Offshore Tax for Americans Living and Working Abroad

perpetual traveler
Christian Reeves

How to Escape the Perpetual Traveler Tax Trap

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Under the US tax code, a perpetual traveler is a US citizen or green card holder living outside the United States who doesn’t becomes a tax resident of another country. Being labeled as a perpetual traveler limits how many days you can spend in the US and can cause all kinds of problems for expats. Here’s how to escape the perpetual traveler tax trap.

A perpetual traveler is someone who travels from place to place never putting down roots. A perpetual traveler doesn’t have a residency visa, doesn’t file taxes in any country other than the United States, and never spends 183+ days in any one country.

The problem being labeled a perpetual traveler is that you can only spend 35 days a year in the United States. Spend one day more and you lose 100% of the tax benefits of living abroad. The international tax benefits that come from living abroad are no prorated over the time you spend abroad… you either qualify for the exclusion and get to take the full deduction or you don’t and get the joy of paying US tax on 100% of your income.

Let’s take a step back… We US citizens and green card holders are taxed on our worldwide income no matter where we live. Also, there’s no benefit to living offshore when it comes to capital gains. We always pay US tax on our passive income and dividends no matter where we live.

  • The only exception for capital gains on the planet is the US territory of Puerto Rico.

Business income and your salary from an active business conducted outside of the United States is eligible for significant international tax breaks. The tax benefits of operating a business offshore are:

  1. The Foreign Earned Income Exclusion allows you to exclude up to $102,100 in salary from Federal income taxes in 2017. A husband and wife working in this offshore business can exclude over $200,000 combined.
  2. You can hold / retain foreign sourced business income in an offshore corporation tax deferred.

To qualify for the FEIE, you must meet the physical presence test or the residency test. The physical presence test is, in theory, very simple: be out of the United States for 330 days during any 12 month period. That’s all there is… easy enough, right?

I say the physical presence test is simple in theory because everyone tries to push the boundaries and spend more time in the United States. Family emergencies, vacations, business meetings, flight delays, I’ve heard it all.

Unfortunately, the FEIE physical presence test is very rigid. If you’re off by even one day, and spend only 329 days abroad, you lose the entire exclusion. Because most Americans try to push the boundaries, the IRS loves to audit expats who take use the physical presence test.

The second and more reliable way to qualify for the FEIE is through the residency test. You can exclude up to $102,100 in salary from work performed outside of the United States if you’re a tax resident of another country.

A “resident” is someone who makes a foreign country their home and their home base. It’s where they return when they travel, where they have residency, and where they intend to be for the foreseeable future. A resident also breaks as many ties to the United States as possible.

The benefit of being a tax resident is that you don’t need to watch your days in the US so closely. You can spend 3 or 4 months a year in the US without issue. You’ll only have trouble if you spend more than 6 months or 183 days in the United States.

As I said above, the FEIE physical presence / 330 day test is easy to calculate and difficult to implement. The residency test takes work and commitment to qualify for but allows you to spend as much time as you need in the US and greatly reduces your probability of an IRS audit.

With all of that said, in order for a perpetual traveler to qualify for the Foreign Earned Income Exclusion, they must be out of the United States for 330 days a year. This is a challenge and increases your risk of an audit.

The solution to the perpetual traveler tax trap is to gain legal residency in a country that won’t tax your business profits. Find a country that you can make your home base and won’t tax your business. For a list of possibilities, see: Which Countries Tax Worldwide Income?

In my experience, the easiest tax free country for a US citizen to gain residency in Panama. Panama won’t tax your foreign sourced business profits. That is, they won’t tax sales to people and companies outside of Panama. Of course, if you sell to locals, you’ll pay tax in Panama.

And the most efficient residency visa in Panama is the friendly nations reforestation visa. Invest $20,000 into Panama’s green initiative (which means to buy $20,000 worth of teak trees) and get residency. This is by far the lowest cost and lowest investment required in any developed country.

The key to escaping the perpetual traveler tax trap is residency in a zero tax country. Do your research and you’ll find that Panama is the most efficient choice for a home base.

I hope you’ve found this article on how to escape the perpetual traveler tax trap to be helpful. For more information, please contact me at info@premieroffshore.com or call us at (619) 483-1708. We will be happy to assist you to set up offshore and connect you with local experts for the friendly nations reforestation visa.

Tax Planning for an International Bank License
Christian Reeves

Tax Planning for an International Bank License

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Tax planning for an international bank license is the most overlooked issue in startup banks. Sure, most offshore jurisdictions don’t tax your profits, but other countries will be looking for their cut if you set up an office or hire employees outside of your licensing jurisdiction. Here’s what you need to know about tax planning for an international bank license.

This article is focused on international bank licensed entities, sometimes referred to as Class B banks. An international bank is usually setup in a low or no tax offshore jurisdiction. As a condition of the license, these banks are prohibited from doing business with locals but can offer all manner of international banking services.

Countries either charge a large annual fee to allow an international bank to operate in the country, or a small tax on your earnings and profits. For example, the Cayman Islands Monetary Authority charges about $87,000 a year, plus other fees, to maintain an international license. Cayman won’t tax your business and makes their money on the annual fees.

  • I don’t consider Panama here because this country doesn’t issue international banking licenses to startup banks. You must have an existing license from a major jurisdiction to get an international license in Panama.

Smaller countries like Belize charge an annual fee of $15,000 and Dominica $10,000. Puerto Rico charges 4% tax on the net profits of the bank and a $5,000 annual fee.

So, the tax rate on income earned by an international bank will be 0% to 4% depending on the jurisdiction you select. That’s all fine and good… so, why does and international bank need “tax planning?” Taxes are very low no matter where you set up.

Here’s the catch: These 0% to 4% tax rates apply to income earned by the bank in its country of licensure.

If you license an international bank in Dominica, all your employees are in Dominica, and all work to generate the earnings of the bank are performed in Dominica, then 100% of the profits of the bank are Dominican sourced income and zero tax will be paid in Dominica.

But, what if you have an international banking license in Dominica, a small office with 2 employees on the island and 30 employees in the UK? The vast majority of the income of the bank will be allocated to the UK and taxed at 19%.

Do you also have a trading desk in Hong Kong? Then some of the profits will need to be allocated to that country and taxable at 16.5%. How about a sales office in the United States? Then income allocatable to that office will be taxed at 35%.

The bottom line is that income is sourced to the country where the work is performed to generate those profits. An international banking license gets you 0% to 4% on income earned in the country where you are licensed. All income earned abroad will be taxed where your employees are located.

Thus, tax planning for an international banking license includes two main components:

  1. Maximizing the value attributable to workers in the country that granted your international banking license, and
  2. Allocating income between your country of license and your foreign offices. This is a form a transfer pricing.

How much tax planning your international bank will need will depend on your business model. If you require 5 employees for a high dollar low volume business, then Dominica and Cayman will be fine. If you need 20 employees to start and plan to grow to over 100, then you should focus on Puerto Rico are a more advanced global tax strategy.

The simplest form of tax planning for an international bank is where all work is performed in your country of licensure. This is difficult in Belize with its population of 350,000 and nearly impossible in n Dominica with only 72,000 residents. While there is an abundance of professionals in Cayman, the costs of living and doing business on this island are very high.

The exception is the US territory of Puerto Rico. With a population of 3.5 million, and lower costs of doing business than any State in the Union, Puerto Rico is the most efficient jurisdiction for an international bank that will require a large number of employees. In fact, Puerto Rico is probably the only choice for a high volume transactional international bank if you want to keep your corporate tax rate below 15%.

There are international banks with over 400 employees in Puerto Rico and startups projecting 180 coming online. Puerto Rico is the only offshore jurisdiction that can support these numbers.

Yes, Puerto Rico is relatively large compared to other offshore banking jurisdictions, but that’s just part of the puzzle. Any US citizen can move to Puerto Rico and begin working… no visa, residency permit, work permit, or other red tape.

This means that an international bank licensed in Puerto Rico can move anyone it likes from the United States to the island. This gives you a virtually unlimited employment pool if you have the cash to entice them to move.

For these reasons, the fastest growing international banking center is Puerto Rico. The Island has 63 international banks operating now and 12 are in process. These banks will launch in 2 to 6 months.

This compares to 6 international banks in Belize, 15 in Dominica and 147 in Cayman (who has a 20 year head start on Puerto Rico). I expect Puerto Rico to surpass Cayman in the next 2 or years.

I hope you’ve found this article on tax planning for an international bank license to be helpful. For more on negotiating a bank license from Dominica, see: How to get an Offshore Bank License in Dominica.

For more on international bank licenses, see:

For more on Puerto Rico see:

For assistance in setting up a new international bank, or to negotiate a new correspondent account, please contact me at info@premieroffshore.com or call us at (619) 483-1708.

Foreign Base Company Service Income
Christian Reeves

How to Eliminate Subpart F Foreign Base Company Service Income

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In this article I’ll explain how to eliminate Subpart F Foreign Base Company Service Income issues in an offshore corporation.  Subpart F issues are the most common tax planning hurdles to overcome when you have a division of a US company operating abroad. Subpart F applies to income of a Controlled Foreign Corporation (CFC).

This article is focused on service income of a foreign division. Service income is earnings and profits generated by work done in a foreign country or a US territory. Service income is not profits from the sale of a physical good into the United States market.

This analysis applies to a business setup in a low tax country, such as Panama, or in the US territory of Puerto Rico under Act 20. For a basic summary of offshore and Puerto Rico, see: Panama vs. Puerto Rico, which is right for your business?

Sub F foreign base company service income is defined under Section 954(e) of the Internal Revenue Code as income derived in connection with the performance of technical, managerial, engineering, architectural, scientific, skilled, industrial, commercial, or like services that are performed for, or on behalf of, a related person, and are performed outside the country under the laws of which the CFC is incorporated. Under this definition, income earned by a CFC will constitute foreign base company services income only if it satisfies all three of the following tests:

  1. The income is derived in connection with the performance by the CFC of certain specified services;
  2. The services are performed by the CFC for, or on behalf of, a related person or company; and
  3. The services are performed outside of the country in which the CFC is organized (IRC Section 954(e)(1) and Treasury Reg 1954-4(a)).

Thus, where a CFC performs services for a related party through a branch established outside of its country of incorporation, it may incur “foreign base company services income.”

Income that is deemed to be foreign base company services income is not eligible to be retained offshore tax deferred and not eligible to be tax free in Puerto Rico under Act 20. That is to say, Subpart F income must be included in the parent company’s US tax return and is taxable in the United States as earned.

EDITORS NOTE: On July 11, 2017, the government of Puerto Rico did away with the requirement to hire 5 employees to qualify for Act 20. You can now set up an Act 20 company with only 1 employee (you, the business owner). For more information, see: Puerto Rico Eliminates 5 Employee Requirement

There is no US tax benefit when Sub F income, including foreign base company services income, is generated in an offshore or Puerto Rican corporation. Thus, all service businesses must strive to eliminate Sub F income and must be prepared to deal with the issue in an audit.

The easiest way to avoid Sub F base company service income issues is to ensure that the services are performed where your offshore business is incorporated. This means that your business should be operated from a low cost and zero tax jurisdiction such as Panama or Puerto Rico.

Where US businesses often run into problems is in setting up a Cayman Islands corporation (in a high cost offshore jurisdiction where they won’t have any employees) and then hiring independent contractors in Latin America and India. You should be hiring employees and building a real division offshore… not just using a shell company to manage independent contractors.

I see the same issue when US companies set up divisions in low cost but high tax countries like Mexico. The Mexican corporate tax rate is 28.5% compared to the US rate of 35%, so not much savings there. Also, Mexico taxes the worldwide income of its corporations.

So, companies incorporate in Panama (which taxes local sourced income but not foreign sourced profits) and put the employees in Mexico, hoping to get the best of both worlds.

If your employees are providing a service from Mexico, and the business operates through a Panama corporation, you’re opening yourself up to Sup F foreign base company service income issues.

The other way to avoid Sub F foreign base company service income issues is for the offshore corporation to contract directly with the customer. The foreign company should contract with the customer and the customer should be paying the foreign company, not the US parent.

Basically, if the US parent is obligated to perform the services which are performed by the CFC, the income earned is attributable to the US company. This can be avoided by having the customer contract directly with the client such that the parent is not responsible for the service.

Also, the “related party” rules can apply if the foreign division receives “substantial assistance” from the US parent. To avoid this part of the test, the foreign division should be operating independently such that the work, as well as the mind and management of the business, is performed in the offshore jurisdiction (the country of incorporation). IRC Section 954(e)(1) and Treasury Reg 1.954-4(a). See also IRC Notice 2007-13.

When it comes to avoiding Subpart F of the US tax code, the US territory of Puerto Rico can provide significantly more cover to a CFC than any offshore jurisdiction. A corporation in Puerto Rico is a US entity for contract purposes and can open a bank account anywhere in the United States.

That is to say, a corporation from Puerto Rico can open a bank account at Wells Fargo in California, Bank of America in New York, or wherever it’s owners have a relationship. While an offshore company can only bank outside of the United States, a Puerto Rican company can bank where it likes.

These facts make doing business through a Puerto Rican company much easier than a foreign entity. This is especially true in high volume low dollar transactions. No one is going to send an international wire for a $200 product.

I hope you’ve found this article on how to eliminate Subpart F Foreign Base Company Service Income issues in an offshore corporation helpful. For more information, or for assistance in planning or forming a division in Puerto Rico or offshore, please contact me at info@premieroffshore.com. 

Puerto Rico Bankruptcy
Christian Reeves

How to benefit from Puerto Rico’s bankruptcy

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The US territory of Puerto Rico is going through some tough times and will enter bankruptcy in the next few months. Puerto Rico is set to become the largest bankruptcy case in the history of the American public bond market. Here’s how you and your business can benefit from Puerto Rico’s bankruptcy.

Puerto Rico plans to file bankruptcy on $123 billion of debt owed by the government and its public corporations. Most is owed to bondholders and public employee pension systems. The bankruptcy is an attempt to deal with creditors while keeping public services going and will likely mean a 60% haircut for bondholders.

By comparison, Detroit’s bankruptcy was for $18 billion — one-ninth the size of Puerto Rico’s. Puerto Rico has a long way to go to reach the largest bankruptcy in history. Greece owed $220 billion in bailout cash when it defaulted.

Bottom line: Puerto Rico is in financial crisis… there’s blood in the streets… now is the time to make money!

Now is the time to setup a business in Puerto Rico.

Because of these financial woes, Puerto Rico is offering a number of tax holidays to new businesses. If you move a service business to Puerto Rico, and hire 5 employees on the island, you’ll cut your business tax rate to 4% on Puerto Rican sourced income.  

EDITORS NOTE: On July 11, 2017, the government of Puerto Rico did away with the requirement to hire 5 employees to qualify for Act 20. You can now set up an Act 20 company with only 1 employee (you, the business owner). For more information, see: Puerto Rico Eliminates 5 Employee Requirement

Just about any business that can provide a service from Puerto Rico to companies and persons outside of Puerto Rico will qualify for this tax deal. This includes banks, brokerages, investment advisors, internet marketers, call centers, technical support, and most online business.

If your business is portable, and requires at least 5 full time employees, you should consider relocating to Puerto Rico. For more see: Puerto Rico is the Top Offshore Business Jurisdiction for Americans.

EDITORS NOTE: On July 11, 2017, the government of Puerto Rico did away with the requirement to hire 5 employees to qualify for Act 20. You can now set up an Act 20 company with only 1 employee (you, the business owner). For more information, see: Puerto Rico Eliminates 5 Employee Requirement

In addition to online and portable service businesses, the following licenses qualify a 4% tax holiday guaranteed for 20 years:

And here’s the killer: Individuals who spend 183 days a year or more in Puerto Rico, and qualify as residents under Act 22, have a zero percent rate on passive income. Dividends from your Act 20 company are tax free, as are capital gains on assets acquired after moving to Puerto Rico. For more, see: Who is a Resident of Puerto Rico for US Tax Purposes.

Move your business to Puerto Rico and get tax deferral at 4%. Move you and your business to Puerto Rico and get tax free!

Puerto Rico is offering some amazing tax deals to businesses and high net worth individuals. The purpose of these tax deals is to bring employment to the island. The reason these tax deals exist is that Puerto Rico desperately needs jobs.

That is to say, Puerto Rico is making you an offer you can’t refuse because they’re broke… because Puerto Rico is in bankruptcy… because there’s blood in the streets.

And these offers from Puerto Rico come with a number of guarantees and protections. Yes, you’re investing in a distressed territory, but you have the protection of the US government and the guarantee of the Puerto Rican government.

As a territory, Puerto Rico is a hybrid. The island is exempted from US Federal tax law and free to create it’s own tax code. At the same time, most other Federal laws apply, such as employment, FDIC, etc.

Only Puerto Rico can offer these tax deals to US citizens because only Puerto Rico is exempted from the US tax code. Of the territories, only Puerto Rico has built a business friendly tax code.

Banking in Puerto Rico

Federal tax law applies to all US owned business abroad and all American citizens and green card holders living in foreign countries. Only American’s living in Puerto Rico are exempted from US Federal tax. For a comparison of Federal income tax of American’s abroad and Puerto Rico’s tax deal, see: Panama vs. Puerto Rico.

Yes, Puerto Rico is in bankruptcy, but their banks are protected by US law. Puerto Rico won’t go the way of Cyprus because all of their local banks are FDIC insured. There’s no risk of the government seizing the assets of depositors.

  • Local banks that accept deposits from Puerto Rican residents are required to have FDIC. Offshore banks licensed under Act 273 generally don’t apply for FDIC coverage.

And the state of banks in Puerto Rico is irrelevant to you. There’s no requirement to hold your income or retained earnings in Puerto Rico. The only requirement for retained earnings is that they remain inside a Puerto Rican corporation.  

So, form a Puerto Rican company and open a bank account in the United States. You can hold your cash at your favorite US bank with zero risk from Puerto Rico.

That is to say, a Puerto Rican company can open an account anywhere in the US. You can take your company documents into any Wells Fargo, Bank of America, or Citibank and get an account opened in a matter of minutes. While it’s impossible to open a US account for an offshore corporation, a Puerto Rican company is treated just like a structure from Delaware or Nevada by US banks.

20 Year Tax Holiday Guarantee

More importantly for a business seeking stability in Puerto Rico, your 4% tax holiday is guaranteed for 20 years. No matter how the political winds blow, your tax deal can’t be reviewed or revoked by the government of Puerto Rico. Even if the law is amended or repealed, you’re golden.

And only the government is locked in. So long as you have 5 employees in Puerto Rico and comply with the rules, you’re guaranteed a 4% tax rate on your Puerto Rico source income. If you want to walk away, you can shut down at any time without penalty.

As to a change in the law, once your company is set up and your tax deal approved, a change could be a great thing. I often tell clients that they should hope the law is repealed. When that door closes, the acquisition value of their Puerto Rican business will increase significantly.

Conclusion

Puerto Rico is offering you a tax deal you can’t refuse… and a deal that can’t be matched by any foreign country. For more information, please contact me at info@premieroffshore.com or call us at (619) 483-1708  for a confidential consultation on moving you and/or your business to Puerto Rico.

IRS Offshore Voluntary Disclosure Program
Christian Reeves

IRS Offshore Voluntary Disclosure Program for 2017

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The IRS Offshore Voluntary Disclosure Program for 2017 offers taxpayers with undisclosed offshore accounts the ability to come forward voluntarily, file their returns, disclose their assets, pay the resulting taxes and penalties, and receive a clean slate. This article covers amendments to the Offshore Voluntary Disclosure Program through February 9, 2017.

As of 2017, the IRS Offshore Voluntary Disclosure Program has collected about $8 billion in taxes and penalties from US persons with undisclosed offshore accounts. The last official number reported by the Service was $6.5 billion taken from 45,000 taxpayers as of June 2014. Unofficial estimates put it at $8 billion today.

The OVDP first came out in 2009 when the IRS was putting pressure on the Swiss bank UBS to turn over account records of US citizens. The IRS claimed that UBS was illegally helping US citizens to hide money from the tax man.

When the dust settled, UBS bowed to the US government. The bank agreed on February 18, 2009 to pay a fine of US$780 million to the U.S. government. This ransom payment broke the back of Swiss privacy and lead to the situation we have today where US persons have zero right to privacy in their financial dealings.

The IRS Offshore Voluntary Disclosure Program allows taxpayers with undisclosed accounts to avoid criminal prosecution and to “come into the fold” as it were. The OVDP is designed for US persons who voluntarily report their foreign accounts and avoid the draconian penalties the IRS will impose if they catch you.

  • A “US person” is any US citizen, green card holder, and resident of the US. The definition can include anyone who spends more than 183 days a year in the US and doesn’t usually include non-resident aliens, but exceptions apply.
  • For a detailed list of penalties and charges you can face if you’re caught with an offshore account, and don’t voluntarily come forward, see FAQs 5 and 6 here.

Before I get into the terms of the IRS Offshore Voluntary Disclosure Program for 2017, note that this program is sometimes referred to the 2012 OVDP or 2014 OVDI. The last major changes to the program came in July 1, 2014. There have been several comments and clarifications from that date to February 9, 2017. This article was written in May of 2017.

The following applies to US persons with undisclosed foreign bank accounts. You were required to report any bank or brokerage account(s) outside of the US with more than $10,000.

This is the combined balance of all your foreign accounts. For example, if you had $6,000 in an account in France and $6,000 in an account in Switzerland, your combined balance was $12,000 and you had a filing obligation.

This filing requirement is based on the highest balance in the foreign account for any one day of the year. It’s not your average balance during the year or year-end balance.  

Let’s say you were buying an apartment in Belize for $200,000 in 2015. You opened a bank account on the island and transferred the purchase money to that account. One day later you wired the $200,000 out of your Belize account and into an escrow account. You had a reporting requirement for 2015 because you had more than $10,000 offshore for that one day.

If you’d sent the money directly from a US account into an escrow account, you would not have a US reporting obligation. This is because an escrow account is not in your name and not under your control.

That is to say, you are required to report any offshore account in your name or under your control. Having a nominee on the account doesn’t eliminate the filing requirement because you still maintain control.

The focus of the IRS Offshore Voluntary Disclosure Program has been offshore bank accounts. There are many other filing deficiencies can be cured through the OVDP. For example, you should be filing Form 5471 if you hold shares in an offshore company. Then there’s Forms 3520 and 3520-A for foreign trust and Form 8938, Statement of Foreign Financial Assets.

Bottom line, if you had an interest in a foreign bank account or structure, you probably had a US filing requirement and should consider the IRS OVDP.

IRS Offshore Voluntary Disclosure Program for 2017 Settlement Terms

There are two flavors of the IRS OVDP, the Streamlined Offshore Voluntary Disclosure Program and the Traditional Offshore Voluntary Disclosure Program. Clients with a low risk of criminal prosecution, and a valid cause for their failure to report and pay, will usually select the streamline option.

Those who are coming forward after their foreign bank entered into an agreement with the IRS, or who’se financial advisor made a deal to turn over their client list, will need to go with the more expensive traditional program. Likewise, those with no valid cause for the account, or who took steps to hide the account from the IRS, should go with the traditional program.

Traditional Offshore Voluntary Disclosure Program

The penalties under the traditional OVDP are as follows:

  1. A 20-percent accuracy-related penalty on the tax due with the filing of your amended returns for all years. If no tax is due with the filing, then no accuracy penalty will apply;
  2. Pay failure-to-file and failure-to-pay penalties, if applicable; and
  3. Pay, in lieu of all other penalties 27.5% of the highest aggregate value of your foreign assets during the period covered by the voluntary disclosure.

If your bank is under investigation, a 50% penalty might apply rather than the 27.5% above.  Remember that the purpose of the program is to convince Americans to come forward voluntarily. If the IRS believes they’d have caught you eventually without the disclosure, they’re going to hit you hard.

The 27.5% penalty applies to all foreign assets which you failed to disclose. If all you had offshore was a bank account, the penalty is based on the highest value of the account during the OVDI period.

In my example above, a client had an offshore bank account that held $200,000 for only one day. In that case, the standard OVDI penalty is 27.5% of $200,000, or $55,000.

If you have other reportable assets, such as foreign real estate, an offshore trust, and a brokerage account, the penalty can apply to the highest value of these assets combined plus the highest value of your offshore bank account.

The OVDP penalty is often assessed on the highest value from a few years back because that’s when you were making money offshore. Since that high-water mark, the brokerage account may lost money, the bank accounts depleted, and the real estate has gone to foreclosure… I even had a client that had all his money stolen by an offshore scammer. None of these losses matter. The penalty is on the highest value and later losses are disregarded.

See FAQ 8 and 31 through 41 on the IRS website for more details on how to calculate the standard penalty.

Streamlined Offshore Voluntary Disclosure Program

The streamlined filing compliance program is available to those who can certify that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part. You must state, and should be able to prove, that you didn’t intend to use the offshore account to avoid paying your taxes.

That is to say, you must state under penalty of perjury that your conduct was not willful. That the failure to report all income, pay all tax and submit all required information returns, including FBARs was due to non-willful conduct.

Non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.

The risk with the streamlined program is that the IRS doesn’t buy your claim of non-willfulness. If they have evidence that you intended to hide money from the Service, or that you lied on the streamlined application, they will come after you with guns blazing.

The reduced penalties under the streamlined OVDP are as follows:

For US persons living in the United States:

  1. File original or amended tax returns, together with all required information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621) for the last years properly reporting your offshore accounts, assets, and income,
  2. File original or amended FBARs for the last 6 years, and
  3. Pay the tax, interest, and a miscellaneous 5% penalty with the filing of your OVIP.

The streamlined penalty for US residents is equal to 5% of the highest aggregate balance/value of your reportable foreign financial assets. For this purpose, the highest aggregate balance/value is the highest year-end balance… which might not be the highest balance for the year.

In our example above, you had $200,000 in an offshore account for one day. Assuming that wasn’t December 31, you’re streamlined penalty won’t include that deposit.

A foreign financial asset is any asset that should have been reported on the FBAR (FinCEN Form 114) or Form 8938. The most common examples of foreign financial assets include:

  • Bank and brokerage accounts held at foreign financial institutions;
  • Bank and brokerage accounts held at a foreign branch of a U.S. financial institution;
  • foreign stock or securities not held in a financial account;
  • foreign mutual funds; and
  • foreign hedge funds and foreign private equity funds.

Note that the streamlined OVDP penalty applies to foreign financial assets while the traditional OVDP applies to all foreign assets.

If you’re eligible for the Streamlined Domestic Offshore Voluntary Disclosure Program, you can avoid  accuracy-related penalties, information return penalties, and FBAR penalties. In most cases, the 5% miscellaneous penalty will be the only penalty assessed.

For US persons living abroad:

If both you and your spouse are non-residents for US tax purposes, you might be eligible for the zero penalty version of the streamlined program. If you’re living abroad, and otherwise qualify for the Streamlined Foreign Offshore Voluntary Disclosure Program, the IRS will allow you to file or amend your returns without the 5% penalty.

Keep in mind that your failure to file or pay taxes must have been non-willful. This criteria is the same for both domestic and foreign filers.

You’re a US citizen “living abroad” for the streamlined OVDP if you were out of the United States for 330 days for one of the last three tax years. If you’re OVDP filing covers tax years 2014, 2015 and 2016 (it is now 2017), then you must have been out of the country for 330 days during one of those years.

If you qualify for the foreign streamlined OVDP, you must submit your last 3 years of returns, 6 years of FBARs, and pay any tax and interest at the time of filing.

The purpose of the foreign streamlined program is to allow American’s living abroad to get back into the system without a penalty. The IRS has determined that, on balance, US persons who are out of the US for 330 days, and thus have few ties to this country, are the most innocent when it comes to their failure to file and pay taxes.

And, when you take the Foreign Earned Income Exclusion and the Foreign Tax Credit into account, most American’s living abroad pay little or no US taxes on their income. In that case, you will pay little to nothing with your foreign streamlined OVDP.

A US citizen who is a resident of a foreign country, or is out of the US for 330 days during any 365 day period, qualifies for the Foreign Earned Income Exclusion. The FEIE allows you to earn about $100,000 in salary or business income free of Federal income taxes. For more on the FEIE, see: Foreign Earned Income Exclusion for 2017

You also get to deduct any foreign taxes paid on your US returns, even when those returns are filed as part of an OVDP. You essentially get a dollar for dollar credit against any taxes paid on your US return.

So, if you’re living in a country with a tax rate equal to or higher than the United States, you shouldn’t owe any US tax on your foreign income. In that case, you’ll pay nothing with your foreign streamlined OVDP.

If you’re living in a zero or no tax country, or aren’t required to pay local tax to your country of residence, then you’ll pay some US tax with your OVDP. If your salary exceeded the FEIE, you will owe US tax on the excess. If you have capital gains, they’ll will be taxable when you file or amend your US returns.

Conclusion

The IRS Offshore Voluntary Disclosure Program for 2017 allows US persons to come out from the cold and get back into the good graces of the US government. No matter the reason for your failure to file, and I’ve heard them all, the OVDP is your best path forward

I hope you’ve found this article on the OVDP for 2017 to be helpful. For more information, please contact us at info@premieroffshore.com or call (619) 483-1708. We’ll be happy to assist you to file a streamlined or traditional Offshore Voluntary Disclosure and negotiate the best settlement available.

EB-5 Investor Visa
Christian Reeves

Changes to the EB-5 Investor Visa in 2017

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The US EB-5 investor visa is one of the lowest cost residency to citizenship programs on the planet. Yes, you heard me right… you can buy US citizenship for a fraction of the cost of other top countries. Here’s how the EB-5 investor visa is going to change in 2017 and why it will still be a great bargain.

As of today, March 25, 2017, you can get US residency by starting a business in the United States with a $1 million investment and employing 10 people. If you set up that business ins a “distressed” area, your investment goes down to $500,000.

Compare that to Austria. The government of Austria will grant you citizenship with an investment of EUR 3 to 10 million in a business which will employ a “substantial number of people.” The investment amount is negotiated on a case by case basis. Most end up investing about EUR 5 million… 5 times more than the United States.

For reference, Australia, the UK, and Canada also have comparable investment programs at $1 million to $5 million. Malta is about $1.2 million, but it’s a very different offer. For more on this EU passport, see: Second Passport from Malta

Here’s how the US EB-5 investor visa works. You setup your own business which will employ 10 people, or invest in someone else’s business which will employ that number.  Many very large projects, including hotels, resorts, call centers, etc. qualify for EB-5 status. Really, any for profit business that needs a lot of employees is a good EB-5 investor visa opportunity.

Once that business is up and running, you apply for your EB-5 investor visa. This gets you and your family (spouse and dependent children) into the United States. You enter on a residency visa and receive your green card shortly thereafter.

So long as the business is active, and employees at least 10 people, you will maintain this residency. After 5 years of residency, you can apply for citizenship.

Those using the EB-5 investor visa are guaranteed citizenship at the end of 5 years of residency. There are no quotas or limits… stick to the terms of your agreement and you and your family will receive US passport(s).

The US EB-5 program is the most popular residency program in the world. It’s raised at least $8.7 billion and created 35,150 jobs since 2012. The program issues a maximum of 10,000 green cards a year and 90% of the applications come from China.

That’s the US investor visa today. Here’s how the EB-5 investor visa is likely to change in 2017.

Expect the $500,000 distressed option to go up to $1.35 million. Bottom line, this program was supposed to help poor areas with high unemployment. In practice, all the cash went to fancy hotels and resorts. Thus, the investment amount is going up, way up.

For those starting businesses that are not in designated low income areas, the minimum investment is going from $1 million to $1.8 million.

When might these changes come into effect? The EB-5 investor visa program is up for renewal on April 28, 2017. I expect changes to the program shortly thereafter.

Two items of note:

First, remember you must keep your business going throughout your residency period. Once you have your passport, you can shut it down. This means you must keep 10 employees working for 5 to 6 years. If the business makes a profit, great – you can take out your earnings. If you lose money, you’ll need to invest more to reach break-even or profitability.

I can’t see starting a business that will employee 10 people from day one with less than $2 million. The original investment amount was set in 1990, when $500,000 to $1 million was real money. Today, it would be difficult to reach ramen profitability with that capital and 10 employees.

Second, the investment requirement is NOT the highest cost associated with the EB-5 investor visa for a high net worth person. The real cost is in taxes, taxes and taxes.

Only the United States taxes its citizens and green card holders on their worldwide income. Once you have that residency visa, you’ll pay US taxes on 100% of your income, no matter where you live and no matter where it’s earned.

None of the other countries mentioned here, such as the UK, Austria, Australia, and Malta, tax nonresidents on income earned abroad. You only pay tax in Austria if you are living in Austria. Get your passport and live elsewhere and you pay zero.

So, someone living abroad might be paying zero tax on $3 million a year in business income with an Austrian passport. If they sign up for the US EB-5 investor visa, they’ll pay 35% to the United States, plus another 10% to their state. This means you’re paying $1,350,000 in taxes on $3 million of income each and every year for the right to a US passport.

There is one way to get your US passport and cut your tax rate from 40% to 4% on business income and 0% on capital gains. Set up in the US territory of Puerto Rico. For more on this topic, see:

Coming to America Tax Free with the EB-5 Visa and Puerto Rico

Where to start an EB-5 business

I hope you’ve found this article on the United States EB-5 investor visa helpful. For more information on this, or setting up a business in Puerto Rico, please contact us at info@premieroffshore.com or call us at (619) 483-1708. 

how to report foreign salary
Christian Reeves

How to report a foreign salary or international business income

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Here’s how to report a foreign salary or international business income. If you earn money from working as an employee or independent contractor, you need to report it on your US tax return. Here’s how to report income paid by a foreign company.

I’ll briefly comment on income earned from abroad while living in the United States. Then I’ll focus on how to report a foreign salary or other income while living abroad and qualifying for the Foreign Earned Income Exclusion.

If you’re living in the United States and are paid by a foreign company, you have self employment income. This must be reported on Schedule C and self employment tax will apply.

Being self employed means you can deduct any expenses you had, such as travel, equipment, etc. It also means you’ll pay self employment tax in addition to ordinary income tax on your net profits. SE tax is 15%.

Anyone who does not qualify for the Foreign Earned Income Exclusion should report income from abroad on Schedule C. Even if you did the work outside of the United States, if you were a US resident during the tax year, you have US source self employment income that goes on Schedule C.

For example, you’re a US citizen living in California throughout 2017. You travel to Taiwan for 2 months on a special project earning $30,000. All of the work on this project is performed while you are in Taiwan.

This income is taxable in the United States and self employment tax applies. If you paid any taxes in Taiwan, you can use the Foreign Tax Credit to eliminate double taxation.

Same facts as above, but you’re in Taiwan for all of 2017 and earn $100,000. You’re out of the US for 330 out of 365 days and therefore qualify for the Foreign Earned Income Exclusion using the physical presence test for 2017.

If you’re an employee of a Taiwanese company, your US taxes are relatively simple. You file Form 2555 with your personal return (Form 1040), claiming the FEIE and reporting your salary from a foreign employer. Because you earned less than $102,300, you will pay zero US tax on your income.

If you had earned $200,000, and paid tax in Taiwan, you would use the FEIE on your first $100,000 and the foreign tax credit on the second $100,000.

Salary is taxable at 18% in Taiwan and your US rate is probably about 30%. So, you’ll pay 18% on $200,000 to Taiwan and 12% to the United States (30% – 18%) on the second $100,000 which was over the FEIE amount.

If you’d been working in a country that didn’t tax your salary, you would have paid zero tax on your first $100,000 using the FEIE. For example, you could have lived tax free in Panama while working remotely for a Taiwanese company.

If you’re not an employee of a foreign corporation, then you have income from self employment. SE income will be reported on Schedule C which will link to Form 2555 and apply the FEIE.

For example, you’re an independent contractor working in Panama for a company in Taiwan. You earn $100,000, which is paid into your personal bank account. You will pay zero income tax because you qualify for the FEIE. However, you will pay 15% in self employment tax. SE tax is not reduced by the FEIE.

For more on self employment tax for those living and working abroad, see How self employment tax works when you’re offshore

You can eliminate self employment tax by forming an offshore corporation and having your employer (the Taiwanese corporation in this example) pay into that account. You then draw a salary reported on Form 2555 and not Schedule C.

Your offshore corporation will file Form 5471. In most cases, this will be attached to your 1040 behind Form 2555.

Keep in mind that Form 2555 can be used with any foreign corporation. It doesn’t matter if you’re an employee of an offshore corporation that you own or an employee of someone else. So long as your salary comes from a foreign company, and you qualify for the FEIE, you can avoid self employment tax and Schedule C.

An offshore corporation can also help to defer US tax on income over and above the FEIE. For example, you’re living in Panama, qualify for the FEIE, earn $200,000 from work, and are paid into your Panama corporation.

You can take out $100,000 and report that as your salary on Form 2555. You leave the balance in the corporation as retained earnings. You will only pay US tax on this money when you take it out of the foreign corporation, usually as a dividend.

I hope you’ve found this article on how to report a foreign salary or business income to be helpful. For help preparing your US returns, or to setup an offshore corporation in a tax free country, please contact me at info@premieroffshore.com or call us at (619) 483-1708. 

Trump Tax Plan for Expats
Christian Reeves

Trump’s Tax Plan for Expats

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Most of Trump’s tax plans will help American expats. If you’re living abroad, and making more than the Foreign Earned Income Exclusion, or have significant capital gains, Trump might cut your US taxes significantly.

First, I should point out that there’s been no indication Trump will attack the FEIE. I don’t expect this Exclusion to be reduced. If you’re working abroad and earning less than $102,100, you’re golden.

Second, note that Trump’s changes to international tax law have been focused on import taxes and preventing jobs from going overseas. Unless you sell a physical good into the United States, his negative tax plans should not affect you.

That is to say, if you’re an expat with a portable business, or an internet, service, drop shipping, or consulting business, Trump’s plans won’t hurt you. So long as you’re not importing into the United States, there’s no need to worry.  

Let’s take a look at a few highlights of Trump’s tax plan.

  • Reduce taxes across the board, with special focus on working and middle-class Americans
  • Ensure the wealthy pays their fair share, but not so much that it’s detrimental to jobs or undermines the ability to compete
  • Eliminate special interest loopholes, make business tax rates more competitive in order to keep jobs in the US, and create new opportunities to revitalize the economy
  • Lower childcare costs by allowing families to fully deduct the average cost of childcare from their taxes

The Trump Plan will increase the standard deduction for joint filers to $30,000, from $12,600, and the standard deduction for single filers will be $15,000. Personal exemptions will be eliminated as will the head-of-household filing status.

In addition, the Trump Plan will cap itemized deductions at $200,000 for Married-Joint filers or $100,000 for Single filers.

Most importantly, Trump’s tax plan will lower personal income taxes and reduce the number of brackets. Under Trump’s plan, our current seven tax brackets will be collapsed into just three.

Lower-income families will end up with an effective income tax rate of zero. According to Trump, a middle-class family with two children would see a tax cut of about 35%.

The proposed income tax rates for a married filing joint taxpayer are as follows:

  • Less than $75,000 – 12%
  • More than $75,000 but less than $225,000 – 25%
  • More than $225,000 – 33%

Tax brackets for single filers will be exactly half of the amounts listed above. This is why there is no more “head of household” or status, nor is there a “marriage penalty.” The single tax brackets are now exactly half of those for married joint filers.

Remember that your first $102,100 will be excluded under the FEIE. So, an expat’s tax bracket will start at 25% and go up to 33% on salary in excess of the Exclusion.

I also note that your bracket begins at 25% and not at 0% or 12%. The excluded $102,100 counts toward your bracket, it doesn’t start at zero as if the income was never earned.

So, someone who earns $200,000 in salary for 2017 will pay 25% on about $100,000 (the amount over the FEIE). If that same person earns $300,000, the first $100,000 is tax free, the second $125,000 is taxed at 25% and the remaining $75,000 is taxed at 33%.

Self employed expats operating through an offshore corporation can manage these taxes by holding income in excess of the FEIE in the corporation as retained earnings. Pay yourself (and your spouse, if possible) the max allowed and retained the balance in your corporation tax deferred.

American expats can eliminate income tax using the Foreign Earned Income Exclusion. There is no such tax break for capital gains. So long as you hold a blue passport, Uncle wants his cut of your passive income.

Trump has suggested he will keep the current long-term capital gains tax rates of 0%, 15%, and 20% but reduce the number of tax brackets from seven to three as described above. Trump’s simplified and consolidated tax brackets, and their corresponding long-term capital gains tax rates are:

Marginal Tax Rate Taxable Income (Single) Taxable Income (Married Joint Filers) Long-Term Capital Gains Rate
12% $0-$37,500 $0-$75,000 0%
25% $37,500-$112,500 $75,000-$225,000 15%
33% $112,500 and above $225,000 and above 20%

DATA SOURCE: WWW.DONALDJTRUMP.COM

It’s also become clear that Trump plans to repeal Obamacare (the Affordable Care Act), and thereby eliminate the 3.8% investment income tax. Under Obama, most investors were paying 23.8% on long term capital gains. Under Trump that will likely go back to 20%.

Nowhere in Trump’s tax plan is a reduction of self employment or payroll taxes mentioned. Therefore, American expats will benefit from incorporating offshore and running their businesses through an offshore company.

You should report your salary on IRS Form 2555 as coming from a foreign corporation to eliminate self employment and payroll taxes of 15%. For more on this, see: How self employment tax works when you’re offshore.

Remember that self employment taxes are not reduced by the Foreign Earned Income Exclusion. The FEIE applies to income taxes paid against your salary. SE tax is not an “income” tax.

The only way for an expat to eliminate SE and payroll taxes is to operate his or her business through an offshore corporation. This trick alone can save you $15,000 a year if you’re single or $30,000 if a husband and wife both work in the business and max out the FEIE.

I hope you’ve found this article on Trump’s tax plan for expats to be informative. For assistance with an offshore corporation or US tax compliance, please contact us at info@premieroffshore.com or call us at (619) 483-1708. 

subpart f income
Christian Reeves

Subpart F Income Defined

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When a US citizen forms an offshore corporation in a low tax country different from his country of operation, he has a Controlled Foreign Corporation with possible Subpart F income issues. In this article, I’ll review the Subpart F rules and determining factors.

First, let’s talk about a Controlled Foreign Corporation. Subpart F only applies to CFCs.

A CFC is a foreign corporation primarily owned by a US person or persons. A US person is any US citizen, resident or greencard holder. Ownership means stock ownership or voting rights / control. So, a CFC is a foreign corporation where US persons hold more than 50% of the stock or voting rights (ownership or control).

Above I said that Subpart F applies to offshore corporations formed in countries other than your country of operation. This would usually be in a low tax country like Nevis or Belize to worldwide local taxes.

This is because Subpart F is targets income and profits that has little or no economic relation to the CFC’s country of incorporation.

Subpart F income includes insurance income, foreign base company income, international boycott factor income, illegal bribes and income derived from counties on the US blacklist (as sponsors of terrorism).

I’ll assume that you, my esteemed reader, aren’t running guns, bribing public officials nor trading with Iran or North Korea. So, that leaves insurance income and foreign base company income.

Subpart F Insurance income is the income earned from insuring risk outside of your country of incorporation. Unless an exception applies, insurance income earned by a CFC is taxable in the United States in the year earned.

The insurance section of the Sub F rules is meant to prevent multinationals from building large stashes of tax deferred profits offshore through “self insurance schemes.” Exceptions include the mini-captive insurance company and certain licensed foreign insurance providers.

The mini-captive exception allows you, the US small to medium sized business owner, to self-insure against foreseeable risks up to $2.2 million per year as of 2017. That is to say, you and expense and take a deduction for of up to $2.2 million per year in self insurance costs paid to an offshore CFC owned by you or your US corporation.

Subpart F foreign base company income is the broadest category and includes any income earned that has no economic connection to your country of incorporation. There are 5 types of foreign base company income:

  • Foreign personal holding company income,
  • Sales income,
  • Services income,
  • Shipping income, and
  • Oil-related income.

The foreign personal holding company rules basically turn your offshore corporation into a disregarded entity or partnership when it comes to passive income. In most cases, passive income and capital gains will flow through from your offshore CFC to be taxed in the United States.

For purposes of subpart F and the regulations, foreign personal holding company income consists of the following:

  • Dividends, interest, rents, royalties, and annuities;
  • Gain from certain real estate transactions (does not apply to real estate professionals earning ordinary income rather than passive income);
  • Gain from commodities transactions;
  • Foreign currency gains; and
  • Income that is equivalent to interest income.

Foreign base company sales income is profits from sales where the CFC is unnecessary in generating the income. For example, a US company sells inventory to a Panama corporation and that Panama corporation sells the inventory to Asia, without making any improvements or adding any value.

In this case, the Panama company is unnecessary and any income attributed to it will flow back to the United States.

However, if the Panama CFC does add significant value to the inventory, then the profit it retains would not be considered foreign base company sales income. In that case, the US company would pay tax on the value it created, the Panama company would retain income based on the FMV of the value it added, and the company in Asia would do the same.

Foreign base company service income is income generated from services earned for work done outside of the CFC’s country of incorporation for or on behalf of a related person. It does not include income derived in connection with the performance of services that are directly related to:

(a) the sale or exchange by the CFC of property manufactured, produced, grown, or extracted by it and which are performed before the time of the sale or exchange; or
(b) an offer or effort to sell or exchange such property. IRC 954(e)(2), Treas. Reg. 1.954-4(d).
(c) nor is service income that falls within the definition of Foreign Base Company Oil Related Income. IRC 954(b)(6).

Finally, foreign base company service income does not include certain services income derived in the active conduct of a banking, financing, securities, or insurance business. IRC 954(e)(2).

I hope this article on Subpart F income has been helpful. For more information on forming an offshore corporation, or devising an international tax plan, please contact me at info@premieroffshore.com or call us at (619) 483-1708. 

self employment tax
Christian Reeves

How self employment tax works when you’re offshore

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If you’re living abroad and paid by a US company, you’ll pay self employment tax on your earnings. If you’re living offshore and operating a business without an offshore company or LLC, you’ll pay self employment tax on your profits. Here’s how self employment tax works when you’re offshore and how to avoid it.

All Americans that are self employed or who business owners are responsible for paying self employment tax in one form or another. It doesn’t matter where you live or work… if you’re self employed and hold a blue passport, you must pay SE taxes.

Self employment taxes are assessed as 15.3% of your net profits. The Social Security portion has a limit on how much of your income is taxed, whereas the Medicare portion does not.

The Social Security component of self employment tax is 12.4% and applies to the first $127,200 of SE income in 2017. The Medicare component is 29% and applies to all SE income.

I generally summarize it to say that an American earning $100,000 offshore will pay about $15,000 in SE tax. This is an oversimplification, but makes the math easier. I will also round off some numbers in this article, such as how to calculate payroll taxes.

Common types of income that are subject to self-employment taxes include:

    • Income from home-based businesses
    • Income from freelance work
    • Income from work as an independent contractor
    • Income from a business operated in the United States that has not been subjected to payroll taxes (reported on a W-2)
    • Income paid to an expat from a US corporation
    • Income paid to an expat that goes into her personal bank account rather than into an offshore corporation
    • Any income from work you do while abroad that’s not a salary from a foreign corporation reported on IRS Form 2555.

Self employment tax is meant to target income from work that’s not otherwise subject to payroll taxes. As an employee of a US corporation working in the US, you pay about 7.5% in payroll taxes, which is matched by your employer. Thus, total payroll taxes are around 15%. When payroll taxes don’t apply, the worker gets to pay the full 15% as self employment taxes.

Note that the Foreign Earned Income Exclusion does not apply to self employment tax. The FEIE allows you to exclude your first $102,100 in wage or business income from Federal income tax. Self employment tax is not an income tax and not covered by the FEIE.

So, an American who spends 330 days abroad, earns $100,000 in salary, and is paid by a US corporation, won’t pay any income tax. However, they will get the joy of contributing $15,000 to our social welfare system.

Here’s how to eliminate self employment tax as an expat.

In this section, I’ll assume you’re an American citizen living abroad and that you qualify for the Foreign Earned Income Exclusion. This means you’re out of the country for 330 out of 365 days or a legal resident of a foreign country and don’t spend more than 3 or 4 months a year in the US.

This article doesn’t apply to Americans working abroad for the US Government or those working for foreign affiliates of US companies that have entered into a voluntary payroll tax agreement.  For more information, see: Social Security Tax Consequences of Working Abroad

Self employment taxes apply to income paid to you from a US corporation or money that goes into your personal bank account. It doesn’t matter where that account is located… if money from labor goes directly into a personal account, it’s subject to US self employment tax.

Self employment tax does not apply to income paid to you as salary from a corporation formed outside of the United States. This company can be incorporated anywhere in the world… a high tax country like France or a zero tax country like Panama are equal in the eyes of the IRS for purposes of SE tax mitigation.

So, if your employer pays you a salary as an employee of his non-US corporation, SE tax doesn’t apply.

Likewise, if your clients pay into an offshore corporation owned by you, and you draw a salary from the net profits, this salary is not subject to self employment taxes. It doesn’t matter that you own 100% of the business.

The compliance key to eliminating SE tax is to report your salary on IRS Form 2555. On Part 1, section 5, you must be able to check box A for foreign entity or box D for a foreign affiliate of a US corporation. Box D is applicable so long as your employer hasn’t entered into a payroll tax agreement with the IRS, which is very rare.

The bottom line is that you should always form an offshore corporation to operate an international business.

You never want to use an offshore LLC treated as a disregarded entity.

Nor should you deposit business income into a partnership, trust, Panama foundation, or a personal bank account. B

Business income and expenses should be processed through a foreign corporation, with your salary moving from the corporation to your personal account each month. This salary is then reported on Form 2555.

If your US clients don’t want to pay into an offshore corporation, you might be able to form a US billing entity. Clients would pay the US corporation and the offshore corporation would bill the US company. This can effectively move taxable income out of the US corp and into the offshore corp with no US taxes due.

A US billing entity is only advisable for those with no US employees, no US offices, and no US source income.

I hope you’ve found this article on how self employment tax works when you’re offshore to be helpful. For more information, and to form an offshore business structure, please contact us at info@premieroffshore.com or call us at (619) 483-1708. We will be happy to set up your US compliant foreign corporation. 

Which Countries Tax Worldwide Income?
Christian Reeves

Which Countries Tax Worldwide Income?

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When you’re planning a move abroad, you need to consider the tax laws of your country of citizenship and your country of residence. The key to a solid expat move is to determine which countries tax worldwide income and avoid them whenever possible.

There are four basic tax groupings of countries. I won’t consider the 22 countries that don’t tax citizens or residents. You can find that list here.

Here’s the 4 tax categories:  

  1. Countries that tax citizens and legal residents on their worldwide income no matter where they live. These countries also tax residents on their worldwide income.
  2. Countries that tax residents on their worldwide income. This is called a residential or physical presence tax system.
  3. Countries that tax citizen residents on their worldwide income but not foreign residents.
  4. Countries that tax residents on their local source income but not foreign source income. This is called a territorial tax system.

The only major nation that taxes its citizens (and green card holders) regardless of where they live is the United States. So long as you hold a U.S. passport or green card, the Internal Revenue Service wants its cut of your profits and capital gains.

  • Some lists of countries that tax citizens and legal residents on their worldwide income include Libya, North Korea, Eritrea and the Philippines. The tax systems of these countries are not well developed and data is limited.

The United States taxes all U.S. persons on their worldwide income. A U.S. person is a citizen, green card holder (who is a legal resident but not necessarily present in the United States), and residents. A resident is anyone who spends more than 183 days a year in the United States.

If you’re living and working outside the United States, and qualify for the Foreign Earned Income Exclusion, you can earn up to $102,100 in salary during 2017 free of Federal income tax. If your salary is more than the FEIE, you will pay US tax on the excess.  

Also, the FEIE only applies to your salary. You will pay US tax on capital gains, dividends, rents, royalties, and passive income no matter where you live.

Category two includes countries that tax residents on their worldwide income. In most cases, a resident is anyone who spends more than 183 days a year in the country. If you’re not living within their borders, you won’t pay tax to these nations, even if you’re a citizen.

I should point out that the “183 days” test is the standard definition of a resident. Some have more complex tests to determine who is and who is not a tax resident. For example, Colombia uses your presence in the country and the following:

1. Staying continuously or non-continuously in Colombian jurisdiction for more than 183 calendar days during a 365 day period (1 year);  
2. 50% or more of your income comes from Colombian sources;
3. 50% or more of your assets are held in Colombian Territory;
4. 50% or more of your assets are managed from Colombian Territory;
5. Having a tax residence in a jurisdiction declared as “tax haven” by the Colombian government.

The best known category two residential taxation countries are Australia, Austria, Brazil, China, Colombia, Japan and Mexico. The residency tax system is the most common and a complete list can be found here.

Category three, countries that tax foreign residents differently than citizen residents, technically includes only Saudi Arabia, Cuba and Philippines. However, some countries impose worldwide taxation on residents only after they have been in the country for several years. So, this category can vary by your situation.

When you’re moving abroad and looking to reduce or eliminate income taxes, you want to move to a category 4 country. These nations are on a territorial tax system and tax only your local source income.


If you live in a category 4 country, operate an online business from a territorial tax country, and don’t sell to locals, you won’t pay income tax to your country of residence. If you move to a territorial tax country and open a restaurant, you will have local source income and thus pay tax on your profits.

The most “business friendly” territorial tax system is in Panama. Other options include Belize, Costa Rica, Hong Kong, Malaysia, and Singapore. For a complete list, click here.

Those are the four tax systems available, with territorial and residency based taxation being the most common. Your objective should be to become a resident of a category 4 country and be a tourist or visitor in countries who would want to tax your business income.

There’s a fifth option you if you plan to spend a lot of time on the road.

You can elect to become a perpetual traveler, as so many internet marketers and entrepreneurs with portable businesses do. If you keep moving, never spending 183 days a year in any one country, you never become a tax resident and are not subject to their income tax reporting or paying requirements.

A perpetual traveler might split her time between Europe, Canada and Asia, or between the United States, Mexico, and South or Central America, never becoming subject to any of these countries tax laws. This option has become popular with nomad internet professionals.

I have two important notes for perpetual travelers:

The first is for Americans. Remember that the U.S. taxes its citizens on their worldwide income, including perpetual travelers. If you go this route, you need to qualify for the FEIE using the 330 day test and not the residency test. Here’s a detailed article on the FEIE for US citizen perpetual travelers. It’s much easier to qualify for the FEIE if you’re a resident of a foreign country for U.S. purposes, even if you spend less than 183 days in that nation.

The second is for everyone else. Several countries will attempt to tax you based on citizenship if you’re a perpetual traveler with no tax home. While their legal standing to require a tax home is unclear, I have seen many nomad clients go to battle with their home country on this issue.

Therefore, I suggest all perpetual travelers become residents of a country with a territorial tax system for the purpose of reporting (or defending your status) to your country of citizenship. Becoming a resident of Panama, while spending only a few days a year there, can simplify your worldwide tax picture.

Panama has one of the lowest cost residency programs. If you’re from a top 50 country, you can become a resident with an investment of only $20,000.

I hope you’ve found this article on which countries tax worldwide income to be helpful. For more on how to setup an offshore company or plan an international trust, please contact me at info@premieroffshore.com or call us at (619) 483-1708. 

offshore trust tax
Christian Reeves

Offshore Trust Tax Status and U.S. Tax Filing Requirements (Form 3520-A)

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An offshore trust owned by a U.S. person must file Form 3520-A and a variety of other reports to remain in compliance with the IRS. Here are the tax filing requirements for offshore trusts with U.S. owners.

First, allow me to define a few terms around offshore trust tax reporting:

Settlor or Grantor: The person or persons creating and funding the trust. The terms settlor and grantor are synonyms for estate planning and the U.S. tax code.

Owner of an Offshore Trust: The settlor is the owner of the trust until his death. Once the trust passes to the heirs, they become the owners for U.S. tax purposes.

Grantor Trust: A grantor trust is considered a disregarded entity for income tax purposes. Any taxable income or deduction earned by the trust will be taxed on the grantor’s tax return. The settlor(s) or grantor(s) are the beneficial owner of the trust for tax purposes until his or her death.

Beneficial Owner: The owner of the assets of the trust for tax purposes. More specifically, Any person treated as an owner of any portion of a foreign trust under the grantor trust rules (Sections 671 to 679 of the U.S. Tax Code).

U.S. Person: Any U.S. citizen, green card holder, or tax resident. This article is focused on offshore trusts owned by U.S. persons. The rules are different for offshore trusts owned by non-resident aliens who become U.S. persons after the trust is funded.

Tax Resident: Any person who spends more than 183 days a year in the United States.

Now let’s get to the U.S. tax filing requirements of offshore trusts with U.S. owners.

We start from the position that U.S. persons are taxed on their worldwide income, no matter where it’s earned and no matter where they live. So long as you hold a U.S. passport or green card, or are a U.S. resident for tax purposes, the IRS will expect you send them their share each year.

Next, all offshore trusts with U.S. owners are grantor trusts for U.S. tax purposes. This means that all income earned within an offshore trust is taxable to the grantor. Likewise, this means that the settlor is considered the beneficial owner of the trust assets for tax purposes.

Note that I repeatedly write, “for tax purposes.” The settlor may not be considered the owner of the assets for liability and litigation purposes. Also, she might not be the owner of the assets for estate planning purposes. This article on the U.S. tax status and filing requirements of offshore trusts looks at these matters only from the point of view of the IRS.

This all means that the settlor or owner of an offshore trust must pay U.S. tax on the taxable gains earned within the trust. This includes capital gains from stock trading, rental income from real estate, and the gain realized on the sale of any trust assets.

Of course, it’s possible for an offshore trust to have non-taxable gains. For example, profits earned within a U.S. compliant offshore insurance wrapper are not taxable to the owner.

The bottom line is that, any income earned within an offshore trust which is not within a tax exempt structure is taxable to the owner. Taxes are not deferred until the profits are brought into the United States, they’re due when the gains are realized.

U.S. Tax Filing Requirements for Offshore Trusts

The most important filing requirement for an offshore trust with a U.S. owner is Form 3520-A.

An offshore trust treated as a grantor trust for U.S. tax purposes must file IRS Form 3520-A each year. Gains, losses and ownership are reported to the IRS on this form. It doesn’t matter whether there were transactions or gains in the trust, Form 3520-A must be filed each and every year.

Failure to file Form 3520-A, or filing an incomplete or inaccurate Form 3520-A  can result in a penalty of the greater of $10,000 per year or 5% of the gross value of the trust assets owned by U.S. persons. That means that the minimum penalty for failing to file this form is $10,000 per year.

An offshore trust where the settlor is alive and a U.S. person will be 100% owned by a U.S. person and the penalty for failing to file Form 3520-A will be 5% of 100% of the trust assets. In the situation where the settlor has passed and one or more of the beneficiaries are not U.S. persons, the penalty will apply only to the portion of the assets owned by U.S. persons.

Note that an offshore trust with U.S. owners must also file Form 3520 to report changes in ownership and certain transactions involving the trust. Failure to file this subform will result in an additional penalty of the greater of $10,000 per year or 5% of the gross value of the trust assets owned by U.S. persons.

So, failure to report an offshore trust in a year where both Form 3520-A and Form 3520 are required can result in a total penalty of $20,000 or 10% of the gross assets. Miss these forms or file them incorrectly for a few years and the penalties add up quickly.

Foreign Bank Account Report (FBAR)

The most basic offshore form is the Report of Foreign Bank and Financial Accounts, Form FinCEN 114, generally 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.

The $10,000 amount is the value of all offshore bank and brokerage accounts combined. If you  have 4 offshore accounts, each with $4,000, your total offshore balance is $16,000 and an FBAR report is due each year.

The penalty for failing to disclose an offshore bank account is $10,000 for each non-willful violation. If the violation is intentional, the penalty is the greater of $100,000 or 50% of the amount in the account for each violation. A separate penalty will be imposed for each year you failed to report the international bank and/or brokerage account associated with your offshore trust.  

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

Other Tax Forms for Offshore Trusts

Form 5471 – Information Return of U.S. Persons with Respect to Certain Foreign Corporations. If your trust owns a foreign corporation, Form 5471 will be required.

A foreign corporation or limited liability company owned by an offshore trust 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. If your foreign trust owns an offshore Limited Liability Company, you might need to file Form 8858. If not this form, then Form 5471. Which form is required is determined using the instructions to Form 8832.

Form 5472 – Information Return of a 25% Foreign-Owned U.S. Corporation. If your offshore trust invests in a U.S. business, or in an offshore corporation that does business in the United States, you may need to file Form 5472 to report U.S. source income.

Form 926 – Return by a U.S. Transferor of Property to a Foreign Corporation. Form 3520 is generally used to report transfers to an offshore trust. Form 926 can be required if you transfer property into a foreign corporation owned by your trust.

Form 8938 – Statement of Foreign Financial Assets was introduced in 2011 and must be filed by anyone with significant assets outside of the United States. Whether this Form 8938 is required will depend on many factors, such as the value of your foreign assets and whether you’re living in the United States or abroad. I won’t go into the details here. Suffice it to say that most offshore trusts are large enough that Form 8938 is required.

Conclusion

Because of the complex web of tax forms and rules that apply to offshore trusts, the severe penalties for getting it wrong, and the potential to use an offshore trust as a tax planning tool (when combined with an insurance wrapper) or as a way to minimize estate tax, I strongly suggest you hire a U.S. expert to form your structure.

Only a U.S. tax and asset protection lawyer is qualified to design and implement an offshore trust for an American citizen or resident.

Only a professional with years of experience in the field should be hired to quarterback your asset protection team.

Only a U.S. lawyer can build an asset protection trust to protect you from U.S. creditors. If your risks are in the United States, so must be your legal counsel.

Only a U.S. tax expert is qualified to keep your offshore trust in compliance.

Only an attorney experienced in both offshore planning and U.S. taxation can assist you with pre-immigration planning using offshore trusts.

Sure, it’s cheaper to hire an offshore trust agent. Take a read through the penalties for failure to file or report again, and then consider whether the savings are worth the risk.

Here’s the bottom line: If you can’t afford to do it right, don’t do it at all. If the amount of assets you want to transfer offshore don’t warrant hiring a U.S. lawyer, then don’t go with a trust. Plant your first flags offshore in a less costly and less complex structure.

For example, if you will move $100,000 offshore, go with a Panama Foundation rather than an offshore trust. The cost savings will be significant and the Foundation offers many of the same asset protection benefits. Also, a Panama Foundation is a great way to hold active trading accounts and businesses, which don’t play well with offshore trusts.

If you want to take a U.S. retirement account offshore, use an offshore IRA LLC rather than an international trust. Your setup and ongoing costs will be a small fraction of those associated with a properly designed trust.

Finally, it’s possible to invest offshore and legally report nothing to the IRS. If you buy foreign real estate, or hold gold offshore in your name, there will be no IRS reports to file. Stick to gold and real estate, avoid offshore structures, and do not have an offshore bank accounts with more than $10,000, and your investments will remain totally private.

Assets within an offshore corporation, including gold and real estate, must be reported on Form 5471. The above refers only to assets held in your name without a corporate structure, LLC, or foreign trust. For more, see: Offshore Privacy Exists!

I hope you’ve found this article on the U.S. tax status and IRS filing obligations of offshore trusts to be helpful. For more information on building an international asset protection structure, please contact me at info@premieroffshore.com or call us at (619) 483-1708 for a confidential consultation.

stop paying payroll tax
Christian Reeves

How to Stop Paying Payroll Tax

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During the election,Trump claimed he’s paid “hundreds of millions of dollars” in taxes over the years. Yet, he probably didn’t pay any personal income taxes since 1995 because of a $916 million loss carryforward. How can both of these statements be true? Because most Americans pay more in payroll taxes than income tax!

In this article, I will explore how you can opt out of the US payroll tax and self employment tax systems by going offshore. How to stop paying into Social Security and other government programs that might not be there when you need them. How to create your own security blanket offshore that’s under your control.

Federal payroll tax is about 15%, with half being paid by your employer and half being deducted from your check. In addition, most states charge a payroll tax of 1.5% to 7.5%, again with half coming from the employee and half from the employer.

Self employment tax is basically payroll tax for small business. If you operate without a corporation, and report your income and expenses on Schedule C of your personal return, you will pay 15% of self employment tax. This is intended to match up with the 7.5% paid by an employer and the 7.5% withheld from every paycheck.

  • I’m using round numbers to keep it simple. For the precise cost of hiring an employee in California, see this great infographic.
  • For purposes of this article, I’ll use the terms self employment tax and payroll tax interchangeably.

When the Donald says he’s paid hundreds of millions in taxes, he’s probably counting employment taxes paid by his many companies, plus payroll and other taxes he’s paid personally. Assuming a payroll tax cost of 10% for each employee, the numbers add up quickly and his boast is probably correct… even if he paid zero in personal income taxes.  

About 66% percent of households will pay more in payroll taxes than they will in income tax. Only one in five households will pay more in income taxes than employment taxes. Those who do pay more income taxes than payroll taxes are at the very top of the wage scale. Middle income and low income taxpayers are paying far more in payroll than income tax.

Only 18% of US households pay neither payroll nor income tax. Of these, half are retirees living on their Social Security and have no other taxable income. The rest have no jobs and not much income.  (source: T16-0129 – Distribution of Federal Payroll and Income Taxes by Expanded Cash Income Percentile, 2016, Tax Policy Center)

If you’re a business owner or an independent contractor, here’s how to stop paying payroll taxes… and income tax on your first $102,100 of salary in 2017.

Live outside of the United States, qualify for the Foreign Earned Income Exclusion, operate your business through an offshore corporation in a zero tax jurisdiction, and you will pay no payroll taxes of any kind.

In order to qualify for the Foreign Earned Income Exclusion, you must be out of the United States for 330 out of 365 days or be a legal resident of a foreign country and out of the US for 7 or 8 months a year. Any income earned while in the US will be taxable here.

As a legal resident, your new country should be your home base for the foreseeable future. If you move somewhere for a short term job, you’re not a resident for purposes of the FEIE. You need to move to a foreign country with the intent to live there indefinitely.

If you don’t want to go through the hassle of getting a residency visa, you need to be out of the US for 330 out of 365 days. While this version of the test doesn’t give you much time with friends and family in America, it’s far easier to prove should the IRS challenge your tax return.

If you live abroad and qualify for the FEIE, but don’t operate your business through an offshore corporation, you will still pay payroll taxes! You will eliminate income tax on your first $102,100 in 2017, but self employment tax will apply at 15%. So, a business that net’s $100,000 is basically paying a penalty of $15,000 for failing to incorporate offshore. A husband and wife who net $200,000, could pay a $30,000 penalty.

  • If you run your foreign business through a US corporation, you will pay payroll taxes. If you don’t have any corporate structure, you will pay self employment tax.

What happens if you make more than $100,000 (single) or $200,000 (both spouses work in the business)? Any excess salary you take out of the business will be taxed at about 32% by the IRS. Still, no payroll or self employment taxes will apply.

If you’re operating through an offshore corporation, you may be eligible to hold those profits in the company and not pay tax on them until they are distributed. That is to say, you can hold income over the FEIE amount as retained earnings in your offshore corporation.  

These retained earnings will basically create a giant retirement account or security blanket. Like money contributed to an IRA, this cash is untaxed until you take it out of the corporation. Unlike an IRA, there are no rules or age requirements forcing distributions.

So, if you want to stop paying payroll taxes and self employment taxes, move out of the United States, qualify for the FEIE, and operate your business through an offshore corporation.

For help on setting up a tax compliant structure, please contact me at info@premieroffshore.com or call us at (619) 483-1708. I will be happy to assist you to set up offshore.

OECD tax exchange
Christian Reeves

European OECD Tax Exchange Agreements

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As of November 2016, most offshore jurisdictions have signed on to the Automatic Exchange Agreements demanded by European governments and the Organisation for Economic Co-operation and Development (OECD). All but Panama has agreed to share information with European tax authorities.

On paper, the OECD defines itself as follows: “the mission of the Organisation for Economic Co-operation and Development (OECD) is to promote policies that will improve the economic and social well-being of people around the world.The OECD provides a forum in which governments can work together to share experiences and seek solutions to common problems.”

In practice, the OECD has simply followed behind the US IRS and our Foreign Tax Compliance Act (FATCA), demanding information on the offshore transactions of EU citizens. Both sets of laws require banks, either directly or through their local government agents, to report ownership, control, and banking activity. The focus of FATCA is account size and transactions while the OECD is tax data (gross sales, profits, taxes paid, employees and assets of each entity).

  • A history of the OECD’s information exchange program can be found by clicking here.

For a list of countries that have signed on to the agreement, click here. The list is a real eye opener. As I said, the only offshore jurisdiction that hasn’t signed on is Panama.

You’ll find that most offshore jurisdictions have agreed to begin sharing data by 2018. Some, such as Cayman and Seychelles will begin in 2017, while Cook Islands, Belize and Andorra will implement in 2018.

You’ll also find that the list of compliant countries includes all but one… the largest tax haven in the world for everyone but it’s citizens… the U.S. of A.. While Russia, Switzerland, the United Kingdom, Mexico, China, Canada, Singapore, Japan, etc., have all signed on, the United States is nowhere to be found.

The fact that the US has refused to join will create some interesting challenges for US banks operating in compliant countries. How our global banks will coordinate compliance in one country while hiding assets based in America, will open the door to all manner of disputes.

As we international entrepreneurs move into 2017, we do so with the knowledge that privacy in our financial transactions is a thing of the past.

But these new rules shouldn’t dissuade you from protecting your assets offshore. Whether you live in the United States or the European Union, the key to solid asset protection is building a structure that no civil creditor can knock down.

In most cases, offshore asset protection should be tax neutral. It should not increase or decrease taxes in your home country. An offshore asset protection structure should do exactly what it’s name implies… protect your assets.

The key to asset protection is putting up impenetrable defenses, not hiding what you have. Even if a creditor has a road map to your offshore structure, it should be impossible for them to breach the walls of your fortress and get to the gold therein.

In fact, hiding your assets, and not being tax compliant in your home country will put your savings at risk. If you’re caught cheating on your taxes, the penalties will be severe and the value of your trust will be destroyed.

Considering how much effort governments are putting into ferreting out tax cheats, hiding assets should be the last thing on the mind of anyone looking to protect assets. All this does is add risk and pits you against both your creditors and your government.

Hiding assets offshore possible back in the day. Those days are long gone for Americans and Europeans. Now, the industry is all about tax compliant planning.

If you’re reading this and have a non-compliant offshore structure, you should take action immediately. Europeans should shut down, get in compliance, and rebuild a properly reported offshore trust.

We U.S. citizens have significantly more risk than our European counterparts. The US government is aggressively pursuing non-compliant citizens, putting them in jail, and levying mind boggling fines.

If the IRS is not on to you yet, it’s not too late. You can join the Offshore Voluntary Disclosure Program, get into compliance, pay what you owe (if anything), and then rebuild offshore.

If you are living or working abroad, you might be able to get into compliance and pay zero in taxes and penalties. If you’re living in the US and have an unreported account, the penalties will be high, but you can minimize risk and fines by coming forward now.

I hope this post on the OECD tax reporting initiative is helpful and puts offshore asset protection in perspective. For more information on legal and tax compliance asset protection techniques, please contact me at info@premieroffshore.com or call us at (619) 483-1708. 

software development
Christian Reeves

Research and Development and Intangible Property Tax Breaks in Puerto Rico

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Puerto Rico has the best tax deals available to Americans… period. No offshore jurisdiction can compete with the US territory of Puerto Rico when it comes to cutting your taxes.

This post will focus on Puerto Rico’s research and development and intangible property tax breaks. Act 73 is for those who develop licensed or patented software that may be reproduced on a commercial scale and those who license intangible property.

I’ve also written on the more traditional business tax breaks available under Act 20. Basically, if you set up a business in Puerto Rico with at least 5 employees, your corporate tax rate on Puerto Rico sourced income will be 4%. For more, see: Puerto Rico is the Top Offshore Business Jurisdiction for Americans in 2016.

I focus on the the software development and intangible property or intellectual property development components of Act 73. These are 2 of the 12 industries covered by the Act. For example, tax breaks are also available to large scale manufacturing, scientific experiments and laboratories, recycling, hydroponics, etc.

Software developed under Puerto Rico’s Act 73 must be for commercial distribution. You may license or sell it, but it must be widely available. Software developed under the Act should not be for your company’s internal use or custom work done for a particular client.

Act 73 applies to any and all forms of intangible property. Intangible property is defined as something which a person or corporation can have ownership of and can transfer ownership to another person or corporation, but which has no physical substance. For example brand identity, knowledge, and intellectual property are forms of intangible property . Copyrights, trademarks, and patents are also forms of intangible property.

It doesn’t matter how the intangible property came to be owned by the Puerto Rico company. You may have developed it on the island within the corporation, or you can buy it from a related or unrelated company.

If you do develop the intangible property in Puerto Rico, you may receive additional tax incentives. Also, developing the IP in Puerto Rico rather than the United States will avoid a taxable event and transfer pricing issue when you sell / transfer the property to the Puerto Rico company.

Tax Exemptions Under Puerto Rico’s Act 73

Once you have your IP offshore, or begin selling your software, here are the applicable tax benefits. Remember that these replace the US federal income tax rates of 35% + your state (0 to 12%). In many cases, you can exchange a 40% tax rate for 4% or less.

The base tax rate for an Act 73 business in Puerto Rico is 4%. This rate is guaranteed for 15 years from the date your company is approved.

You might be thinking, wow, a 4% corporate tax rate is just too high. “Pioneer” activities in Puerto Rico are taxed at only 1%. Pioneer businesses are typically those who create or develop intangible property on the island.

If you’re still thinking this is too high, I say come on, give me a break… and it can still go lower. If you setup your business in an approved low income area, your corporate rate will be between 0.5% and 0%. Combine this with the tax credits below and you could have a net positive tax rate.

If you’re not a pioneer, you can get to a 3% tax rate. Any business where at least 50% of the shareholders are residents of Puerto Rico, the rate is lowered from 4% to 3%. The same goes for any small to medium sized software or IP development business operated from the island (where average gross income is $10 million or less during the previous three years).

Still not convinced? You will also find a 100% tax exemption on dividend distributions and a 2% or 12% withholding tax on royalty payments to foreign entities for intangible property used in the exempt business. The lower rate includes a 12% matching tax credit for royalties paid to foreign entities, so your rate may vary depending in your situation.

When you sell the business, you’ll pay a 4% fixed income tax rate on the gain. This tax on capital gains trumps any other Puerto Rico income tax code section. The 4% rate is guaranteed under Act 73 for 15 years, so you should have an exit strategy in place prior to this term expiring.

Other tax breaks include:

  • 90% tax exemption from personal property taxes.
  • 90% tax exemption from real property taxes.
  • 90% tax exemption on municipal license taxes.
  • 100% tax exemption on municipal construction taxes.
  • 100% tax exemption on excise taxes.

Remember that this article is focused on IP and software development businesses. I do not discuss accelerated depreciation, sales and use, and other tax benefits.

Puerto Rico’s Act 73 Tax Credits

The Act provides various tax credits, including:

  • 25% tax credit on purchases of products manufactured in Puerto Rico;
  • 35% tax credit on purchases of products manufactured in Puerto Rico made from recycled materials;
  • Tax credit for job creation during the first year of operations that ranges from $1,000 per job created in an industrial area of intermediate development (as determined by the Office of Industrial Tax Exemption) to $2,500 for jobs created in an industrial area of low development. In the case of businesses established in the municipalities of Vieques and Culebra, this tax credit is $5,000 per job;
  • 50% tax credit on eligible research and development activity costs; and
  • 12% tax credit for royalties paid to foreign entities with respect to intangible property used in the exempt business.

When comparing Act 73 to Act 20, note that there is not a minimum number of employees attached to Act 73. Act 20 requires at least 5 employees. Both Acts 73 and 20 can be combined with Act 22 for a personal tax exemption.

Act 22 gives a Puerto Rico resident a 0% tax rate on capital gains and dividends. If you’re living in the United States, you will pay US tax on distributions from your Puerto Rico corporation. You are not required to take any distributions, but when you do, they will be taxed in the United States.

I hope you’ve found this article on Puerto Rico’s Act 73 research and development and intangible property tax breaks helpful. Click here for a list of my other articles on Puerto Rico’s tax deal.

For more information, and a confidential consultation on moving your business to Puerto Rico, you can reach me at info@premieroffshore.com or (619) 483-1708.  

Foreign Earned Income Exclusion for 2017
Christian Reeves

Foreign Earned Income Exclusion for 2017

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The Foreign Earned Income Exclusion for 2017 has finally been released and we expats get an increase of $800 this year. The U.S. government has increased the Foreign Earned Income Exclusion for 2017 to $102,100, up from $101,300 in 2016.  

You can attribute this big time increase of the Foreign Earned Income Exclusion for 2017 to the “robust” U.S. economy. That’s because the FEIE is indexed annually for inflation. The official inflation rate for 2016 was 1.4% and it’s expected to between 1.5% to 1.6% for 2017.

Note that this article is about the 2017 FEIE. For the 2018 Exclusion, see: Foreign Earned Income Exclusion for 2018

The Foreign Earned Income Exclusion for 2017 is the amount of salary or business income you can exclude from your United States taxes while living abroad. If you qualify for the FEIE for  2017, and you earn $102,100 or less in wages, you will pay zero Federal income taxes.

To qualify for the FEIE, you must be out of the United States for 330 days during any 12 month period, or a legal resident of a foreign country for a full calendar year. The 330 day test is simple math… be out of the U.S. and you’re golden. It doesn’t matter where you are in the world, so long as you’re not in the U.S.

For more on the 330 day test, see: Changes to the FEIE Physical Presence Test Travel Days

To apply the FEIE for 2017 over two calendar years, see: How to Prorate the Foreign Earned Income Exclusion

The residency test is more complex and based on your intentions. You must move to a foreign country for the “foreseeable future.” This new country should be your home and your home base. When you travel, it’s where you return too. It’s where you lay down roots. It’s where you file taxes and where you’re a legal resident (with a residency permit).

  • You should be filing taxes in your new home. It doesn’t matter if you’re paying taxes… just that you are following their laws as a legal resident. If your country of residence doesn’t tax your income earned abroad or in an offshore corporation, all the better.

In most cases, you will use the 330 day test in your first year abroad. That will give you time to secure residency, find your home base, and do all the things necessary to break ties with the U.S.  Beginning January 1 of year two, you will file for the Foreign Earned Income Exclusion using the residency test.

The reason you want to use the residency test when eligible is that it will allow you to spend more time in the United States. Under the 330 day test, you can spend all of 36 days a year in the land of the free. If you qualify for the residency test under the Foreign Earned Income Exclusion for 2017, you can spend 4 or 5 months a year in America.

Someone with no home base, and no residency visa, will never qualify under the residency test. A perpetual traveler will need to use the 330 day test. Likewise, someone on temporary assignment for a year or two, who intends to return to the U.S. when their job runs out, will need to use the 330 day test.

Just remember than any income earned in the USA is taxable here. The FEIE doesn’t apply to U.S. source income. If a U.S. citizen works for 10 days in the U.S., the income from those days is U.S. source and Uncle Sam wants his cut.

The FEIE for 2017 applies to married persons individually. A Husband and Wife working in their own corporation, or drawing salaries from a foreign company, can earn $204,200 combined this year and pay zero Federal income tax.

If you earn more than $102,100, you’ll pay U.S. income taxes on the excess. For example, if you earn $202,100, in salary, you will pay U.S. Federal income tax on $100,000 at 28% to 33%.

Note that your expat tax bracket begins at 18%. This is because the full $202,100 counts towards the bracket. Thus, you are paying a rate on your last $100,000 as if you had earned $202,100 in wages, not just $100,000.

If you pay tax in the country where you work, your U.S. tax on this $100,000 over and above the Foreign Earned Income Exclusion for 2017 will be reduced. Every dollar you pay in foreign income tax should reduce your U.S. rate by one dollar.

  • A dollar for dollar credit is the theory behind the foreign tax credit. You will see some variance on your return when you account for deductions, credits, etc.

Another tool for high earners who are self employed is to hold earnings over the Foreign Earned Income Exclusion for 2017 amount in their corporation. Pay yourself a salary of $102,100 and keep the rest in the corporation as retained earnings. For more on this, see: How to Manage Retained Earnings in an Offshore Corporation.

Be aware that the Foreign Earned Income Exclusion doesn’t apply to income that’s not  “earned.” So, the FEIE doesn’t cover passive income like rents, royalties, dividends, or capital gains. Income which is earned is money made from paid work / labor.

For more on tax planning for foreign real estate, see: US Tax Breaks for Offshore Real Estate

Most clients who contact us about the FEIE are business owners or self employed. They want to form an offshore corporation to retain earnings, maximize the value of the FEIE, and eliminate Self Employment tax.

Note that the Foreign Earned Income Exclusion does not apply to Self Employment tax, only income tax. So, a self employed person living abroad and qualifying for the Exclusion will still pay 15% in SE tax. That means about $15,000 on your salary of $102,100 for FICA, Medicare, Obamacare, etc.

If you don’t want to contribute to Social Security, you can opt out of Self Employment tax by forming an offshore corporation. Incorporate in a country that won’t tax your income, get your clients to pay that company, draw a salary from your foreign corporation reported on U.S. Form 2555, and you’ve eliminated U.S. social taxes.

For more on the tax benefits of living abroad, see: Tax Benefits of Going Offshore

For more on setting up a business offshore, see: Benefits of an Offshore Company

If you’re reading this article on the Foreign Earned Income Exclusion for 2017 and planning to set up a large business offshore, you might consider Puerto Rico. If $102,100 is a small portion of your net profits, think Puerto Rico. If your take home is closer to $1 million than $100,000, think Puerto Rico. If you have at least 5 employees, Puerto Rico might be for you.

The Puerto Rico tax deal, referred to as Act 20, is the reverse of the Foreign Earned Income Exclusion. With Puerto Rico, you pay U.S. tax rates on your first $100,000. Then you pay 4% profits over this amount and distribute those profits to yourself as a tax free dividend.

The Puerto Rico tax deal requires you live on the island for 183 days or more, significantly less than the 330 days required by the FEIE. If your net business income is well over the FEIE of $102,100, consider Puerto Rico.

The catch in Puerto Rico is that you must hire 5 employees on the island. You and your spouse can be 2 of those 5, and then you need 3 more. When setting up offshore, there’s no minimum number of employees required.

For a comparison of the Puerto Rico deal with the FEIE, see: Puerto Rico Tax Deal vs Foreign Earned Income Exclusion

For more on who qualifies as a Puerto Rico employee, see: Who is a Resident of Puerto Rico for US Tax Purposes

To read more about Puerto Rico and the Foreign Earned Income Exclusion, see: How to Maximize the Tax Benefits of Puerto Rico

For more on setting up a one man or one woman business offshore, see: Move Your Internet Business to Cayman Islands Tax Free

The bottom line is that the FEIE is great for those earning $100,000 from a business (or $200,000 of both spouses are working). If you are earning well over this threshold, and you can benefit from 5 employees, take a look at Puerto Rico.

I hope you’ve found this article on the Foreign Earned Income Exclusion for 2017 to be helpful. For more information on taking your business offshore, to Puerto Rico, or for a referral to a U.S. tax preparer, please contact me at info@premieroffshore.com or call (619) 483-1708.

retained earnings
Christian Reeves

Watch Where You Invest Those Retained Earnings – IRS Tracking Luxury Home Purchases from Offshore Companies

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According to the N.Y. Times, The IRS has begun tracking homes bought through offshore companies and shell corporations in the United States. If you’ve setup an offshore structure, and used your retained earnings to buy real estate in the United States, you’re probably a target of the IRS.

Even if your offshore company is tax compliant, you still may be in trouble with the tax man for using those retained earnings for your personal benefit. You may be living in the property at below market rent or taking the rents as personal income.

If you’ve managed to avoid the worst of the pitfalls, investing retained earnings in the United States might have converted them to taxable distributions to the parent company. For more information, see: How to Manage Retained Earnings in an Offshore Corporation

The bottom line is that offshore retained earnings are best held offshore. Unless you have a tax plan and written opinion from a reputable firm, leave the money alone and allow it to build up inside your operating company.

And now, here’s the rest of the story:

As I said above, the IRS is targeting luxury home sales involving offshore companies. Because buying US real estate is a common, if risky, use of retained earnings, this investigation is likely to net many offshore entrepreneurs.

The first stage of this investigation is now complete. It was focused on Miami and Manhattan, where over 25% of the all-cash luxury home purchases made using offshore companies or shell corporations were flagged as suspicious.

Today, officials said they would expand the program to areas across the country. The IRS will target luxury real estate purchases made with cash in all five boroughs of New York City, counties north of Miami, Los Angeles County, San Diego County, the three counties around San Francisco, and the county that includes San Antonio.

The IRS says that the examination, known as a geographic targeting order, is part of a broad effort by the federal government to crack down on “money laundering and secretive offshore companies.” As we know, “money laundering” is basically code for “tax cheats.” For every one drug kingpin caught in their net, they’ll land 1,000 tax cases.

Cases will be selected based on the purchase price of the property. Only all cash sales will be targeted in this round of audits. The dollar values involved are as follows:

  • $500,000 in and around San Antonio;
  • $1 million in Florida;
  • $2 million in California;
  • $3 million in Manhattan; and
  • $1.5 million in the other boroughs of New York City.

You might be thinking, that the IRS doesn’t have data on every real estate purchase in the United States. How the heck are they going to audit every single transaction over these amounts.

Never fear, the IRS thought of that. All they needed to do is issue an order to every title insurance company in the United States. Basically, they’ve drafted title insurance agents into the IRS army (unpaid, of course), to search through their records and select those who should be investigated.

  • Title insurance companies are involved in just about every residential and commercial real estate transaction in the United States.

And these insurance agents aren’t just providing information on the home in question. They’re identifying the escrow agent, the US and offshore banks involved, all paperwork from the offshore company, etc.

Once the IRS has the bank account information, they’ll summon your account records. This will enable them to chase down all inbound and outbound wires.

Here’s the bottom line: investing retained earnings into the United States opens up a pandora’s box of trouble. I’ve been telling clients this for years and now it’s come to fruition.

If you have an active business offshore, keep your retained earnings offshore. Don’t make you and your cash a target for the IRS. Even if you’re 120% tax compliant, avoid the audit, avoid the battle, and protect your hard work from the Service.

I hope you’ve found this article on the IRS’s targeting of offshore retained earnings to be helpful. If you have questions on structuring a business offshore, you can reach me at info@premieroffshore.com for a confidential consultation.

IRA when you give up US citizenship
Christian Reeves

What Happens to Your IRA when you give up US Citizenship / Expatriate?

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Thousands of Americans will turn in their blue passports in the next few months. Some because of our crazy political climate, some to stop paying taxes into a broken system, and some because of FATCA and the international banking laws which make it impossible to live or do business abroad. This post will consider what happens to your IRA when you give up your US citizenship or expatriate from the United States.

Whatever your reason for giving up your US citizenship, you need to carefully plan the expatriation process. It’s be fraught with risks, costs, and problems for high net worth individuals.

First, let me define who is a “high net worth expatriate.” The IRS only cares about losing high earners and payors. They could give a damn about the rest of us.

When I consider what happens to your IRA when you give up US citizenship, I am referring only to this group high net worth expatriates.

According to the IRS, a high net worth expatriate is someone whose:

  • Average annual net income tax for the 5 years ending before the date of expatriation or termination of residency is more than $151,000 for 2012, $155,000 for 2013, $157,000 for 2014, and $160,000 for 2015. As you can see, this amount goes up each year and is tied to inflation’
  • Net worth is $2 million or more on the date of your expatriation or termination of residency, or
  • Fails to certify on Form 8854 that you have complied with all U.S. federal tax obligations for the 5 years preceding the date of your expatriation or termination of residency.

If you meet any of these criteria, you’re high net worth person (high value taxpayer) for US expatriation purposes, otherwise referred to as a “covered person.”

So, the question more properly framed is, what happens to your IRA when you give up your US citizenship or expatriate and you are a covered person?

  • High net worth covered persons pay tax as if their IRA was fully distributed to them on the day they expatriate.
  • The early distribution penalty does not apply.

The only published information from the IRS is Notice 2009-85. The discussion of specified tax deferred accounts Section 6 of this notice.

“The mark-to-market regime does not apply to specified tax deferred accounts. Instead, section 877A(e)(1)(A) provides that if a covered expatriate holds any interest in a specified tax deferred account (defined below) on the day before the expatriation date, such covered expatriate is treated as having received a distribution of his or her entire interest in such account on the day before the expatriation date. Within 60 days of receipt of a properly completed Form W-8CE, the custodian of a specified tax deferred account must advise the covered expatriate of the amount of the covered expatriate’s entire interest in his or her account on the day before his or her expatriation date.”

Note that the covered person is treated “as having” received a distribution. This is not the same as having your IRA account cancelled or closed. In fact, you have the option of continuing your IRA after giving up your US citizenship.

If you were to close your account and take a distribution, you’d be liable for the early distribution penalty. If you close your IRA as part of giving up US citizenship before reaching 59 1/2, you will pay a 10 percent early withdrawal penalty in addition to income tax on the amount withdrawn.

If you decide to keep the IRA open after expatriating, you’ll pay US tax when you take distributions from the account, presumably at age 70 ½. This tax will be calculated only on appreciation in the account from the date of expatriation.

That is to say, a covered person will pay US tax on all the gains in her account on the day she gives up her US citizenship. Then she’ll will pay US tax on the gains earned in that account after expatriating when she take the required distributions.

The IRA remains intact. All you did is “prepay” your US taxes on the account.

For example, you have $100,000 in your IRA on January 1, 2017 when you give up your US citizenship. You pay tax on this $100,000 on January 1, 2017 . You decide to keep the account open after expatriation and begin taking distributions 5 years later, in 2022. As of January 2022, your account is valued at $130,000. You will pay tax on the gain of $30,000 as you take these distributions.

Considering you will remain linked to the US tax system after expatiating through your IRA, you would have to be facing a very large early distribution penalty for it to make sense to keep an IRA open.

If you’re a 45 year old doctor who rolled a two million dollar defined benefit or profit sharing plan into an IRA, then you might keep the account going. If you have $150,000 in your IRA, pay the 10% penalty and be done with it.

I hope you have found this article on what happens to your IRA when you give up US citizenship to be helpful. The bottom line is that 95% of us should close our accounts and be done with the IRA. Only those facing large early distribution penalties should consider keeping their account open.

For more information on how to give up your US citizenship, and how to expatriate from the United States, please contact me at info@premieroffshore.com. 

Keep in mind that the first step in giving up your US citizenship is to get a second passport. Until you have a second passport in-hand, you can’t burn your blue passport. For ideas on where to buy a passport, see my article: 10 Best Second Passports.

Pre-Immigration Tax Planning
Christian Reeves

Pre-Immigration US Tax Planning for Future US Residents & Citizens

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If you’re moving the the United States, get ready for our crazy tax system. Most importantly, if you will become a US resident, be prepared for US tax on your worldwide income. You need to do your pre-immigration US tax planning before you arrive to minimize these taxes.

Let me begin by defining what I mean by a US “resident.” Then I’ll review your pre-immigration tax planning options and what you need to do NOW before landing in the United States.

The United States taxes its citizens and it’s green card holders on their worldwide income. It doesn’t matter where you live or where your business is located. So long as you hold a blue passport or a green card, you will pay US tax any income you earn.

Likewise, the US taxes its residents on their worldwide income. A US resident is anyone who spends 183 days or more in the US in a calendar year. If you spend more than 183 days in one year, and then fewer days the next year, you might be a US resident for both years because a weighted average is used to determine residency.

  • I won’t bore you with the details of how to calculate the average. Suffice it to say, if you spend significant time in the United States, Uncle Sam wants his cut.

A US tax resident is ANYONE who spends 183 days a year in the country. Even if you are here on a tourist visa, or illegally, you are a tax resident and expected to pay US tax on your worldwide income. Your legal or immigration status is separate from your tax status.

US Pre-Immigration Tax Planning Techniques

If you plan to become a US resident, green card holder or citizen, you need pre-immigration tax planning before you move to the America. Some of these strategies require you to plan years in advance. So, if you are working towards residency in the United States, stop and think about taxes NOW.

Minimizing US Tax on the Sale of a Foreign Business

When you sell a foreign business after you become a US resident, you pay US tax on the gain from that sale. This means you’ll pay US tax on all of the appreciation and value that has accrued in your business over the years.

For example, let’s say you started a business in Hong Kong 10 years ago. You invested $100,000 and now the business is worth $1 million. You move to the US and sell this Hong Kong company the following month. The IRS expects you to pay US capital gains tax on $900,000.

Obviously, the simple way to avoid this tax is to sell your business before you move to the United States. I suggest you sell the business and then wait a month or two before traveling to the United States to make sure there are no issues.

But, what if you’re not ready to sell today? What if you want to move to the United States for a year or two and then sell? Serious planning and US filings are required to minimize your US tax obligations.

You can basically sell the business to yourself by making certain elections in the United States for your Hong Kong business. By converting the business from a corporation to a partnership or disregarded entity, you are selling it to yourself for US tax purposes. Do this before moving to the US, and you will have no US taxes due on the phantom sale.

Then, when you sell the company again in one or two years, you will only pay US tax on the appreciation in value from the day you sold it to yourself. This is called Stepping Up Basis. Here’s an example:

You plan to move to the United States on January 15, 2017. So, you file forms with the US IRS to treat your Hong Kong company as a partnership on December 15, 2016.  This triggers a sale of the assets to you, but no tax is due in the US because you are not a US resident for tax purposes. The value of the business on December 15, 2016 is $900,000.

Then, on December 15, 2018, you sell the business for $1 million dollars to a third party. Because of the pre-immigration tax planning you did along the way, you will only pay US tax on the $100,000 of appreciation that accrued from December 15, 2016 to December 15, 2018.

Another business income tax planning tool is to recognize as much income as possible before you move to the United States. You pay yourself as much in salary and bonuses as possible to deplete the value of the Hong Kong company before you move to the United States.

Note that salary from a foreign corporation will be taxed at about 35% Federal plus your State (maybe 12%). So, taking as much in salary before moving to the US can save you big time. Even if it requires borrowing money from banks or other sources, accelerating your income can be beneficial.

Offshore Trusts in Pre-Immigration Tax Planning

When you move to the United States, you need to worry about business tax, personal income tax (salary and capital gains) and death taxes. High net-worth residents pay a tax on the value of their worldwide assets when they pass away.

  • United States death tax applies to residents, green card holders and citizens with assets of more than $5.45 in 2016 and the tax rate is 35% to 40%.

You can minimize or eliminate the US estate tax by giving away your assets before you move to the United States. Most transfers after you become a resident will be subject to US gift tax, which is 40% plus your state.

This form of pre-immigration tax planning can also reduce your US personal and business income taxes. If you give your assets to family who will not be residents of the United States, America can’t tax those assets when sold or as business income is generated.

Most clients want to maintain control over their assets while they are alive. They don’t want to pay US income or estate taxes, but they do want to manage the assets or business for the benefit of their heirs.

This is where offshore trusts come in to pre-immigration tax planning.

When you setup an offshore trust to manage your assets, they’re removed from your US estate and the death tax doesn’t apply. Also, gains or income from these assets can be removed from your US income tax if you plan ahead.

If you set up and fund an offshore trust at least 5 years before becoming a US resident, the income generated in that trust will not be taxable to you in the United States.

Thus, if you are thinking about becoming a US resident, or moving to the United States is a possibility (even a remote possibility), you would do well to create an offshore trust and engage in some pre-immigration tax planning now.

If you can’t meet the 5 year threshold, there are several benefits to creating an offshore trust before moving to the United States. For example, an irrevocable offshore trust can reduce transfer tax, estate / death tax, and protect your assets from creditors. Considering that the United States is the most litigious nation on earth, asset protection is an important part of pre-immigration planning.

I hope that you have found this information on pre-immigration tax planning to be helpful. For more information, and to consult with a US attorney experienced in these matters, please contact me at info@premieroffshore.com. 

asset protection puerto rico
Christian Reeves

Asset Protection for a Puerto Rico Act 20 Business

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Once you have your Act 20 business in Puerto Rico up and running, you need to think about protecting its retained earnings or distributed profits. Asset protection for a Puerto Act 20 business  becomes urgent because of the amount of capital held in the company tax deferred.

There are two levels of asset protection for Puerto Rico Act 20 companies. The first is retained earnings within the Puerto Rico LLC or corporation and the second is asset protection of dividends taken out under Act 22.

When you operate an Act 20 business based in Puerto Rico from your home in the United States, you get tax deferral at 4%. That is to say, if the business owner is living in the US, you can hold  Puerto Rico sourced profits in the corporation tax deferred.

You will pay 4% tax on the net profits earned from work done in Puerto Rico. This cash must stay within the Puerto Rico corporate structure to continue to be tax deferred year after year. When you distribute those profits as a dividends to the US based owner, you will pay US tax on the qualified dividend at 20% to 23.5% + your state.

If you’re operating a business in Puerto Rico under Act 20, and living in Puerto Rico while qualifying for Act 22, then you can withdraw the corporate profits from the corporation each year. This is because residents of Puerto Rico pay zero tax on dividends from an Act 20 Puerto Rican business.

When it comes to protecting the assets of your company, remember that Puerto Rico is a US jurisdiction. Any US judgement will be enforceable in Puerto Rico just as it is in any other State. As a result, you must take steps to protect your cash without changing its status as tax deferred “offshore” profits.

The best asset protection for Puerto Rico Act 20 businesses is to move your cash out of Puerto Rico and into a safe and secure bank. We have relationships with a number of banks in Switzerland, Germany and Austria that will open accounts for your Act 20 company and allow you to hold retained earnings offshore and out of reach of civil creditors.

The next level of asset protection for a Puerto Rico Act 20 company is incorporating offshore subsidiaries. This is done to put a layer of insulation between the Puerto Rico company and the assets held offshore. We can form a corporation in Panama, Cook Islands, Cayman Islands, or any other solid asset protection jurisdiction to manage your corporate capital.

In order to maintain the tax benefits of tax deferral, these offshore companies must be wholly owned subsidiaries of the Puerto Rico Act 20 company. For example, we form a Panama Corporation owned by the Puerto Rico company. This gets us access to all of the banks and asset protection benefits of Panama and allows us to maintain our tax deferral status.

For this reason, we can’t use other more advanced techniques. It would not be possible for the owner of the Act 20 business to create a Cook Island Trust and fund the trust with retained earnings. Once those profits moved from the Puerto Rico company to the Cook Island Trust, they would become taxable in the United States as a distribution.

This limitation applies only to retained earnings. Residents of Puerto Rico operating under Act 22 may use any means necessary to protect their personal after tax assets from future civil creditors. Remember that, unlike a business based offshore, once you have paid your 4% corporate tax and withdrawn the dividends tax free, this is “after tax” money. You can invest and do with it whatever you like, just as you can with money taken from a US business after paying 40% in taxes.

If you’re new to the Puerto Rico tax holiday, and would like to compare it to traditional offshore tax plans, see Puerto Rico Tax Deal vs Foreign Earned Income Exclusion and Move Your Internet Business to Cayman Islands Tax Free

One of the best asset protection systems is to have capital paid directly to a Cook Island Trust. This will maximize the asset protection afforded your dividend distribution and keep it out of the reach of any civil creditor.

We can make arrangements for the dividends to pass directly to the Trust and bypassing any risk of a civil creditor reaching them. We can also setup a subsidiary of the Puerto Rico company in the Cook Islands to facilitate this transfer and the related cash management.

Another offshore asset protection strategy for Puerto Rico Act 20 business will allow you to carry forward the tax benefits of Puerto Rico once you move away from the island and no longer qualify for Act 22.

Let’s say you’ve been operating your Act 20 business for 5 years and have been living in Puerto Rico all of this time. You’ve taken out $10 million in tax free dividends, with the only tax paid being 4% to the government of Puerto Rico.

You’ve had enough of island life, your business has run its course, and are want to return to the United States. Once you make the move, all capital gains, dividends and passive income earned on that $10 million will become taxable by the IRS and your State.

One option is to invest this money into an offshore single pay premium life insurance policy. Money held in the policy will be protected from future civil creditors as well as the US taxing authorities.

This is because capital gains earned within the US compliant offshore life insurance policy are tax deferred. You only pay US tax on the gains if you close out the policy or otherwise remove the cash. Of course, you are free to borrow against the life policy with no tax cost.

If you hold the policy until your death, then the total value will transfer to your heirs tax free (or with a step-up in basis). If you put in $10 million, and it’s grown to $20 million, you’re heirs get $20 million tax free… and the only tax you ever paid on any of that cash is the 4% to Puerto Rico. Quite an amazing tax play.

I hope you’ve found this article on asset protection for a Puerto Rico Act 20 business helpful. Please contact me at info@premieroffshore.com or call (619) 483-1708 for more information on setting up your business in Puerto Rico or on protecting your retained earnings within that structure.