. If you spend 6 months or more in the United States, you are by definition a resident.  Exactly how much time you can spend in your homeland will depend on the specific facts and circumstances of your situation.

I also note that the Residency Test must cover a calendar year. While the Physical Presence test can be used for any 12 month period, the Residency Test is much more rigid and is usually not an option in the first year you move abroad…unless you happen to move on January 1st.

If you are a perpetual traveler, or on a work assignment abroad, you will need to use the Physical Presence Test. This is because the perpetual traveler never puts down roots in a particular city, and so she is not a “resident” of anywhere, at least as defined by the US tax code. Likewise, the person assigned to work for 3 years in Medellin, Colombia by his employer intends to return to the United States at the end of that job assignment (at least, until he learns how much fun the city can be), so he is not a resident of Colombia for US tax purposes.

Once you qualify for the Foreign Earned Income Exclusion, you can earn up to $97,600 in 2013 in salary from your offshore corporation and pay nothing in US Federal Income Tax. If a husband and wife both qualify, then you can earn $195,200 jointly.

If you are operating a business, and your net profits exceed $200,000, read-on, additional planning is required.

Step 3 – If you are self-employed or have a business, form an offshore corporation

If you are operating a business, you must form an offshore corporation. Failure to incorporate will have dire consequences on your US tax situation. Here are a few examples:

If you do not incorporate, you will pay Self Employment tax on your income, which is approximately 15% and is not reduced by the Foreign Earned Income Exclusion. On joint income of $200,000, SE tax is a little less than $30,000 per year – money you could have saved by planning ahead.

If you do not incorporate, your Foreign Earned Income Exclusion will be reduced by your business expenses. This is a complex matter, but I can summarize it as follows: if your business expenses are 50% of your gross, then your FEIE will be reduced by 50%, from $97,600 to $48,800. So, only $48,800 of your salary is tax free under the FEIE.

If you do not incorporate, 100% of your net profit must be reported as salary. If you incorporate and earn more than the Foreign Earned Income Exclusion, you may be able to retain earnings over and above the FEIE and thereby eliminate or defer US tax. 

It is not tax efficient to draw a salary of more than $100,000 single, or more than $200,000 jointly, from a foreign corporation. If your net profits are above these levels, leave the excess in the corporation and defer US tax until the money is distributed.

There are a number of rules to consider when dealing with retained earnings. For additional information on retained earnings in your offshore corporation, read my previous article here.

Step 4 – Gain residency in your new home country

During your first year offshore, I highly recommend you use the Physical Presence Test to qualify for the Foreign Earned Income Exclusion and spend as little time in the United States as possible. Keep in mind that the Residency Test requires a full calendar year and that qualifying as a resident is a challenging and complex matter.

Once year two rolls around, have all of your documents filed, your ties to the US cut, and your roots firmly in to the community. No matter your long term plans, being able to come and go in the US will be a benefit, and being recognized as a resident of your country of operation will  open a number of doors, both in America and abroad.

For example, a resident will have a much easier time opening bank accounts, getting favorable apartment and office leases, and generally conducting business.  As the luster of the American passport diminishes around the world, a residency card becomes more of a necessity.

Step 5 – File your US Tax Returns, Offshore Corporation Returns, and Report your Foreign Assets and Bank Accounts

As an American citizen, you are required to report your income and foreign assets to the US government or face the wrath of the IRS. This includes an interest in an offshore corporation. The penalties for not reporting these resources are intended to be so draconian that failure to comply is simply not worth the risk.

For the international business owner, the Foreign Earned Income Exclusion and a properly structured entity should remove most of the tax cost of compliance, so reporting and running a “clean” operation should be a welcome relief.

Below is a basic review of the expat Entrepreneur’s US filing obligations:

International Bank and Brokerage Accounts

The most critical filing requirements is the Report of Foreign Bank and Financial Accounts. Anyone who is a signor or beneficial owner of a foreign bank or brokerage account with more than $10,000 must disclose these accounts to the U.S. Treasury.

The law imposes a civil penalty for not 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.

Offshore Corporation and Trust Filing Requirements

There are a number of filing requirements for offshore corporations, IBCs and International Trusts. Failure to file the required returns may result in civil and criminal penalties and may extend the statute of limitations for assessment and collection of the related taxes.

•            Form 5471 – Information Return of U.S. Persons With Respect to Certain Offshore Corporations must be filed by U.S. persons (which includes individuals, partnerships, corporations, estates and trusts) who owns a certain proportion of the stock of a foreign corporation or are officers, directors or shareholders in Controlled Foreign Corporation (CFC). If you prefer not to be treated as a foreign corporation for U.S. tax reporting, you may be eligible to use Forms 8832 and 8858 below.

•            A offshore corporation or limited liability company should review the default classifications in Form 8832, Entity Classification Election and decide whether or not to make an election to be treated as a corporation, partnership, or disregarded entity. Making an election is optional and must be done on or before March 15 (i.e. 75 days after the end of the first taxable year).

•            Form 8858 – Information Return of U.S. Persons with Respect to Foreign Disregarded Entities was introduced in 2004 and is to be filed with your personal income tax return if making the election on Form 8832. A $10,000 penalty is imposed for each year this form is not filed.

•            Form 5472 – Information Return of a 25% Foreign-Owned U.S. Corporation is required to be filed by a “reporting corporation” that has “reportable transactions” with foreign or domestic related parties. A reporting corporation is either a U.S. corporation that is a 25% foreign-owned or a foreign corporation engaged in a trade or business within the United States. A corporation is 25% foreign-owned if it has at least one direct or indirect 25% foreign shareholder at any time during the tax year.

•            Form 926 – Return by a U.S. Transferor of Property to a Foreign Corporation is required to be filed by each U.S. person who transfers property to a foreign corporation if, immediately after the transfer, the U.S. person holds directly or indirectly 10% of the voting power or value of the foreign corporation. Generally, this form is required for transfers of property in exchange for stock in the foreign corporation, but there is an assortment of tax code sections that may require the filing of this form. The penalty for failing to file is 10% of the fair market value of the property at the time to transfer.

•            Form 8938 – Statement of Foreign Financial Assets was new for tax year 2011 and must be filed by anyone with significant assets outside of the United States. Who must file is complex, but, if you live in the U.S. and have an interest in assets worth more than $50,000, or you live abroad and have assets in excess of $400,000, you probably need to file. If you are a U.S. citizen or resident with assets abroad, you must consult the instructions to Form 8938 for more information. Determining who must file is a complex matter. See http://www.irs.gov/uac/Form-8938,-Statement-of-Foreign-Financial-Assets for additional information.

With proper planning, selecting the best country of operation and formation of your offshore corporation, keeping in compliance, gaining residency, and, most importantly, utilizing the Foreign Earned Income Exclusion, you can operate your business free of both US and local taxes and make the most of your time abroad.

Please contact me directly at info@premieroffshore.com or call (619) 483-1708 for a confidential consultation.

retained earnings in an offshore corporation
Christian Reeves

How to Manage Retained Earnings in an Offshore Corporation

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The key to maximizing the tax benefits of being offshore is to generate retained earnings in an offshore corporation. Retained earnings in an offshore corporation will allow you to accumulate (basically) unlimited amounts of tax differed dollars in your company.

If you have been reading my postings for a while, you know that anyone operating a business outside of the United States should be using an offshore corporation. You are also aware of the risks associated with these entities if not structured and reported correctly.

Operating a small business through an offshore corporation allows you to draw a salary of up to the Foreign Earned Income Exclusion (FEIE) amount, which is $97,600 for 2013. The offshore corporation also eliminates payroll or self-employment taxes, saving about 15% in most cases.

But, what if your business net profits exceed the FEIE amount? What if you earn $1 million? Must you pay tax on $902,400? The answer is yes; unless you structure your business from day one to provide for retained earnings in your offshore corporation, you will pay U.S. taxes on the income over and above the FEIE amount.

So, how do companies like Google defer tax on $10 billion with a Bermuda offshore structure? Why does Bloomberg claim there is $1.2 Trillion (yes, Trillion, with a capital T) in untaxed profits offshore? These companies spend big money on political lobbying to protect the Active Financing Exception, which can be found in Section 954(h) of the U.S. Tax Code and was recently renewed in the Fiscal Cliff deal.

The Active Financing Exception allows multinationals to create “friendly” offshore banks which actively lend and invest in the controlled group’s international divisions. The profits of this bank can be retained offshore indefinitely, or until the parent decides to repatriate these profits to the United States.

The Active Financing Exception works great for the world’s largest companies, but what about the rest of us? How can we use an offshore corporation to defer U.S. tax on our business profits? We must generate retained earnings in our offshore corporation from an active business.

How to get Retained Earnings in an Offshore Corporation

In order to get tax deferred retained earnings in an offshore corporation, you must first:

1. Be living and working abroad and qualify for the FEIE,

2. Operate through a properly structured and maintained offshore corporation,

3. Generate ordinary / active business income in excess of the FEIE,

4. Pay yourself a salary of up to the FEIE amount,

5. Retain profits in excess of the FEIE in the corporate bank account,

6. Pay tax in the U.S. on those retained earnings in your offshore corporation when you take them out in the form of dividends or other payments.

This first step, to be living and working abroad while qualifying for the FEIE, is covered in great deal on this website. Click here for additional information on the FEIE for 2013.

If you are an American who may generate retained earnings in an offshore corporation, you should begin your business with the proper structure…and that structure should be created by a U.S. international tax expert. Please contact us at (619) 483-1708 or info@premieroffshore.com for a confidential consultation to design your offshore structure.

The basics of a properly structured offshore corporation are these: you must utilize a corporation (not an LLC, Foundation, Partnership, or other pass-through entity), which is incorporated in a country that will not tax your profits. It does not matter where you live, or where you operate your business (unless you provide professional services, see below), you should incorporate in a tax free jurisdiction such as Belize, Panama, or Nevis.

You must report your activities and retained earnings of the offshore corporation on IRS Form 5471, report your foreign bank account, and keep up on all other U.S. reporting requirements. As your profits grow, so do the penalties for failing to properly report your activities. See the list of filing requirements below.

You may generate retained earnings in an offshore corporation from ordinary / active business profits. Ordinary business income is income received from the sale of a product and must be attributable to the normal and recurring operations of the company.

Next, you should pay yourself a monthly salary up to the FEIE amount. If a husband and wife are both operating the business, they can each draw $97,600 for 2013, and leave the rest of the money in the corporation.

The remainder of your net profits is to be held in the corporate bank account and become your tax deferred retained earnings. By creating retained earnings in an offshore corporation, you are deferring U.S. tax on those profits. In most cases, you must pay tax when funds are withdrawn from the corporation.

  • One possible exception would be paying out retained earnings as salary in future years where those salaries benefit from the FEIE. The availability of this option would depend on a number of factors and your bona-fide business must be ongoing (see below).

Four rules that allow you to hold retained earnings in an offshore corporation

Rule 1: Understand the U.S. tax regulations regarding retained earnings in your offshore corporation.

The theory behind an offshore corporation is simple: these are not U.S. entities, so the IRS has no right to tax them. Not to be deterred by such a technicality, the IRS goes after the shareholders, not the entity.

The U.S. claims authority over anyone with a U.S. passport, no matter where they live. Our government has enacted a number of laws controlling how and when U.S. citizens must pay tax on earnings from or retained in offshore corporations.

If you are going to generate retained earnings in your offshore corporation, there are two international tax code sections you should be familiar with:

Controlled Foreign Corporation (CFC): If a U.S. person holds 10% or more of the stock (or voting control) of an offshore corporation, and U.S. persons hold more than 50% of the shares or control of that company, then U.S. persons can defer tax on active income, but not passive income.

In other words, if American(s) control an international business, then that business may defer U.S. tax on retained earnings in an offshore corporation from active / ordinary activities, not from investments. If less than 50% of the business is owned by U.S. citizen(s), then the CFC rules do not apply. For Deloitte’s worldwide CFC guide, click here.

The CFC rules also limit deductions and control how retained earnings are taxed upon distribution:

  • Passive income from interest, dividends, investments, etc. is not active income, thus no U.S. tax deferrals are available. Passive income flows through to the shareholders of a CFC and is taxable on your personal return.
  • When you distribute retained earnings from a CFC, they are taxed at your marginal rate. Long term capital gains rates (currently 20% for 2013) are not available.
  • Losses in a CFC do not flow through to the shareholders. Losses are not deductible until the company is liquidated.
  • If you die holding shares in a CFC, your U.S. heirs do not get a stepped up basis. When they sell the shares, they will pay tax on their value when you acquired them, not when they inherited them.

Passive Foreign Investment Company (PFIC): If you or your offshore corporation generates high levels of passive income, or invest in non-U.S. mutual funds, a complex tax regime may be imposed on those earnings.

Basically, you can elect to pay U.S. tax on the appreciation in your investment account each year, or you can pay U.S. tax on the gain when you sell funds or shares from your account. If you elect to pay tax when you sell, a punitive interest rate is added to the tax due to eliminate any benefit from deferral.

PFIC rules are complex and I consider them in their most basic form here. My intention is to let you know of their existence and warn you that passive income in an offshore corporation is not tax exempt or deferred. If you hold a U.S. passport, America gets a piece of your investment profits. The only major tax benefit available to the offshore entrepreneur is for active business income.

Rule 2: Have a bona-fide offshore business

You must be operating a bona-fide business if you wish to hold tax deferred retained earnings in your offshore corporation. In its most basic form, this means you should be selling something on a regular and continuous basis, you should make a profit in at least 3 of the last 5 years, you should be working at the enterprise full time, and it must be a business and not a hobby.

You should be selling a product, not providing a professional service. A professional service which is performed outside of your country of incorporation and generates income from technical, managerial, engineering, architectural, scientific, skilled, industrial, or commercial activities is not bona-fide ordinary income for U.S. tax purposes.

If you are operating a consulting or professional service business, you may utilize the Foreign Earned Income Exclusion, but you are not allowed to hold retained earnings in your offshore corporation. For additional information, see Section 4.61.24 and 25 of the IRS CFC Audit Guide.

A hobby is an activity you do for entertainment and does not have a significant profit motive. Here are a few factors use to determine if you have a business or a hobby:

  • Does the time and effort put into the activity indicate an intention to make a profit?
  • Do you depend on income from the activity?
  • If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
  • Have you changed methods of operation to improve profitability?
  • Do you and your advisors have the knowledge needed to carry on the activity as a successful business?
  • Have you made a profit in similar activities in the past?
  • Do you expect to make a profit in the future from the appreciation of assets used in the activity?

As you can see, the most important component in the hobby vs. business analysis is your profit motive. Your bona-fide business must generate significant profits over a number of years or risk being classified a hobby. This can be an issue for a business with one big year, followed by losses in all subsequent years.

Of course, this bona-fide business must be operated outside of the United States. The U.S. owner and operator must be living and working abroad and qualify for the Foreign Earned Income Exclusion in order to generate retained earnings in their offshore corporation.

An offshore corporation may have shareholders who live in the United States. These shareholders must be passive investors, having no control over the company’s day to day operations. The offshore corporation should not have a U.S. office or employees. Nor should it have any U.S. agents working exclusively to market or distribute its goods in the United States.

NOTE: A bona-fide business rarely includes individuals who trade their own investment accounts. This is the number one question I get at conferences and in emails – though I have had only one client in 12 years who was a professional trader. Unless you are working full time at your trading business, you are not considered a trader in securities. And, unless you are a professional trader, you may not utilize the Foreign Earned Income Exclusion, or generate retained earnings in an offshore corporation from your investment activities.

Rule 3: Keep records as if you were in the United States

Remember that you must file U.S. tax returns and therefore may be audited by the IRS. Your offshore business must maintain records of income and expense in accordance with U.S. accounting principles. If you can’t prove your expenses, they may be denied by the Service.

For additional information on accounting for business expenses, see IRS Pub 535. For a list of small business tax deductions, click here.

Rule 4: Know your reporting requirements

Offshore corporations must file a number of U.S. tax forms. Failure to file can result in some very draconian penalties.

  • 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 (http://www.irs.gov/pub/irs-pdf/f8832.pdf).

Conclusion

The risks and rewards are great when doing business offshore and generating retained earnings in an offshore corporation. If the business is properly structured, you may be able to eliminate or defer U.S. tax on 100% of your active income. However, most of these tax rules are “all or nothing.” If you miss qualifying for the FEIE by one day, you lose 100% of the benefit. If you use the wrong type of structure, the ability to retain earnings offshore is gone. If fail to accurately and completely report your activates, you may face enormous penalties from the IRS – possibly hundreds of thousands of dollars.

The U.S. licensed tax experts and international attorneys at Premier Offshore, Inc. give you the best of both worlds – unparalleled offshore know-how combined years of experience in dealing with the IRS. Please contact us at info@premieroffshore.com or (619) 483-1708 for a confidential consultation on any aspect of offshore corporate formation and tax law.

Recent Articles (External Links)

Because of the tough economic times most American’s have experienced in recent years, much ado has been made of multinationals use of offshore tax tools to hold out on Uncle Sam. Here are a few articles on this topic, most of which are quite biased against the entrepreneur.

Older Articles (External Links)

Offshore Corporation
Christian Reeves

Tax Traps and Landmines in Your Offshore Corporation

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An Offshore Corporation can provide extraordinary tax planning opportunities to those living and working offshore. For the misinformed, this same structure is fraught with risk and may blow up in your face if planned or reported incorrectly.

I take calls every day from those who want me and my team of U.S. licensed tax experts to form an offshore corporation and to discuss their tax filing obligations. Most of you have done your research and are well versed on the topic. You have searched the web, called around, got a few quotes, and talked to a variety of sources.

I take great pride in the fact that my readers are well informed and I’m glad you, like me, are significantly invested in being offshore. Unfortunately, so much of the information on the internet, or provided by unscrupulous unlicensed promoters, is incorrect and intended to deceive.

For example, I was speaking with a potential client…we will call her Ms. Q…yesterday. By way of background, she is living and working in California, is self-employed, and most of her clients (and revenue) are from Asia. She had been talking with a promoter in Nevis and was convinced she could operate her business through a Nevis corporation and not pay any tax.

Here is the gist of her conversation with the promoter:

Q: If my Nevis offshore company earns money from Asia, will I pay any taxes on that money if I don’t bring it in to the U.S.?

A: No, you will not pay any taxes in Nevis. Your offshore company is not required to file a tax return or pay any taxes of any kind.

Q: Do I need to follow certain accounting standards, file accounting reports, or keep records?

A: No, Nevis does not require you to keep business records, provide audited statements, or file any documents. Basically, all you need to do is pay your monthly fee to keep the company in good standing.

Q: Can my offshore corporation retain earnings?

A: Sure, you can retain as much capital in your Nevis Corporation as you like. Nevis imposes no requirements on dividends or corporate capital.

Q: When will I need to pay taxes on the money earned by my offshore corporation?

A: In most cases, clients must pay tax on the money they pay themselves in salary. So, you may need to pay taxes on your earnings when you take them out of the company.

Q: Is my offshore bank account private?

A: Absolutely. We value your privacy in Nevis and have very strict laws preventing disclosure of your offshore corporation or bank account to anyone.

The client came away from this conversation with the belief that her bank account would be secret and that no taxes would be due unless and until she repatriated money from Nevis to the U.S. The promoter stuck to the facts, misdirects but did not lie, and gave only one side of the story…that of Nevis…ignoring the client’s obligations in her home country.

In fact, the tax rules for offshore corporations are rather simple:

1. If you are living and/or working in the United States, an offshore corporation or LLC provides no tax benefit. Where your clients are located is irrelevant. Your domicile while performing the work controls.

a. The offshore corporation will provide unparalleled asset protection, access to international markets, the ability to diversify out of the United States and its currency, and other benefits, but it is tax neutral for the U.S. resident.

2. If you are living and operating a business outside of the United Sates, and qualify for the Foreign Earned Income Exclusion, then doing business through an offshore corporation may reduce or eliminate all U.S. taxes.

(Note: An IRA or other retirement account may achieve significant tax savings by going offshore but this is outside the scope of this article. For more information on this topic, click here.)

In other words, if you are living in the U.S., an offshore corporation should not increase or decrease your U.S. tax bill. It may require you to file a number of forms with the IRS, but it should be tax neutral. If you are living outside of the States, then an offshore corporation may be a great tax tool and you should consult with a U.S. licensed expert.

Ms. Q was asking all the right questions, but to the wrong person. If you ask a Nevis attorney a tax or legal question, you will get an answer according to the law of Nevis. As a U.S. citizen, it is important that you operate from a tax free jurisdiction like Nevis, Belize or Panama, but the majority of your tax planning and structuring concerns involve the U.S. tax code. So, your offshore corporation must be created and maintained by a U.S. licensed tax expert.

Here is another example: I recently received a call from an investment advisor who had read my article on International Taxation. He came away from that page thinking that an offshore corporation can be used to eliminate self-employment taxes for those living in the U.S.

To eliminate self-employment and/or Social Security, Medicare, and FICA taxes through an offshore corporation, you must 1) live and work outside of the United States, 2) operate your business through a non-US corporation, and 3) qualify for the Foreign Earned Income Exclusion.

A U.S. resident may operate his business through an offshore corporation for asset protection or other reasons, but your salary will be fully taxed. Your corporation should issue a W-2 and have proper withholding. If a W-2 is not filed, or a payroll system is not in place, you should report all income from the offshore corporation on your personal return as being subject to self-employment tax.

The moral of the story: If you carry a U.S. passport, your offshore corporation or international asset protection structure must be created and maintained by a U.S. licensed tax expert. Failure to comply with the various tax laws can result in extremely draconian penalties. For example, click here for FBAR rules or click here for the IRS Disclosure Initiative.

If you are considering incorporating offshore, please contact me for a confidential consultation. We can be reached at (619) 483-1708 or info@premieroffshore.com. For more information on offshore corporations, please click here.