Tag Archive for: International Tax

Retire Overseas Tax Free

Retire Overseas Tax Free

First, let me tell you about my inspiration for this post. France has been in the news and on this site quite a bit recently. They are pushing hard against America’s recent extortion of $9 billion from one of their banks, and I think this could have a major impact on the dominance of the dollar.

You might be wondering what this has to do with how to retire overseas tax free. Well, let me tell you. Like the United States, France taxes the heck out of its citizens … with the maximum rate reaching 75% on incomes over $1 million. These new tax measures have brought in about € 70 billion Euros ($94 billion) over the last three years, but are now driving French citizens out of the country in waves.

Even with this extreme tax rate, I’d swap my U.S. passport for a French one in a heartbeat. You see, France, like most countries, only taxes citizens who live in the country. Anyone can leave France and retire overseas tax free without making any special arrangements … just be out of the country for 163 days a year and you can live, work, and/or retire overseas tax free.

As a result, French citizens are moving to Portugal. This country doesn’t tax foreign pensions and, again, France doesn’t tax its citizens living abroad, so a French citizen may retire to Portugal and live tax free.

In our part of the world, there are many countries that won’t tax your U.S. pension (or your business income, for that matter), such as Panama, Belize, and Chile. Other nations, like Colombia, will only think about taxing you if you are there for more than a few years. In other words, you get to try them out before becoming subject to their tax laws.

Now, here’s the problem. While a French citizen can retire overseas tax free rather easily, Uncle Sam wants his cut no matter where you live. The U.S. taxes its citizens on their worldwide income, including pensions, retirement income, passive and active income, and all forms of compensation. No matter where you live and no matter where the income is generated, the default rule is that you must pay taxes. The rest of this post is about the exception to this rule.

For example, if a U.S. person retires to Panama, and earns $30,000 in capital gain, Panama won’t tax you, but the U.S. will. You are looking at standard U.S. long term (20% ObamaCare tax if applicable) or short term (ordinary) income rates on your income earned in Panama.

Here are four options to retire overseas tax free.

  1. Retire to Puerto Rico

The U.S. territory of Puerto Rico is a special case and is exempt from U.S. Federal Tax laws. As a territory, their rules take precedent over the IRS.

If you retire to Puerto Rico, live there for 163 days of the year, and become a (tax) resident of the island, you can retire overseas tax free. Puerto Rico will not tax your pension or other income, and their long term capital gains rate is 0% on assets (stocks, bonds, real estate, etc.) you acquire after moving. You will pay tax on things you owned before the move, but all stock bought and then sold after becoming a resident is tax free.

Let me clarify. If you retire overseas to Panama City, Panama won’t tax your passive income, but the U.S. IRS will. You will pay 20%+ on all long term capital gains.

This is the case because the default U.S. Federal tax laws control U.S. citizens in foreign countries. If you move to Puerto Rico, and become a tax resident of that U.S. territory, their laws govern and supersede those of the U.S. IRS … because Puerto Rico is a territory and not a foreign country.

Puerto Rico also offers business tax breaks and the above is just a summary of their tax deal for Americans who want to retire “overseas” tax free. Please see my two detailed articles on Puerto Rico for additional information.

  1. Give Up Your U.S. Citizenship

As I have said a few times, the U.S. taxes its citizens on their worldwide income. If you give up your U.S. citizenship, your duties to Uncle Sam are terminated and you may retire overseas tax free … you can’t retire in the U.S. tax free, but you can do so anywhere else you like.

The two most common issues or questions I get on this topic are:

If I give up my U.S. citizenship, can I visit America from time to time? Absolutely. If you have a quality second passport, you can enter as a tourist at any time. If your passport doesn’t allow for visa free travel to the U.S., then you can apply for a visa just like everyone else.

I have had a number of clients do this without issues. They dumped their U.S. passports and returned as a tourist to visit friends and family several times a year. Not one ever had a problem going through immigration.

I even had a client who gave up his U.S. citizenship and then was forced to return to the U.S. as a tax resident by his wife. She decided she couldn’t live so far from her family, so they both became U.S. resident/green card holders using their foreign (second) passports. Now, he is free to burn his green card at any time and go back to his tax free existence … so long as his wife allows it. Giving up your citizenship is a big deal, leaving and no longer being a resident for tax purposes is simple.

This first question begs the second: Do I need a second passport? Yes, you must be a citizen and have a second passport from a country before giving up your U.S. citizenship. If you don’t have a second passport, you would be a person without a country and unable to travel. It’s impossible to give up your U.S. citizenship until you have a second passport in hand.

You can obtain a second passport in three ways: 1) If you have family ties to certain countries, you can come a citizen through lineage … usually because your parents, or maybe grandparents, were born there. 2) You can become a resident of a country like Panama and may qualify for a passport within 5 or 6 years. 3) You can buy a passport from countries like St. Kitts and others.

For additional information on how to obtain a second passport, please see my page (top right menu of this site). We will be happy to help you buy a passport through one of these programs or to become a resident of Panama or Belize.

  1. Eliminate Most Capital Gains or Passive Income Sources

Assuming you don’t want to get rid of that blue passport just yet, you can minimize your taxable income by investing in tax free vehicles offshore.

*Of course, this assumes you don’t need capital gains to live on … that you can rely on your savings.

One option is offshore life insurance. So long as it’s U.S. compliant, the cash in your offshore policy will accrue tax free and may get a stepped up basis when you pass (transfer to your heirs tax free).

Another option to retire overseas tax free is to take only required distributions from your IRA or retirement accounts. These accounts can travel with you overseas, if you move them into an offshore IRA LLC or a Panama Foundation. Then, you can open offshore bank accounts and transfer your IRA or other retirement accounts to your country of residence. The same rules will apply offshore as they would onshore, so you can maintain the tax benefits of your retirement accounts overseas.

Finally, you might create an offshore Trust or Foundation and move your assets into that structure. While you will pay tax on any sales, you can accrue capital gains in the trust and use certain estate planning techniques (such as gift tax exclusions) to minimize or eliminate U.S. tax.

I also note that your IRA or trust can hole gold and real estate. You are not limited to stocks, bonds or treasuries. Certain rules apply to offshore retirement accounts, so please see my other articles for more information.

  1. Convert Passive Income in to Active Income

One of the best ways to retire overseas tax free … is to start a business! While this might sound strange, please allow me to explain.

If you are living and working outside of the United States, and qualify for the Foreign Earned Income Exclusion, you can earn up to $99,200 tax free from your foreign corporation in 2014. If a husband and wife both work in the offshore company, they can both draw a salary and get about $200,000 tax free.

The most common way to qualify for the Foreign Earned Income Exclusion is to move overseas and become a resident of a foreign country. So long as your business doesn’t involve selling to locals, nations like Panama won’t tax you and you can “retire” overseas tax free.

So, if you are an active investor, and spend most of your time trading stocks, maybe you are a professional trader and should incorporate offshore. If you are managing a number of rental properties, or buying land to develop into a multi-unit complex, maybe you are a professional real estate developer and should run that through an offshore company. Maybe your retirement includes selling goods or books over the internet and that should escalate from a hobby to a business. Any of these can become active income and qualify for the Foreign Earned Income Exclusion.

The key to operating a tax free business overseas rather than generating taxable capital gains is how much effort you put in to it. If you are spending 40 hours a week researching, reading, training, and trading, then you are clearly a professional trader. If you are spending 25 hours per week, then you might qualify. If you are regularly and continually searching for and managing real estate projects, you are probably a professional.

So, to retire overseas tax free, you need to spend as much time as possible on your income generating efforts, qualify as a professional in your trade or business, operate through an offshore corporation, qualify for the FEIE, and draw out your profits as tax free salary up to the FEIE and retain any excess in the offshore company.

I hope this article on how to retire overseas tax free has been helpful. If you have any questions, please give us a call or send an email to info@premieroffshore.com. We will be happy to discuss these options with you and plan your new life overseas.

ObamaCare Tax

Avoid the ObamaCare Tax, Offshore Edition

The new ObamaCare tax, called the Net Investment Income Tax, or NIIT, hits U.S. residents and expats alike with a 38% levy on most forms of investment income.  If your taxable income in 2014 was $200,000 (single) or $250,000 (joint), the ObamaCare tax is coming your way.

  • These rates are fixed and will not increase with inflation.

The ObamaCare tax applies to the following forms of income:

  • interest,
  • dividends,
  • capital gains,
  • rental and royalty income,
  • non-qualified annuities
  • businesses classified as passive activities, and
  • income from investment and trading businesses.

Assuming you don’t want to pay any more than necessary to the Obamanation, there are a number of ways to amputate the ObamaCare tax.  For example, you can get a divorce or cancel the wedding to avoid the marriage penalty.  Two single people may earn up to $400,000 before paying in to ObamaCare, compared to a married couple who start contributing to the cause at $250,000.

If you have residency or citizenship outside of the United States, and can qualify to file as a nonresident alien, you will avoid the ObamaCare tax all together, regardless of your income.  That’s right, the NIIT doesn’t apply to nonresident aliens.

If your spouse won’t go for a divorce, and you don’t qualify as a nonresident alien, here are a few other suggestions:

One way around the ObamaCare tax is to give appreciated property to your heirs.  If their incomes are below the $200,000 and $250,000 thresholds no NIIT will be due.  This can also have significant estate planning and asset protection benefits.

As you may know, when you donate property to your children, who are minors or full-time students up to age 24, they must pay capital gains at your higher rate.  However, the ObamaCare tax does not apply to this kiddie tax.

Another solution to the NIIT is to form a Family Foundation and donate appreciated property to that Foundation.  This allows you to maintain control over the property, take a deduction for the fair market value on this years return, and then transfer small portions each year to a charity.  This allows you to maximize your deduction and avoid both the capital gains and NIIT taxes… all while maintaining control over the assets.

  • If you don’t need to control the distributions over a number of years, you can achieve the same benefits by donating the appreciated property to a traditional charity.

You can also cut out the ObamaCare tax by lending money to your onshore or offshore business.  Interest income from a third party is taxable under the NIIT, but interest coming from your own business is not.  This is a rather strange differentiation, but should motivate you to invest in your business.

Along the same lines, if you take an active roll in a business, rather than being a passive partner, dividends and royalties from that company are not subject to the ObamaCare tax.

An active roll, or, more properly, material participation, means that you spend at least 500 hours per year in the business, you are the primary worker, or you can show a consistent work history in the company.  Special care should be taken when converting from passive to active, as other taxes might outweigh the NIIT.  But, it is quite possible for this to save you money.

If your business is offshore, and you qualify for the Foreign Earned Income Exclusion, then you should be taking out the full exclusion each year to maximize the benefits of being offshore.  This means you (and you spouse) should be taking $99,200 in tax free salary from your offshore company in 2014 and holding any excess as retained earnings in the offshore corporation.

The ObamaCare tax doesn’t apply to this salary.  As you will be an active participant in the business, which is why you qualify to take the FEIE, you will also avoid the NIIT on interest, dividends and royalties this business generates.  When combined, these savings should be major incentives to invest in your offshore company.

  • If your offshore company needs cash, take the full FEIE salary and lend back whatever is requires.
  • Note that these benefits do not apply to an onshore or offshore company in the business of trading financial instruments or commodities.

Keeping the trend going, you can rent property to your business and avoid the ObamaCare tax on these payments.  The NIIT usually applies to rental income, but not if it comes from your onshore or offshore company.

Leaving offshore companies behind, you can also avoid the ObamaCare tax when you sell your real estate by doing an exchange rather than a traditional sale.  A Section 1031 exchange allows you to swap one like-kind property for another and defer the capital gain until you sell the acquired property.  A 1031 exchange also defers the ObamaCare tax for as long as you hold the property.

“Like-kind” means that the property you swap for must be similar to the one you are giving up.  So, you can transfer one business property for another, one rental for another, etc.  However, you may not swap a U.S. property for a foreign property.  You must swap a U.S. property for another U.S. property… and you may exchange a foreign property for another foreign property.  The foreign properties need not be in the same country.  The only requirement is that they both be outside of the United States.

My last suggestion on how to eliminate the ObamaCare tax is that you might sell your losing stocks and use these tax losses against your winners.  This common tax mitigation strategy works against the NIIT as you may net capital gains against capital losses and calculate the ObamaCare tax on the net.  Even better, you can use a carry forward loss against current year gains to keep the NIIT at bay.

I hope you have found this article on cutting out the ObamaCare tax helpful.  If you have questions about forming or operating an offshore company, please contact me at info@premieroffshore.com.  I will be happy to work with you to structure your offshore business and keep it in compliance with the Internal Revenue Service.

Dollar Will Fail

The Offshore Tax Inversion

What the heck is an offshore tax inversion and why should I care?  The inversion has been all over the news and was even called “un-American” by our President today (July 25, 2014).  Here is everything the small to medium sized business owner needs to know about the tax inversion.

Where a large corporation is headquartered is called its tax home.  Its tax home is usually where its “brain trust” is located… where its President, CEO, CFO, and primary decision makers reside, often the tax home of a world-wide conglomerate.

Where a corporation tax home is located determines which laws guide the business.  So, if your tax home is in the United States, then the U.S. laws control.  If you move your headquarters to a country that is business friendly and has less onerous lax laws, then that nation’s laws govern.

An offshore tax inversion occurs when a large corporation headquartered in the U.S. acquires another large corporation located in a tax friendly jurisdiction, such as Ireland.  Then, they move the decision makers to Ireland, turning it in to their headquarters and thus their tax home.

Once the offshore tax inversion is complete, U.S. tax laws only apply to any officers or production facilities located here.  Most tax inversions are done to save many hundreds of millions in taxes on worldwide income and to get away from the complex sections of the U.S. tax code, such as the Controlled Foreign Corporation and Passive Foreign Investment Company rules.

A tax inversion can be compared to an individual changing his citizenship and moving out of the U.S.  All U.S. citizens are taxed on their worldwide income.  If you dump your U.S. passport and move to a country with more favorable tax laws, you probably won’t pay tax on your worldwide income… just on your local income.

In much the same manner, a corporation changes its domicile and tax home through an offshore tax inversion.  Once its headquarters are moved, it only pays U.S. tax on its remaining U.S. operations.

While the offshore tax inversion is used by large corporations to get out of the U.S. tax system, there are other provisions of the U.S. code that allow smaller businesses to do the same.

Those of us with a smaller operation can take our business and ourselves offshore, qualify for the Foreign Earned Income Exclusion, and earn up to $99,200 per year free of Federal Income Tax using an offshore corporation.  If we leave some employees in the U.S., we will pay some tax to the U.S.  If we get rid of all U.S. ties, we can eliminate U.S. tax all together… even if our sales are to U.S. persons.

  • Tax is based on where you and your business are located, not by where your customers are.

If you are thinking about moving your business offshore, please start by browsing my articles on the Foreign Earned Income Exclusion.  Basically, you need to move abroad and become a resident of another country or be out of the U.S. for 330 of 365 days to qualify.

Next, you can form an offshore corporation and draw a salary up to the FEIE amount.  If a husband and wife are working in the business, and both qualify, each can take a salary and you’ll (basically) get to earn $200,000 free of U.S. tax.  If your business profits exceed this amount, you may retain earnings in your offshore corporation and defer U.S. tax for as long as you like.

You’ll find a number of articles on this site describing how to take your business offshore.  If you have any questions, please send an email to me at info@premieroffshore.com.

IRS Collection Statute

IRS Collection Statute for Expats

A few days ago I wrote an article on dealing with the IRS as an expat.  Apparently, a number of you are carrying tax debt and are concerned with the IRS collection statute – how long the IRS has to collect that tax debt.  This article is specifically for those living abroad that owe the IRS.  The IRS collection statute might just be the fresh start you have been looking for.

The basics of the IRS collection statute are these:  They have 10 years to collect from you once a tax is assessed.  A tax is assessed when you file a return, an audit is completed and your appeals run their course, or the government computers prepare a return for you based on whatever information they may have (called a substitute for return).

If you never file a return, and the IRS doesn’t prepare one for you, the IRS collection statute never starts.

The IRS collection statute is placed on hold whenever the IRS is prohibited by law from collecting from you.  This is usually when you file an Offer in Compromise, a Collection Due Process request, or bankruptcy.  These can delay the IRS collection statute for many months or years.

Not to hurry the lead, but the IRS collection statute is put on hold while you are out of the United States.  More specifically, Sections 6502 and 6503(c) of the U.S. Tax Code work together to extend the collection statute if you are out of the U.S. for “a continuous period of six months or more.”

That is to say, if you are out of the U.S. for any six month period, the IRS collection statute is extended.  If you return every few months, so you are never gone for six months, then the IRS collection statute is never tolled.

Application of the IRS Collection Statute

If you incur a U.S. tax debt while living abroad, and you never set foot in America, the collection period never starts.  If you incur a tax debt and then move abroad, again never visiting your country, the collection period (basically) never starts.

Conversely, if you’re visiting family in the U.S. every few months, even for a day or two and thus never out of the country for a continuous period of at least six months, the IRS collection statute is running and the debt will expire in 10 years.

If you incur a U.S. tax debt while abroad, and then return to the U.S., the collection statute starts when you touch down.  So, if you are traveling to America from time to time, you might want to make sure you are never out for six months.

There is one more minor issue for expats.  If you are out of the U.S. for six months or more, and when you return the IRS collection statute is about to expire, the statute is automatically extended for six months.

Basically, if you are out of the country for six months or more, the IRS will always have six months after your return to get you and your assets.

Now let’s talk about the practical implications of the IRS collection statute on expats.  Most of you will find that the IRS computers stop sending you bills, and that your debt will drop off and out of the system, after ten years.

If the great collector ever gets its act together, and compares the travel days claimed on IRS Form 2555 filed with your personal return, expats with tax debts might well have an issue.  So far, this has not happened and the collection statute is running… at least the computers are processing bills as if the debts have expired.

If you want to know how much you owe the IRS, you can phone them and ask for a Transcript of Account.  This will tell you which years show a balance due, as well as the tax, interest and penalties that have accrued.

If you know you owed for a particular year, and think the 10 year collection statute may have run, you can call the government and ask the status of a particular year.  Though, I wouldn’t mention to them you are living abroad.

I hope this post helps to clarify the IRS collection statute and how it applies to expats.  If you have any questions, feel free to call or send an email to info@premieroffshore.com.

IRS Audit Statute

Offshore IRS Audit Statute

For most Americans, the IRS audit statute, the amount of time the IRS has to come after you once you have filed your return, is three years.  Not so for those with foreign accounts and foreign assets.  In most cases, the IRS has six years to audit your international investments.

First, let’s review the IRS audit statute of limitations.  Basically, it says that the IRS has three years to come after you once your file a tax return.  If you never file, the IRS audit statute never starts… so file your returns.

There are several exceptions to this three year IRS audit statute of limitations.  For example, if you omit more than 25% of your income, the three year statute is doubled to six years.  Which is to say, if you have a substantial understatement, the IRS has six years to find it.

  • It is common for tax preparers to allow returns with aggressive deductions that don’t exceed 25%.

Also, there is no IRS audit statute of limitations for fraud.  If the IRS can prove fraud, which is tough for them to do, they can go back as far as they like.  In practice, it is rare for the IRS audit statute to be extended beyond six years.

For U.S residents who keep their money at home, the IRS audit statute of limitations is linked to your income.  If you make $100 million, and make an error of $10 million, the statute will not be extended to six years without a showing of fraud on your part… again, the IRS’s burden on fraud is high, and so it is not used too often.

For those of us living, working, or investing abroad, it’s a different story.  If you omitted more than $5,000 of foreign income from your return, regardless of your total income, the IRS audit statute is doubled to six years.

That’s right… if you made $100 million, and inadvertently omitted $5,000 of foreign income from your personal income tax return, your IRS audit statute is six years.  And, this increase applies to every aspect of your return, not just your foreign source income.

Even worse, and as I stated above, if you never filed a particular return, the audit statute never starts.  So, even if you reported all of your foreign source income, but you did not file an offshore corporation return (IRS Form 5471) or an offshore trust return (IRS Form 3520 and/or 3520-A), the IRS audit statute for these foreign structures never started.

The same holds true for the Foreign Bank Account Report form, commonly called the FBAR.  If you never file this form, the IRS can audit your offshore bank accounts as far back as they like… and impose penalties of up to $100,000 per year.

And this is one of the ways the IRS goes after expats and those with foreign assets even after the six years has passed.  You might have included some, but not all, of your foreign income on your return and were just waiting for the three year or six year IRS audit statute to pass.  Well, if you did not file the forms required in addition to your 1040, your clock never started to run.

I note that failure to file the FBAR, financial asset report and offshore company or offshore trust forms extends the IRS’s time to audit those forms, as well as add any tax due to your personal return.

In addition to the items above, which are specific to those of us living, working, and investing abroad, there are other ways your IRS audit statute can be extended.  The most common is by mutual agreement between you and the IRS.  If you are being audited and either side needs more time, you will be asked to sign an IRS audit statute extension.

Most of us in the tax representation game suggest you should extend the statute whenever asked.  The reason is simple:  if you don’t agree, the IRS assesses whatever additional income you have and disallows all expenses and deductions you took on your return.  From here, you can fight it out with appeals and the IRS audit statute is not an issue… the audit is over.

Your IRS audit statute can also be extended by your filing an amended return.  If you file a return with an increase in tax (balance due) within the three year audit statute, your statute is not increased.  If you file a return with a balance due after the statute runs out, the IRS gets one year to revise it.  So, file your amended returns with a balance due 60 days before the statute runs out and cut the Service off before they get to you.

  • An amended return that does not have a net increase in tax does not extend the IRS audit statute.

Understanding the IRS audit statute can become a major issue and determine how far you want to push the envelope.  It begins with you filing a return, so always send in your returns by certified mail or file electronically.

Note that this article is focused on the IRS audit statute.  Your state may also treat your domestic and international source income differently.  I will mention that my State of California has a four year audit statute rather than the more traditional three year period.  You should check with your local office.

Offshore business tax reporting

Offshore Business Tax Reporting Summary

If you’re operating a business outside of the United States, your offshore business tax reporting obligations can be daunting.  Failure to comply can result in significant interest and penalties, the loss of your business, and even the loss of your freedom.  Here is a brief description of the most common offshore business tax reporting obligations.

The first and most important offshore business tax reporting obligation is not about paying taxes, but reporting where your assets are located.  FinCEN Form 114, commonly referred to as the FBAR, requires you to disclose your foreign bank accounts if you have more than $10,000 offshore.  This form requires the name of the bank, account number, account size, address of the bank, and whether you own the account.  Failure to file FinCEN Form 114 can result in a penalty of up to $100,000 per year and 5 years in prison.

The next non-tax offshore business tax reporting obligation is IRS From 8939, “Statement of Specified Foreign Financial Assets.”  This one expects you to disclose all assets and investments you hold outside of the United States.  It is only required if you have “significant” assets abroad, so check the instructions for the filing requirements.  They vary depending on where you live (in the U.S. and abroad) and whether you are married or single.

There are several exceptions to Form 8939.  For example, you do not need to report gold you hold in a vault nor real estate that you hold in your name.  For more information, please see my articles on gold and offshore real estate.

The balance of your offshore business tax reporting obligations are in concert with your personal income tax return (Form 1040) and the forms are attached there, too.  For example, you should be drawing a salary from your offshore company of up to the Foreign Earned Income Exclusion and retaining earnings in excess of this amount ($99,200 for 2014).  To accomplish this, you will attach Form 2555, “Foreign Earned Income,” to your personal return.  This form requires information on your employer (the offshore company you own), your salary, foreign residency if any, and your travel days to and from the United States.

The largest (in terms of number of pages) offshore business tax reporting item is IRS Form 5471, “Information Return of U.S. Persons with Respect to Certain Foreign Corporations.”  This is a full blown corporate tax return, akin to IRS Forms 1120 and 1120-S.  It will require information on the owners and shareholders of the offshore business, as well as Profit and Loss and Balance Sheet data.  It includes a variety of forms and schedules and is attached to your personal income tax return.

Because Form 5471 goes in with your personal return, it is due whenever your 1040 is due.  If you’re living in the U.S. on tax day, you need to mail it by April 15.  If not, you can get an automatic extension to October 15.  If you are living outside of the U.S., you get an extra two months to file.

If you will use an offshore Limited Liability Company to hold intellectual property, or to manage personal investments, you will file IRS Form 8858, “Information Return of U.S. Persons with Respect to Foreign Disregarded Entities.”  This form allows you to create subsidiaries of your parent corporation and eliminates corporate level tax on passive investments that you wish to flow through to your personal 1040 or Form 5471.

Finally, if you will hold your business inside an offshore trust for estate planning, privacy and asset protection purposes, you may need to file IRS Forms 3520 and 3520-A.  These will allow you to hold your offshore business in an offshore asset protection trust and may provide significant tax benefits if your estate is over $5 million.

The bottom line of IRS Forms 3520-A and 3520 is that income from the trust will flow through to the settlor’s personal income tax return (your 1040).  Only at your passing will your heirs need to begin reporting and paying tax, albeit at a stepped up basis.

I hope you’ve found this post on offshore business tax reporting interesting.  See our tax section (top right of the website) for more detailed information.  If you are interested in receiving these posts by email, please sign up for our free email newsletter.

U.S. Source Income

What is U.S. Source Income?

All income that is U.S. source income is taxable in the United States.  Income that is not U.S. source income is not taxable.  So, planning to ensure your business income is not considered U.S. source income is the only way to keep Uncle Same out of your wallet.

This article will describe U.S. source income and tell you how to avoid it in your offshore company.  From here on, I will assume that you are living and working abroad and that you qualify for the Foreign Earned Income Exclusion.  If you are not sure you qualify, please check out the various articles on these topics before reading on.

Your offshore company must pay U.S. tax on any U.S. source income, so a quality international tax plan will do everything necessary to ensure you have no U.S. source income.  Note that whether your profits are U.S. source income is not determined by where your clients are located.  It is based on where you and your company are doing business.  If your business is operating from Panama, and all of your customers are in the United States, you probably do not have U.S. source income.

In other words, if your offshore company has minimal contacts with the United States, then it does not have U.S. source income.  If your offshore company has significant ties to the U.S. then you probably have U.S. source income (U.S. Tax Code Section 882).

The income earned in your offshore company is U.S. source income, and thus effectively connected to a U.S. business, if you have an office, employees, or other similar connections to the United States.  Even if most of your operations are in Panama, and you have an office in California, you will have some U.S. source income (U.S. Tax Code Section 86(c)(1)-(3)).

If you don’t have employees in the U.S., you are not necessarily safe from U.S. source income.  There is much planning that goes in to ensuring your offshore company’s contacts with the U.S. don’t rise to the level of being engaged in a business within the United States.

The simplest case is when you have an internet based business in Panama, selling an electronic product, such as a book delivered by email.  Assuming all staff and banking is in Panama, you have no U.S. source income.

If we take the same example, but we move banking and credit card processing in to the United States, assuming no other contacts, you still don’t have U.S. source income.  An offshore company with bank and merchant accounts in the U.S. is not conducting a business in the U.S. for tax purposes and thus has no U.S. source income.

Keep in mind that it does not matter where your customers are located.  Title/ownership of the electronic product passes to the buyer in Panama, where the business is located.  Even if 100% of your customers are in the U.S., you are safe.

Add to this a website and IT in the United States and you still do not have U.S. source income.  Hosting your internet e-commerce site in the United States does not create sufficient contacts to result in U.S. tax.

Now, let’s change the electronic product to a physical product such as a new miracle vitamin.  If you don’t set up a plant that manufactures the vitamin, you will have U.S. source income.  If your Panama company contracts with an unrelated/independent fulfillment house, you can avoid this tax issue.

To clarify, the independent fulfillment house must be providing similar services to other companies, and not be controlled by you.  If it were, it may be considered a branch of your Panama company.

The safest scenario is a fulfillment house that is manufacturing the same or similar products for many firms, slapping your label on the bottle, and shipping it to your customers.  Again, so long as this is an arms length transaction, it will not result in U.S. source income.  See IRS Treasury Regulation 1.864-7(d)(3)(i) and 1.864-7(b)(1).

Since we are piling on, let’s now assume you are marketing your business through an affiliate marketing group.  For those of you not so tech savvy, an affiliate marketer is someone who advertises your web page through search engines and pay per click to earn a commission on each sale they generate.  Leads are tracked by “cookies” that are saved on to your computer each time you click on one of their links.

I believe contracting with an affiliate network is safe and will avoid U.S. source income.  In an affiliate network, you pay the network (i.e. management firm) and they pay their agents.  If these agents are independent contractors, then the network is responsible for issuing 1099s and U.S. tax issues.  See U.S. Treasury Regulation 1.864-7(d)(3)(i).

I strongly recommend working with affiliate networks rather than contracting with individual affiliate marketers.  If it was found that your affiliates are employees and not independent contractors, in a payroll tax audit, then some of your income may be deemed U.S. source income.  The U.S. would like nothing better than to tax a Panama corporation.  The risk of having the marketers reclassified as employees is eliminated with a network.

I will conclude by pointing out that the U.S. source income tax rules are not an “all or nothing” proposition.  If it is found that you have both U.S. source and foreign source income, then only that income earned in the U.S. will be taxable in the U.S.  Foreign source income will still be eligible to be retained in your offshore company.

In that case, the calculation of what is U.S. source income and what is foreign source income is referred to as transfer pricing.  You and the IRS must agree on how much value is being added to the product (your vitamins) by your sales office in the U.S. and how much value is being added by the office in Panama.

If the transfer pricing analysis finds that 50% of the value of the bottle of vitamins is being derived from the work you are doing through your branch in the U.S., and 50% is being created by the parent company in Panama, then half of the net profits from the sale of the product is taxable in the U.S. and half can be attributed to Panama and retained in that offshore company as active business profits.

If you are considering forming a business outside of the United States, proper planning will consider these U.S. source income rules.  Please call or email us at info@premieroffshore.com if you are considering forming an international business.  We will be happy to design and incorporate an offshore company that will maximize your tax benefits and keep you in compliance with the U.S. IRS.


Controlled Foreign Corporation Defined

If you are doing business offshore, you need to understand the IRS Controlled Foreign Corporation rules.  It is these tax laws that allow you to retain earnings from an active business offshore.  These same rules force you to pay tax on passive income.  If you have a non-U.S. partner, then avoiding the Controlled Foreign Corporation rules is great international tax planning.

Any business that is incorporated outside of the United States with a U.S. shareholder or shareholders directly or indirectly owning or controlling more than 50% of the entity and is a Controlled Foreign Corporation for U.S. tax purposes (Section 957 (a)).

It is important to note that it is more than 50% of the vote or control, which is another way to say ownership or control of the company.  So, while you might assign nominee directors and voting proxies to an offshore corporation, so long as a U.S. person is pulling the strings (control), the entity is a Controlled Foreign Corporation.  Back in the day, nominees were powerful tools.  Under current IRS rules, they are of little value.

Indirect ownership of a Controlled Foreign Corporation can also refer to shares held by your children.  Even if they are not U.S. persons (you are living outside of the U.S. and they don’t hold U.S. passports), the attribution rules mean the offshore company you and your kids control is a CFC.  See Section 958(b).

These same attribution rules apply to ownership of the offshore company by a foreign trust.  Most offshore trusts are taxed as grantor trusts.  In that case, the settlor of the trust (presumably you) is deemed to be the owner of the shares of the company because you control the trust.

If the offshore company is owned by an offshore trust that is not a grantor trust, your heirs are usually the beneficiaries.  In that case, ownership is attributed back to you, the settler, and, again, the offshore company held by the offshore non-grantor trust is considered a Controlled Foreign Corporation.

What Does Being a Controlled Foreign Corporation Mean?

So, what does it mean to you, the American business person operating abroad, that your offshore company is a Controlled Foreign Corporation?  It means that the subpart F anti-deferral rules defined in Section 951 of the U.S. tax code apply.  These rules disallow continued reinvestment by forcing the distribution of certain types of income, summarized as passive income.  It also means that these types of income, regardless of whether actual corporate dividends are paid, will not be eligible for U.S. income tax deferral as retained earnings.

Now, let me translate that into English.

Because your offshore company is categorized as a Controlled Foreign Corporation, you don’t get to defer U.S. tax on passive income and capital gains the business generates.  Assuming you are living and working abroad, and qualify for the Foreign Earned Income Exclusion, you can defer U.S. tax on active business income by holding it in the company, but not passive income.

Also, if you have passive income, such as capital gains and interest on your investments, and you don’t pay it out to the shareholders, those owners are still required to report and pay tax on it.  This often frustrates partners because they are paying tax on money they did not receive, but that’s offshore tax law for you.

Let’s say you are living and working in Panama, and operating your business through a Belize entity to minimize or eliminate tax in Panama.  That company nets $300,000 in profits this year (2014).  You and your wife are both working in the business and both qualify for the Foreign Earned Income Exclusion.  Both you and your spouse should take out the maximum Foreign Earned Income Exclusion as salary from the Belize company.  Let’s round that up to $100,000 each, for a total of $200,000.

As a result, the offshore company has left over profits of $100,000.  The Controlled Foreign Corporation rules allow you to keep that $100,000 in the corporation and not pay U.S. tax on it until you take it out as a dividend or in some other form… which is great for you.  You are operating free of tax in Panama and free of current tax in the United States because of your structure.  Your U.S. taxes are deferred for as long as you leave the cash in the offshore company.

Now, let’s assume you’ve built up $1 million in retained earnings in your offshore company over a few years.  That cash generates $30,000 per year of interest income (a 3% return from your bank).

Because your offshore company is a Controlled Foreign Corporation for U.S. tax purposes, that $30,000 is taxable on your personal income tax return, Form 1040.  If you distribute it out to yourself, you have $30,000 in hand with which to pay the tax.  If you leave this interest income in the offshore company, you still must pay the tax.

There is only one way to avoid this Controlled Foreign Corporation issue.  If your business partner is not a U.S. citizen and not a U.S. resident, and he or she owns 50% or more of the venture, then the company is not a Controlled Foreign Corporation and may be eligible to retain passive income.

Note that you are still required to report an offshore company which is not a Controlled Foreign Corporation to the IRS on Form 5471.  So long as U.S. persons hold 10% of an offshore company, you will have U.S. reporting requirements.

I hope you have found this article on Controlled Foreign Corporations to be helpful.  For assistance in structuring your offshore company or business, please give us a call or send an email to info@premieroffshore.com.  We will be happy to work with you to structure your affairs.

You can find additional information on this site on how to eliminate your U.S. filing obligations, such as Form 5471, the FBAR, and others… assuming you have a partner or spouse who is not a U.S. person for tax purposes.

State Tax for Expats

State Tax for Expats

If you are planning to live, work, or invest offshore, you need to plan for your state taxes.  This State Tax For Expats guide will help you eliminate your state’s taxes and keep you out of trouble with local tax authorities.

If you move offshore, and plan to return to your home state, then your state’s tax laws apply to all income you earn abroad.  So, state tax for expats battles center around the issue of your intent to return… whether you moved out of your state and took up residency elsewhere, or if you remain a tax resident of that home state.

If your state’s tax laws remain attached to your income, then you need to know how your state treats foreign income.  For example, some states have laws that match the federal government’s Foreign Earned Income Exclusion so you can earn up to $99,200 in wages while abroad and pay no federal or state tax.

Others have a variation of this law, while yet others, like California have no FEIE and thus attempt to tax ALL income you earn abroad.  You must research your state’s laws before you devise a plan to move offshore.  I’ll focus on California because that’s the state I’m most familiar with.  If you are living in a tax free state like Texas or Florida, your state tax for expats analysis is simple – no problems.

As I said above, State Tax For Expats is focused on your intention.  If you move abroad and intend to return to your home state, then its laws govern.  If you move to another country, become a tax resident, and do not intend to return, then you should have no state tax obligations.  While this sounds great, it is much more difficult to prove… especially if you are moving from a hungry and aggressive state like California.  I also note that the burden of proof is on you to show that you intended to move out of your state and not return for the foreseeable future.

For example, if you are a contract worker in Iraq, on a 3 year agreement, and you keep a home and family in California, you remain a resident of California for tax purposes.  No one will believe you intended to move to Iraq for the foreseeable future… you intended to work there for the term of your contract and then return to your home and family in California.

That is to say, your state will want its share if you leave sufficient contacts in that state.  If your wife, school aged children, home which you have not rented out on a long term contract, bank accounts, driver’s license, are all in California, you are probably a tax resident of California.  If your job is such that you obviously intend to return to California, then you are probably a tax resident of California.

Though, it is possible to be a tax resident of a foreign country and not a state in the U.S., while your wife and children are here.  I have had three clients over the years in that situation.  One was an attorney living and working for 15 years in the U.K., while his wife and kids remained in California.  He would spend about 30 days a year in the state.  Note that is one of the toughest state tax for expats situations, but it can be overcome.  In this case, he qualifies as a resident of the U.K.

Of course, California found a way to get to at least some of his worldwide income.  They passed a law that basically says the income of a family unit is attributable equally to each spouse.  This law passed legal challenges in community property states and means that 50% of the U.K. lawyer’s income is attributable to his wife’s support (taking care of the children, etc.) and is thus California source income and taxable in the state.

That’s right, if you are living and working abroad, qualify for Foreign Earned Income Exclusion, are a tax resident of a foreign country, and remain married to someone living in a community property state, 50% of your income is taxable in that state.  One solution is to get a divorce.  Some suggest that prenuptial or transmutation agreements may also help.

Adding insult to injury, because California has no Foreign Earned Income Exclusion, state tax applies to all California source income.  If the attorney were to earn $99,000, he would owe no Federal tax, but 50% of the income would be taxed by California at around 9%.  This is why state tax for expats can be so confounding to the uninformed.

Capital gains is another issue you must consider when dealing with state tax for expats.  Let’s say you move out of the United States to Panama.  You move to Panama permanently, obtain residency, file taxes (if applicable), become part of a community there, cut all ties with your home state by selling your home, etc.

However, you leave your bank and brokerage accounts in the U.S. and your state has no idea that you left.  They won’t get notice (Form W-2) from your job in Panama, but they will receive 1099s from your bank and brokerage accounts.  And, these 1099s will reflect only the sales, and not the purchases in that trading account.  This means the state will have a very distorted view of your income… all stock sales and no expenses/purchases.

California will take this information and prepare a return on your behalf, create a tax bill, and attempt to collect.  The first you may hear about this is when they empty out your U.S. bank and brokerage accounts with a tax levy.  Think I am exaggerating?  I have represented too many clients to count over the years in this very situation.  One was a day trader with a net loss on his brokerage account, but $1 million in sales for 2012.  California taxed that $1 million and levied his account for the balance due.  He was left to negotiate, beg, and file a claim for refund.  He had to prove he was not a resident of California, which is an uphill battle… especially after the government has a hold of your cash.

When dealing with state tax for expats, you have two options:  1) move everything out of the reach of your state, or 2) move to a state with no income tax for a year before you go offshore.  Option 1 will protect your assets, but option 2 will protect you AND avoid a confrontation.

Had my client moved his wife and child to Florida or Texas before going to work in London, he would have zero state taxes to pay.  Assuming his income was $99,000 (it was closer to $800,000), he could have also moved them to any state with a matching Foreign Earned Income Exclusion with the same result.

Likewise, you can first relocate to a non-taxing state, file a partial year return with your state referencing the change, and then go offshore without the risk of California coming after you.  This prevents the substitute for return issue, and makes an audit unlikely.  People in the military have been doing this for years.  Expats should take a page from the Navy’s playbook.

However, you must be sure to cut all ties with your original state and become a resident of Florida or Texas before going offshore.  You should sell or rent out any real estate (I am a big believer that selling is better than renting), close any bank and brokerage accounts in California and open new ones in Texas or Florida, get rid of your CA driver’s license, and cut all ties with California.

As you can see, it is important to be proactive when dealing with the state tax for expats issue.  Remember that these state tax problems can come back to bite you years after you move offshore, so dealing with them now will save you in taxes, interest, penalties, and fees to a CPA or Attorney.

IRS Levy

How to Settle Your Expat Tax Debt

If you are a U.S. citizen living abroad, you have the same rights and responsibilities when it comes to your expat tax debt as those stuck in America.  The IRS has ever increasing powers to collect on that expat tax debt, so it is in your best interest to get into compliance and make arrangements to settle your IRS debt.

Maybe you read my post on the new Offshore Compliance Program, or you just decided it was time to come out of the shadows and file and settle your expat tax debt.  Maybe you had a very profitable year, followed by two low income years, and don’t have the cash to pay off the IRS.  This article is dedicated to you.  Here is how you can get the IRS off your back.

Expat Tax Option 1:  IRS Installment Agreement

If you owe money to the U.S. government, and have assets abroad, you can rest assured that the IRS will find a way to get to you.  While this might scare some, I say it to entice you to come forward, file and delinquent tax returns, and make payment arrangements.  Don’t make them chase you down.  I guarantee that will only make matters worse.

Just like the U.S. resident, the expat with an IRS tax debt has a right to an installment agreement.  Whether you owe $10,000, $25,000, or $100,000, you can set up a payment plan that will allow you to resolve your IRS debt over time.

If your expat tax debt is $20,000 or less, you can phone the IRS and ask to pay $500 to $1,000 per month.  They will usually accept such an offer and no financial information will be required.

If you owe more than $20,000, setting up an installment agreement is more complex.  You must complete IRS Forms 433-A and 433-B, which are detailed financial statements that describe your income, expenses and assets.  You will also need to provide proof of your income and expenses, such as 6 months of bank statements, rental agreements, proof of an auto payment, etc.  No, the government will not take your word for these items!

The key to resolving your expat tax debt is to produce an accurate financial statement that you and the IRS can live with.  You will agree to pay what you can afford, and if the government finds your expenses reasonable, you will reach an accord.  If you are able to pay off the debt within 24 months, the IRS will be lenient on your expenses.  If you are not able to make substantial payments, they will be more aggressive.

And it is these allowed standard expenses which are typically the focus of contention in expat tax debt settlement cases.  The IRS doesn’t want you living high on the hog while not paying your “fair” share.

For the U.S. resident, these allowed standards are set in stone.  You can go to www.IRS.gov and search for “collection expense standards” to find national standards and local standards for housing and utilities.  No such standards are defined for those with expat tax debts.  The IRS negotiates your allowed housing and living expenses on a case by case basis.  This means that much of the burden of proving what is reasonable falls on you.

Of course, this gives the U.S. expat a bit more room to negotiate.  The IRS agent can accept just about any amount which he or she finds to be reasonable.  So, if you will pay off the debt within a few years, and certainly well within the collection statute (more on this later), they can be more lenient with you.  Their hands are tied when it comes to these standards and the U.S. resident.

Expat Tax Debt Option 2:  Offer in Compromise

If you are not able to pay your expat tax debt over several years, and you don’t have assets (either in the U.S. or offshore), then you might be one of the very few who get an Offer in Compromise.

First, I would like to point out that much of the information available on the internet about the IRS Offer in Compromise program is false, misleading, or a scam.  Most promoters promise you “pennies on the dollar” deals but they are very few and far between.  Do your research and don’t fall for a scammer if you are considering an IRS Offer in Compromise.  This goes double for the expat, whose case for an OIC is even more challenging than the U.S. resident’s.

Next, while you have a right to an installment agreement if you can’t afford to pay the bill in full, you have no right to an Offer in Compromise.  An OIC is at the discretion of the IRS and depends on your situation and on the agent assigned to your case.  About 25% of the OICs filed are accepted.

In order to qualify for an IRS OIC on your expat tax debt, you must prove to the IRS that:

1)  There is some doubt as to whether the IRS can collect the expat tax debt in full – now or in the foreseeable future.  This standard is called “doubt of collectibility.”

2)  Due to “exceptional circumstance,” forcing you to pay your expat tax debt in full would be unfair, unreasonable, inequitable, or otherwise create an economic hardship.

Those of you who have followed my writings know that I was a U.S. tax attorney for over a dozen years.  In that time, I never saw one OIC approved under exceptional circumstances.  So, let’s talk about OICs based on doubt of collectibility.

First and foremost, doubt of collectibility DOES NOT mean that your assets are offshore and out of the reach of the IRS.  The government is to treat OICs and installment agreement requests from expats the same as they treat filings from U.S. residents.  They place no weight on the risks or expenses associated with collecting from an expat whose assets are secure.

Next, the expat has the same problem with the Offer in Compromise he did with the installment agreement:  the allowed expense standards are not well defined.  You and the agent might have very different ideas on what it takes to live safely and reasonably abroad.

While this lack of expense standards might be helpful in negotiating an installment agreement that will pay off your expat tax debt in a few years, they are a challenge in the IRS OIC program.  The IRS doesn’t like to give expats (or anyone for that matter) what they consider a free ride.  They might push down on your expenses to the point where an OIC is impossible.

If you can get past these issues, you have the same rights as the U.S. resident when it comes to the OIC.  In order to apply for the program, you should first take a look at www.irs.treasury.gove/oic_pre_qualifier/ to determine whether you are a candidate for the IRS Offer in Compromise.

When you submit an OIC, you must make a good faith payment, and pay the user fee.  The user fee is $150 and the good faith payment is 20% of your offer amount.  So, if you are offering to settle your expat tax debt of $100,000 for $10,000, you pay $150 + $2,150.

Expat Tax Debt Option 3:  10 Year Collection Period

Often the best expat debt relief option is running out the clock.  The IRS has 10 years to collect from you after you file your returns.  If the Service doesn’t get to your assets within that time, you usually walk away free and clear.

  • The clock starts when you file your return.  If you never file, the collection clock never stars.

If your forms have been filed for a number of years, and you are now concerned that the IRS collection efforts might reach you abroad, I recommend an installment agreement.  When you don’t have income or assets sufficient to pay in full, you can set up a partial pay installment agreement.  You pay what you can afford, again, according to the allowed standards (whatever they might be), until the 10 year collection statute runs out.

If you are coming up on this 10 year statute, don’t file an Offer in Compromise.  The OIC will put that collection statute on hold while the IRS considers your offer.  If you are not successful, this wait, often 1.5 years, has been for nothing.  You may be worse off because your ability to pay has increased in this time.

Rather than an OIC, apply for an installment agreement.  Considering your rights to appeal, this can take several months.  When it is done, you pay a few dollars each month and then walk away.

Expat Tax Debt Relief Option 4:  Innocent Spouse Relief

If your spouse is running a business that you are not involved with, and you can prove to the satisfaction of the IRS that it would be unfair to tag you with the resulting tax debt, then you might qualify for Innocent Spouse Relief.

The most common example for expats is where one spouse is operating a business abroad and the other is living in the U.S.  The expat runs up a big tax bill, you get a divorce, and the domestic spouse wants out from under the IRS.  So long as you did not know about the debt, were not involved in running the business, and did not financially benefit from the untaxed money, you might be an innocent spouse.

In my experience, about 20% of these filings are successful.  Basically, if your assets came from the business, the government will not let you go.  If your assets came from your work, and not your “guilty” spouse, then you might have a chance of success.

If one spouse is living and working abroad, and the other is in the U.S., there is a much easier solution to this issue than an innocent spouse claim.  It doesn’t require you to get a divorce and is guaranteed to improve your marital bliss.  I believe this to be the best advice I have ever given expats where only one spouse is involved in the business:

File your U.S. returns as Married Filing Separate.  Never file a joint tax return!

Yes, it will cost you a little extra each year, maybe $1,500, but it will keep the family unit together and protect the assets of the “innocent” spouse.  No one likes to admit that there is risk in the new business they are so excited about, but a little planning can make a big difference if things go south.

Expat Tax Debt Considerations

If you have an expat tax debt, there are a few issues you should keep in mind.  Among these, the most important is that you must be honest in your filings and report your foreign bank accounts each and every year.  The IRS has painted a very large and bright target on the expats and has put over 100 of you away in the last couple of years to prove its point.  While the average American might not end up in jail for an innocent error, it is a very real possibility for the U.S. citizen living and working abroad.

Owing the IRS is a civil matter and you have the advantage because your assets are out of the reach of the automated collection system.  Don’t give up that advantage and turn a civil matter into a criminal case where the IRS is trying to hang a pelt on its wall to scare others in to compliance.

The next item unique to expats is that not all offshore banks are created equal.  If your bank has a branch in the U.S., the IRS can issue a levy and reach your foreign account.

That’s right, if you are banking with HSBC in Columbia, the IRS can issue a levy to HSBC NY and empty your account in Columbia.  Obviously, this puts you at a disadvantage when it comes to setting up an installment agreement or an Offer in Compromise.

The solution is simple:  if you are an expat with an IRS tax debt, never use a bank with a branch in the United States.

You should also be aware that real estate and other assets in the U.K., France, and Canada are subject to seizure.  The IRS has the right to take your property in these countries and sell it at auction.  No expensive or time consuming court action is required.  Basically, the IRS has the same powers in these nations as it has at home.

Another area of concern for the expat with a tax debt is the Foreign Earned Income Exclusion.  I won’t go in to detail on it here, but, suffice it to say that the FEIE allows you to eliminate up to $99,200 in salary from your U.S. return in 2014, and slightly lesser amounts in prior years.  You will find a number of articles on this site on how to use the FEIE to reduce or eliminate your U.S. taxes if you are living abroad.

The expat tax debt collection issue with the FEIE is that, if you don’t file your U.S. returns, and you are audited, you can lose the FEIE.  This could be a financial disaster for the American abroad.

Let’s say you are living in Columbia, making $80,000 as a website designer for a local firm or through your own offshore corporation.  If you file your returns on time, you pay no U.S. tax because you qualify for the FEIE.  If you don’t file, and you get caught, the FEIE could be gone and you owe about 35% of 80,000, or $28,000.  Forget to file your returns for four years, and you could be looking at an expat tax debt of $112,000, all of which could have been avoided by filing on time.

What might happen if you don’t resolve your expat tax debt before the IRS catches up to you?  Of course, the same rules apply:  the IRS can attempt to levy your banks and income sources and seize any assets it can get its hands on.  That’s standard fare, but there are a few issues unique to the expat.

As I have said before, your failure to file can become a criminal case, which is very rare for someone living in the U.S.  It is also possible for offshore asset protection systems that are designed to keep money away from the IRS to become criminal cases.

Assuming you file on time, and don’t hide assets, then the IRS will have a tough time collecting from you… especially if your offshore bank doesn’t have a branch in the U.S.

One weapon in their arsenal is your U.S. passport.  The United States can revoke your U.S. passport for significant delinquent tax payments, and they have been known to use this against those who don’t cooperate in an installment agreement process, especially after the Service has gone to the trouble of tracking you down.  Without a passport, you will be forced to return to the U.S. to face the music.

Expats should also note that the IRS is opening branches “to serve you better” around the world.  The most recent grand openings have been in Panama, Australia, and Hong Kong… with more to come.  Agents from these offices can come in to your business, audit you at will, and have significant collection powers… and even more authority from intimidation.

If you are living abroad, and have an expat tax debt or other IRS issue, you should contact a firm experienced in these matters that understands the expat life and can negotiate with the Service on your behalf.  The majority of the risks of being offshore can be eliminated if you participate in the process and file the necessary forms.

For more information on expat tax debt and collection matters, please give us a call or send an email to info@premieroffshore.com.  As always, consultations are confidential.

Retire Abroad

2014 IRS Offshore Settlement Program

If you have unreported offshore bank accounts or foreign assets, the IRS has one last best offer called the 2014 IRS Offshore Settlement Program.  Come forward and, if you are living offshore, pay no penalties.  If you are living in the U.S., pay only 5% for a fresh start.

This, the third installment of the IRS Offshore Voluntary Disclosure Initiative, is a great deal for some and bad news for others.  No matter where you stand on filing and paying taxes to the U.S., if you have a blue passport and an unreported offshore bank account, you need to understand your rights, risks, and costs of the 2014 IRS Offshore Settlement Program.

To give you a little background, the IRS has been going after offshore accounts hot and heavy since 2011.  They’ve attacked banks and U.S. citizens alike, getting banks to pay monster fines and putting 100 + citizens in jail.

These IRS indictments for offshore bank accounts have brought forward 45,000 taxpayers who have voluntarily paid $6.5 billion in taxes, interest and penalties.  As a result, the Criminal Investigation Division of the IRS has the highest return on dollars spent of any IRS division.

Banks have also kicked in a few billion to keep things moving.  UBS paid $780 million and gave up 4,400 clients in 2011.  Then, Credit Suisse paid $2.6 billion in May of 2014, and there are more settlements in the works for 2014 and 2015… including banks in Israel, Singapore, and Hong Kong.

2014 IRS Offshore Settlement Program Explained

The current Offshore Voluntary Disclosure Initiative is aimed at those with a good reason for having an offshore account, but who were unaware of their filing obligations.  Maybe they found out about their risks a few years ago, but, by then the costs of compliance were just too high.  Whatever your situation, you must have a good excuse as to why you have not filed to get in to this program.

The stated aim of the 2014 IRS Offshore Settlement Program is “…to get people to disclose their accounts, pay the tax they owe, and get right with the government.´ This is according to IRS Commissioner John Koskinen.

The IRS promises to go easy if you come forward and can prove to the satisfaction of the IRS that you did not intend to violate the law.  Note that the Service has the final say as to your intent.  If your story is not convincing, your penalty goes way up.  As you will have given them a roadmap to your income and assets in your initial filing, you don’t have the option of backing out if it doesn’t go your way.

Let’s get down to the numbers of the 2014 IRS Offshore Settlement Program.

Under the 2012 Offshore Voluntary Disclosure Initiative, if you were living and working abroad and owed $1,500 or less as a result of filing your U.S. tax returns, then you paid no penalties for failing to report your offshore bank account.  If you owed more than $1,500, then you paid 27.5% of the highest balance in your accounts and, in some cases, 27.5% of all foreign assets.

For an expat living in a high tax country, which is to say a country with a tax rate and system comparable to the United States, it was easy to qualify for the 2012 Offshore Voluntary Disclosure Initiative.  If you were living in a low tax country, or were operating through a tax efficient offshore company structure, but your salary exceeded the FEIE, the prior OVDI was quite expensive.

Under the 2014 IRS Offshore Settlement Program, it doesn’t matter how much you owe when you file your tax returns.  If you are living abroad, file and pay your last 3 years and show good cause for not reporting the accounts.  You will pay taxes for these three years and will pay no FBAR penalties.

If you are living in the United States and have an unreported offshore account, then you can qualify to pay a 5% penalty rather than the 27.5% fine.  Though, I must say that the hill to climb for a U.S. resident is much steeper than for an expat.  Like the expat, if the U.S. resident can sell a good story for his lack of compliance, it doesn’t matter how much you owe as a result of filing or amending your last three to six years of personal income tax returns.

If you (the expat or U.S. resident) can’t convince the IRS of your good intentions, you will be required to give up 27.5% of your foreign assets, which is what you would have had to do under the 2012 version of the Offshore Voluntary Disclosure Initiative.  However, if the IRS is already on your trail when you come forward, which is to say, the IRS is investigating the bank where you have your unreported accounts, then the penalty goes all the way up to 50% of your foreign assets.  Obviously, this creates some urgency, as the IRS is currently after a number of offshore banks.

Note that these penalties are assessed against the highest balance in your offshore bank account since it was opened.  If you had $1 million offshore for only one day, maybe because you were buying a foreign rental property, the 5%, 27.5%, and 50% penalties apply to the $1 million and not your average balance over the years.

I expect those living and working abroad for several years will have relatively easy time in the 2014 IRS Offshore Settlement Program.  This is especially true if you hold dual citizenship.  If you are in a low tax country, now is the time to come forward if you are willing to disclose all of your accounts and assets to the IRS in order to keep your U.S. passport and to get back in good standing with your government.

For those of you in the U.S., your road is sure to be more challenging.  What kind of story might succeed?  If you are a signor on a parent’s foreign bank account, and they live abroad, then I expect you might get away with the 5% penalty.  Also, if you had foreign assets before you moved to the U.S., and have been reporting your U.S. income, but not capital gains on these international accounts, I think you have a decent chance of success.

Also for those who are U.S. residents, I think the size of your payment when you file or amend your 1040 will be considered.  If you owe a few dollars, and it is minimal compared to your other taxes paid, then your chances of reaching the 5% deal are increased.  If your tax bill is increased by 90%, you better have an excellent story.

My last suggestion is that someone with a foreign rental property, who was not aware they should be reporting, might qualify for the discount.  Keeping in mind that you can take depreciation (all be it straight line and not accelerated) and ordinary and necessary expenses on the foreign rental, just as you do with a U.S. property, you will probably have a loss when you amend your return.  I believe such a case will qualify for the 2014 IRS Offshore Settlement Program’s 5% penalty.

I hope you have found this article helpful.  Please note that no 2014 IRS Offshore Settlement Program filings have been completed, so my suggestions above are just my opinion.

If you would like to determine your costs, risks, and probability of success in the 2014 IRS Offshore Settlement Program, the first step is to prepare or amend your tax returns.  For additional information, or for an assessment of your case, please call or email to info@premieroffshore.com.  All consultations are confidential.  We have helped many clients navigate the two previous IRS Offshore Voluntary Disclosure Initiatives and we can get you through this one with the best result possible based on your particular situation.

IRS Fees

IRS to Target Offshore Bank Accounts

If you have unreported offshore bank accounts, the IRS is coming for you … again.  U.S. expats are about to find themselves under even more IRS scrutiny because of the 2014 Offshore Voluntary Disclosure Initiative, a new attack on offshore bank accounts.  The IRS is starved for cash and they are coming after expats with a vengeance.

Today I am writing on why the IRS is targeting expats and offshore bank accounts.  Tomorrow I will take a look at the recently released 2014 Offshore Voluntary Disclosure Initiative.  Today’s post tells you why.  Tomorrow is on how… and what you can do to protect your assets.

The IRS’s budget has been cut by $900 million since 2010, which means they are trying to do more with less.  Of these cuts, abut $500 million was the result of the “sequester.”  Most of the other cuts are being pushed by Republicans angry over the IRS targeting their cash machines.

Ever wonder what kind of Return on Investment the IRS generates?  The $500 million they lost from the sequester led to a drop in tax revenue of more than $2 billion.  This, according to IRS Commissioner John Koskinen.

That equates to an ROI of $4 to $1 – for every $1 spent auditing taxpayers, Uncle Sam gets $4.

In another example, IRS revenues from enforcement are down $4.3 billion from four years ago.  The IRS Commish said that this… “decline in audit revenue is attributable to a decline in the number of returns audited.”

While I don’t wish an audit on anyone, these numbers present problems for those who need to resolve their tax debt or otherwise contact the IRS.

Because of these IRS budget cuts, customer service has fallen apart.  For example, 15.4 million telephone calls from taxpayers went unanswered in 2013.  That’s over 15 million Americans who were trying to do the right thing and could not get their questions answered in a timely manner.

These budget cuts have also basically eliminated training for IRS personnel.  The National Taxpayer Advocate says that the average spent per employee on training dropped from $1,450 to less than $250 from 2009 through 2013.

You know full well how complex the IRS tax code is, especially for expats.  If the IRS employees have no idea what’s going on, how are they going to implement a program like the 2014 Offshore Voluntary Disclosure Initiative?  If they don’t understand the laws, how are they going to explain them to callers?

And these budget shortfalls place a much greater and more immediate burden on expats than average citizens.  First, your questions and filing requirements are much more complex than the average person who files Form 1040EZ and gets $100 back from their W-2.  You have to negotiate an ever changing landscape of laws, collection regimes, IRS policies, and code sections.  If you are lucky enough to get through to an IRS agent, your chances of finding one who understands your situation is slim.

Next, as the IRS collections group attempts to do more with less, they will go after high return taxpayers, which is how the IRS has viewed the expat and your offshore bank account for years… a cash cow.  You are a successful hard working bunch with average incomes several times higher than most Americans.  You also face a far more complex tax code with more opportunities to make an error.  For example, failure to file a FBAR alone can result in a penalty of $100,000 per year.

The bottom line is that the IRS’s ROI is 20 times higher when they attack expats than when they go after average, or even high net worth, U.S. residents.  The U.S. expat has a target painted on his back and it is just getting larger and brighter as the demand for cash increases.

Stay tuned for more on the recently released 2014 Offshore Voluntary Disclosure Initiative.  If you are living and working abroad, and you have unreported offshore bank accounts, you need to know your rights.

Currency Transaction Report

IRS Currency Transaction Report

Today I’m taking time out from my offshore beat to warn you about the CTR.  An IRS Currency Transaction Report is a form filed by U.S. banks and casinos each time you make a deposit or withdrawal of $10,000 or more.  It is filed in secret, without your knowledge, you don’t receive a copy, and it becomes part of your permanent IRS file.  An IRS Currency Transaction Report greatly increases your chances of an audit.

If you are a high stakes gambler, you should be aware that any casino transaction of $10,000 will result in a Currency Transaction Report being sent to the IRS.  Just as high dollar wins are reported on form W-2G, buying in or cashing in high dollar chips is traced with a Currency Transaction Report.  Both W-2G and CTR increase your chances of an audit and require you to prove 1) where the cash came from, 2) where the cash went, and 3) whether the cash was properly reported on your tax return.

  • IRS Currency Transaction Reports are filed by U.S. banks and U.S. casinos.  These rules do not apply to offshore casinos.  Also, offshore banks do not file CTRs … for now.  I expect that will change soon enough.

If you are in a cash business, like a successful bar, or restaurant, you will generate an IRS Currency Transaction Report every time you deposit more than $10,000.

Now for the point of this article:  Never attempt to avoid the IRS Currency Transaction Report.  You might end up behind bars.

Yes, planning your deposits to avoid the CTR is a crime.  While it might be hard to believe, there are Americans sitting in jail because they “structured” their cash transactions in an attempt to avoid a costly IRS audit.

And I’m not talking about terrorists, money launderers, or the likes of Al Capone.  I mean ordinary citizens are sitting in jail for attempting to avoid an IRS exam by depositing $6,000 one day and $6,000 the next, rather than $12,000 all at once.  Planning to avoid an IRS Currency Transaction Report is the crime of “structuring,” and it is punishable by up to 5 years in prison.

  • Never heard of structuring?  Very few have, but ignorance of the law is not a defense to a criminal charge.

If you are in a cash business, you must have policies in place to track and deposit cash.  Maybe you go to the bank every morning or maybe twice a week.  Don’t vary your routine and never hold cash in your safe to prevent the CTR.

If you take steps to structure your affairs, you run the risk of your bank filing a Suspicious Activity Report.  This will certainly bring down the weight of the Federal Government up on you and is far worse than and IRS Currency Transaction Report.

One interesting issue:  If your policies result in your depositing around $9,000 twice a week, you might want to change to once a week.  As strange as this sounds, it will guarantee the IRS Currency Transaction Report and avoid the STR.

As the United States works even harder to control its citizenry, and ensure only “approved or compliant” transactions get through, you can be assured that laws like the IRS Currency Transaction Report will continue.

Offshore Captive Insurance Company

The Mini Offshore Captive Insurance Company

The Mini Offshore Captive Insurance Company (sometimes referred to as a pure offshore captive) is a powerful and unique way to cut both your business and estate taxes while moving your assets out of the reach of future business and personal creditors.  If you are operating a business with $500,000 to $1.2m per year in profits you want to eliminate from your U.S. tax return, and move in to an offshore asset protection structure, you should consider a Mini Offshore Captive Insurance Company.

Note:  This article describes the Mini Offshore Captive Insurance Company.  It is intended for those who wish to deduct up to $1.2m per year.  The full sized Offshore Captive Insurance Company is a very different and more complex animal.

Let’s start from the beginning.  The Mini Offshore Captive Insurance Company was created by Congress in 1986 and can be found in IRC S 831.  This section of the U.S. tax code and the related safe harbor provisions, allow you to form an Offshore Captive Insurance Company to underwrite all types of business property or casualty risk.  Your U.S. company may then pay up to $1.2m to this Offshore Captive Insurance Company, taking a 100% deduction in the year paid.  This should result in a tax savings of about $420,000 per year.  However, you must pay U.S. taxes on all passive income these premium payments/retained earnings generate.

I note that this savings is only available to those who form a licensed Captive Insurance Company.  While you can self-insure using a sinking fund, you may not deduct transfers to a fund.  Only payments to an insurance company are excluded from income when paid.

In order to be classified as a Mini Offshore Captive Insurance Company, you must agree to be taxed as a U.S. C Corp, make an irrevocable election with the IRS, and file U.S. returns on the calendar year in most cases.  While this election is irrevocable, it is automatically terminated if you pay more than $1.2m in a year to the Captive Insurance Company.  Thus, if you want to play in the big leagues for a year, you can do so and then file a new election to return to the minors.

Because a captive is taxed as a C corporation, distributions as dividends from a Mini Offshore Captive Insurance Company are considered “qualified” dividends and taxed at the long term capital gains rate.

Also, because of the Mini Offshore Captive Insurance Company’s unique standing in the U.S. tax code, you can move significant wealth out of your U.S. estate and away from the U.S. estate tax (which applies to U.S. assets in excess of $5m) as well as gift and generation skipping taxes.  Assuming the offshore captive operated for 10 years, you could move as much as $12m offshore.  To take advantage of these tax benefits, offshore trusts should be the owners of the offshore captives and your children and heirs should be the beneficiaries of these trusts.  One trust per heir is suggested.  And these returned earnings enjoy the highest level of offshore asset protection available.  Because the premium payments are considered ordinary and necessary business expenses, there should be no risk of a claw-back from a U.S. court on issues of fraudulent conveyance.  In fact, if the offshore captive was formed before a problem arises, I expect these transfers will be allowed to continue during and after litigation.  You should consult an attorney prior to forming and offshore captive if this applies to you.

One additional benefit of the Mini Offshore Captive Insurance Company is that it provides a tax efficient way to compensate key employees.  To use the captive in this way, you might operate a (second) offshore captive for their benefit or issue preferred shared from your primary offshore captive.  These key employees would redeem these shares upon retirement and pay tax at long term capital gains rates, which should be lower than the tax on any other form of deferred compensation.

Above, I suggested you can form a second Mini Offshore Captive Insurance Company.  In fact, you can from as many mini captives as you like, so long as they have different shareholders.  This is a good way to accommodate shareholders with differing retirement and investment goals, multiply the tax benefits, and ensure you make the most of the estate planning options… especially when the partners are not related.

  • Watch out for the attribution and constructive ownership rules under IRC S 1563 that might combine offshore captives, thereby exceeding the $1.2m limit and crashing the system.  Advanced planning is required if you wish to deploy multiple Mini Offshore Captive Insurance Companies.

If you do not have at least $500,000 to move offshore (I suggest this arbitrary amount as being cost effective), but have a group of entrepreneurs that want to plant that first flag offshore and begin building towards a full captive, you might consider a series LLC Mini Offshore Captive Insurance Company.  In this case, a master LLC is formed in a state that allows for this and each partner forms his or her own LLC as part of the series… basically a subsidiary of the master LLC.  The master LLC will obtain a mini captive license and each series LLC will pay in premiums as they see fit, up to a combined total of $1.2m.  These series LLC will insulate the partners from each other’s assets and liabilities, allow them to pool resources to cover costs, and to insure much lower amounts of risk.  Such an arrangement might be best suited to a group of professionals who wish to deduct around $250,000 per year each.  By forming an offshore trust for each LLC member, investors will also receive the estate planning benefits.

Offshore Captive Insurance Company Must Provide Insurance

Because a Mini Offshore Captive Insurance Company must actually provide some type of insurance, and premium payments must be reasonable, at fair market value, and ordinary and necessary expenses of your U.S. business, forming an offshore captive is a rather complex and costly undertaking.  These costs are the main reason I suggest a minimum annual principal payment of $500,000, or a series LLC to get your group to $1.2m.

In order to be classified as an insurance company by the U.S. tax code, you need 1) and insurance license from an offshore jurisdiction like Cayman, Bahamas, BVI or Vanuatu, and 2) to shift risks from the operating company or its affiliates to the licensed insurance company.  In order to meet this requirement, you must show that the Mini Offshore Captive Insurance Company you formed is insuring specific risks of your business in exchange for a reasonable premium.

These requirements make the formation of an Offshore Captive Insurance Company a long process.  Feasibility studies, capitalization, financial projections, risk analysis and premium value analysis, and the retention of a qualified insurance manager are all required before you can apply for a license.

The amount of capital required (capitalization) of the captive insurance company is based on the type and level of risks being insured and varies by jurisdiction.  Capitalization may provide you with an opportunity to move after tax retained earnings or personal savings offshore for asset protection purposes.  Alternatively, you might qualify for an irrevocable letter of credit to satisfy this requirement.

As a Mini Offshore Captive Insurance Company must provide insurance (insurance is in the name by gosh, but many ignore this aspect), a complete risk analysis is required.  You must determine which risks you will cover “in-house,” which you will leave with your current provider, and the fair market value of these premiums.

The key to the risk analysis for a mini captive, compared to a full captive, is that you should insure only risks that have a low probability of occurring.  For example, you might insure against product liability, war, major currency devaluation, labor strikes, workers comp, product recall, pollution liability, group pension plan liabilities, a nuclear explosion, and property theft from the office (usually minor claims only).

  • If you decide to insure risks with a higher probability, you may be able to purchase reinsurance at a lower rate than is available onshore.

Note that an insurable risk is one that might occur, not one that will occur.  If an event will occur, even if the amount/cost of the event can’t be determined, it’s not an insurable risk.  Payments in to an offshore captive for an event that will occur are considered deposits in to a sinking fund and are not deductible.  (IRS rev. Rule 2007-47)

The last requirement I’ll cover here for Mini Offshore Captive Insurance Company is that more than 50% of its total revenue must come from premium payments (IRC S 816(a)).  If interest, dividends or other passive income from investing premiums and initial capital exceeds income from premiums, you may lose your insurance company status and be considered a passive foreign investment company.

  • Remember that the owner of a Mini Offshore Captive Insurance Company gets to deduct 100% of his/her premium payments but must pay U.S. tax on all passive income.  Treatment of premiums and passive income is much more complex for an offshore insurance company that doesn’t make the “mini” election and those with more than $1.2m in premiums.

The 50% of revenue requirement is not a problem during the first few years of operation.  You might even expect to run for 10 years without hitting this PFIC limit.  In later years, assuming your investment returns are significant, you may need to shut down the captive and form another, invest capital in more conservative products, or distribute out sufficient funds as qualified dividends.

Uses of a Mini Offshore Captive Insurance Company

So long as you make the proper election, adhere to the principles of risk shifting and insurable events, avoid excessive loan backs and anything that might look like self dealing, do not provide life insurance, and keep up with your IRS obligations, a Mini Offshore Captive Insurance Company is a very powerful international tool.  It provides significant tax savings, unparalleled asset protection, and offshore estate planning not available elsewhere.

Now that you have a solid understanding of what a Mini Offshore Captive Insurance Company can do, let’s talk about who should consider forming one.  An offshore captive is best suited for those with:

  • A profitable business that can deduct up to $1.2m from its U.S. taxes.
  • A business with multiple entities, or that can divide itself in to multiple operating subsidiaries – (if you have only a single entity, don’t worry, we can set these U.S. affiliates up for you).
  • A business with at least $500,000 per year in sustainable operating profits.
  • A business owner who wants personal and business asset protection and/or estate planning.
  • A group of independent professionals who want to go in together on a Mini Offshore Captive Insurance Company using a series LLC.

A few examples of potential clients are medical doctors, lawyers, investment advisors, hedge fund operators, family offices, and anyone with a mature business and a few million in profits each year.

For example, let’s say you are an investment advisor with $3m in profits P.A., 4 children, and a significant personal net worth.  Your objectives for a Mini Offshore Captive Insurance Company might be to maximize wealth accumulation, reduce current income taxes, protect assets from personal and business creditors, and devise a tax efficient system to transfer wealth to your heirs.

You might decide to from a Mini Offshore Captive Insurance Company in Cayman.  You might then form four offshore trusts in Belize, one for each of your children, to own the captive.  In this way, the shares (and thus the assets) of the captive are lifted out of your U.S. estate and you can avoid both estate and generation skipping taxes.

During the formation state, the manager of the captive will need to perform a feasibility study and find a number of “real” or “insurable” risks to be covered by the offshore captive.  In the case of the financial advisor, the study might identify ten risks and therefore wire ten separate policies.  Each policy must apply the usual and customary insurance industry underwriting principles and must be reasonable in light of the risks being transferred to the offshore captive.

As a result, premiums paid by your investment advisory business are fully deductible in the year paid and the captive is not taxed on premium income.  Only the investment income on money in the captive is taxable as earned (no tax deferral available).  Also, distributions to the four trusts qualify as dividends and are taxed at 20% (was 15% in 2012).

I also note that the premiums paid to the offshore captive, as well as distributions to the four offshore trusts, are not subject to the claims of your personal creditors or the creditors of your investment management business.  Because these payments are deemed ordinary and necessary business expenses, the offshore asset protection is iron clad.

I hope you have found this article helpful.  The planning, formation, and management of a Mini Offshore Captive Insurance Company is a complex matter.  I’ve done my best to summarize the basics.  For additional information please send me an email to info@premeiroffshore.com or give us a call anytime.

Cheap offshore Company

A Cheap Offshore Company Cost Me $100K

Are you considering forming a cheap offshore company?  Has some scammer in Nevis promised you tax freedom and privacy?  Forming a cheap offshore company that does not include U.S. tax compliance is a roadmap to disaster for the American living, working or investing abroad.

How much would you be looking at in penalties for using a cheap offshore company formation mill?  The most common error is failing to Ale the Foreign Bank Account Report or FBAR.  Most get a penalty of $100K per year and are happy to avoid jail time.

Others get in to even more trouble for failing to file an offshore corporation return on Form 547 or one of the various LLC reporting forms.  Those of you with complex asset protection trusts have even more risks.  You may need to file a form when you fund the structure and Forms 3520 and 3520-A each year to report transactions in your trust.  Add to this the requirement to report foreign assets in a variety of situations, and in improperly structured and reported cheap offshore company can cost you a fortune.

When asked how much a cheap offshore company will cost, I like to say about $100K.  This is because the FBAR is the IRS’s first line of attack and other forms base their penalties on the amount of unreported tax or as a percentage of assets (i.e. an offshore trust).  For the trust, the usual penalty is 25% of assets under management per year!

Back when I was defending cheap offshore company users, I commonly saw people who were out of compliance for multiple years and who owed more in taxes and penalties that they had taken offshore.  In one case, a client put $75,000 offshore for a few years and ended up paying $225,000 in taxes, fines and penalties. . .and happy to pay up rather than sit in jail.

Some were not as lucky.  U.S. jails are full of people who had a cheap offshore company and found themselves in theirs crosshairs – to eventually spend time

behind bars.  How much does a cheap offshore company cost?  If the IRS wants to make an example of you, about 3 to 5 years of your life.

The U.S. is one of the very few nations on earth that locks away its citizens for not paying taxes.  In fact, America has put people away for failing to file a form when no tax was due (lawyers calls this a zero tax loss case).  I personally know people in jail for 10 months for failing to file a form in a zero tax loss case.  I know of another person who got 2 years home confinement on a zero tax loss case.

This is all to say, stay away from cheap offshore company formation mills unless you are an international tax expert, you are heading for trouble using such a provider because you can’t tell puffery and salesmanship from fact.

When you form an offshore company with Premier, we include 12 months of tax and business consulting services at no cost.  Our U.S. tax experts are here to answer any questions from you or your tax preparer, explain what forms to use and when to file and make sure you in compliance with the IRS.  We also assist with any business or banking questions – including opening additional bank or brokerage accounts in the first 12 months.  We are always her to answer your questions.

While advice and consulting services are free, we also offer tax compliance packages for corporations, LLCs, trusts and asset protection structures that we have created.  We do not prepare complex returns for structures we have not formed . . .this is just too much liability for us to assume from others’ mistakes.

  • We also prepare personal returns, Form 1040 and 2555, for anyone living and working abroad.

So, how much does a cheap offshore company formation cost?  Too much!  If you don’t select Premier to structure your international affairs, please use a U.S. attorney or firm that can keep you out of trouble.  The cheap offshore company formation is not worth the risk.

For a confidential consultation, please call us anytime or send an email to info@premieroffshore.com.  All discussions are private and there is no obligation.

Cheap offshore Company

How to Prorate the Foreign Earned Income Exclusion

When you first move offshore, you will need to know how to prorate the foreign earned income exclusion. This is because, you will be using the physical presence test in your first year and, presumably, won’t move abroad on January 1, so you will need to prorate the foreign earned income exclusion.

Let me take a step back. As you probably know, the Foreign Earned Income Exclusion allows you to exclude $99,200 in salary from your US taxes in 2014. To qualify, you must be a resident of a foreign country (residency test) or be out of the United States for 330 out of 365 days (330 day test or physical presence test).

Under the physical presence test you can choose any consecutive 12 month period for your Foreign Earned Income calculation. So, you might have moved abroad on Mach 15, 2014 and begin your new job on April 1, 2014. Therefore, you will probably want to prorate the Foreign Earned Income Exclusion from April 1, 2014 to April 30, 2015.

In this case, you should be out of the U.S. 330 days from April 1, 2014 to April 30, 2015. You could use March 15th as your start date, but that would mean you lose 15 days of the exclusion and these 15 days can’t be recouped when you file your 2015 return.

I note that it is necessary to prorate the Foreign Earned Income Exclusion because most people don’t leave the good ole USA on January 1, so they need to prorate in the year they begin their new lives. Also, to qualify as a resident of a foreign country, you must be out of the US for a full calendar year. Therefore, the physical presence test is common in year one.

In the example above, it would be possible to use the 330 day test to qualify for the FEIE from Aril 1, 2014 to December 31, 2014, and then use the residency test to qualify for the exclusion from January 1, 2015 to December 31, 2015. However, this will not affect your exclusion amount. You will still need to prorate the Foreign Earned Income Exclusion. In other words, there is no financial benefit to converting to the physical presence test, though you will be able to spend more time in the United States. The prorated exclusion amount may not exceed the maximum allowable exclusion.

To prorate the Foreign Earned Income Exclusion, use the number of days you were physically present during the tax year over 365. That is to say, exclusion is calculated by dividing the number of days physically present in the foreign county or countries (numerator) by the number of days in the year (denominator). (See Publication 54, section on part-year exclusion.)

In the example above, your 2014 exclusion is April 1, 2014 to December 31, 2014, or 274 days. Each day is worth $271.78 ($99,200 / 365= $271.78), so you can exclude up to $74,467.72 in 2014. If you earned $100,000 in salary from April 1, 2014 to December 31, 2014, you will owe U.S. tax on about $25,500 ($100,000 – $74,467 = $25,532.28) because of the prorated Foreign Earned Income Exclusion calculation.

Prorating the Foreign Earned Income Exclusion is common in the first year an ExPat moves abroad. It is also possible to prorate if you are forced to leave the country due to civil unrest.

According to the instructions for IRS Form 2555, under Waiver of Time Requirements:
If your tax home was in a foreign country, you reasonably expected to qualify for the Foreign Earned Income Exclusion in that country, but were forced to leave because of war, civil unrest, or similar adverse conditions, the time requirements residency test or the 330 day test may be waived. You must be able to show that you reasonably could have expected to meet the minimum time requirements if you had not been required to leave.

To support this rule, the IRS publishes a list of countries and the dates they qualify for the waiver. If you left one of these countries during the period indicated, you can claim a prorated Foreign Earned Income Exclusion on Form 2555 for the number of days you were a resident of or physically present in the foreign country.

As I wrote above, you must reasonably expect to qualify for the Foreign Earned Income Exclusion in the affected country. This is aimed at contractors moving in to dangerous areas. Basically, if you move to a dangerous area, and then decide to leave or are forced to leave, you don’t get the benefit of this rule. If you move to an area after it is listed in the IRS publication, you are on notice that it is dangerous and don’t get the benefit of this section.

I hope you have found this article helpful. Please post any questions in the comments below and I will respond online. You may also contact me directly at info@premieroffshore.com.

Offshore IRS Audit

Will the IRS Audit Me for Going Offshore?

For those of you living and working abroad, or investing outside of the United States, the fact that you file one or more of the offshore company forms and report a foreign bank account on the FBAR will have little to no effect on your chances of an audit. The IRS is focused like a laser on those who fail to report their offshore transactions. So, if you are in compliance, you have little to fear.

To put it another way, individuals who file an offshore return are not currently a target for the IRS. They have amassed their forces to go after the banks and non-compliant individuals because that’s what makes headlines…that’s what brings in the cash.

How much are we talking about you ask? The IRS has brought in about $4 billion through the Voluntary Disclosure Program and another few billion in fines and penalties against Swiss and other banks who helped Americans avoid taxes. These are the kind of numbers the government is going for…they are not concerned with the average person’s compliant offshore dealings.

This is all to say that the IRS is not so concerned with those in compliance. If you have been filing your forms and paying along, you are no more likely to be audited that the average person. If you get in to compliance voluntarily, then you take the target off of your back.

It is also important to realize that the IRS audits less than 1% of taxpayers each year…and their budget for 2014 and 2015 has been cut by Republicans angry about the way their fund raising groups were treated in the last election cycle. Based on the following factors, I believe that most of my clients have a 3% to 5% chance of facing the tax man…not because of international structures, but because of their higher levels of income.

My point here is not that you will never be audited. It is simply that going offshore does not significantly increase your probability of facing down the IRS. For more on this topic, please take a look at my article How to Avoid an IRA Audit – Expat Edition.

If you are behind in your U.S. tax filings, I suggest you take a look at my article on the IRS Voluntary Disclosure program. If you qualify as an Expat, this might be a cost effective avenue for you to get right with the Service.

IRA & Retire, Asset Protection

How to Avoid an IRS Audit – Expat Edition

If you are living and working abroad, you still need to worry about the IRS. In this article, I will talk about how to avoid an IRS audit with a focus on Expats.

Are you worried that the IRS will come knocking on your door? Want to know how to avoid an IRS audit? I battled the IRS for a decade and here are a few of the tips and tricks learned, often the hard way, in those skirmishes.

So, what are the major audit flags? What will bring the IRS to your door? Some are selected at random, a kind of control group, but there are a number of items that can increase your chances of being selected by the computer for an audit.

The key factors are the amount you earn, the type and quantity of deductions you take, the volume of capital gains transaction on Schedule D, your line of work, and whether you own your own business.

Of these, income level is far and away the most important factor. As I said above, less than 1% of the taxpaying population is audited each year. If your income is $200,000 or more (defined as rich in today’s America), your chance of an audit jumps to 3.26%. If you have a great year, and make $1 million, your chance of a visit skyrockets to just over 11% (about 1 in 9). So, you want to know how to avoid an IRS audit…just stop working!

I assume you won’t decide to work less, or earn less, to keep the IRS from your door, so let’s talk about what you can control. By far, the most egregious error is failing to report all of your income…and this is exactly what the IRS is targeting with FACTA and its offshore banking initiatives.

You see, FACTA forces all banks around the world to report the income and transactions of their American clients to the IRS, just as American banks do today. It essentially turns your foreign banker in to an unpaid agent of the U.S. government.

Next, IRS computers compare these reports to the return you file and audit those whose report doesn’t match the computer file. The larger the discrepancy, the higher your chance of an audit. The purpose of FACTA is to ensure all Americans are reporting each and every transaction and to provide a tool to the IRS to easily track down and persecute those who failed to toe the line.

Therefore, the best way for the U.S. person living, working or investing abroad to avoid an IRS audit is to file all necessary forms.

Another red flag is your charitable donations. The IRS keeps statistical data by income bracket on this category. The further you get from the standard deviation, the higher your chance of an audit. If you give 5% of your income to charity, with no non-cash donations, your audit meter will hardly register a beep. Give 50% of your adjusted gross income in donations of clothing and personal affects, and I guarantee you will be audited…possibly before you have time to cash the refund check.

Next on the list of red flags are rental real estate losses. If you have a loss from one foreign or domestic property of less than $25,000, your risks are minimal. If you claim to be a real estate professional so you can take larger losses, or because your income from other sources exceeds $150,000, then your risk of an audit is very high.
The last major caution is to day traders and those claiming to be professional traders of their own accounts. I understand that the desire to be considered a professional trader can be strong, and I field a number of calls from those wishing to do this “business” offshore.

Those who trade in stocks and securities as professionals have big time advantages over the rest of us. Their expenses are fully deductible and their profits are exempt from self-employment tax. Losses of traders who make a special section 475(f) election are fully deductible and aren’t subject to the $3,000 cap on capital losses.

But, to be a professional trader, and not just a simple investor, you must regularly and continuously trade stocks. It must be your primary business and you should be spending about 30+ hours a week trading, researching, and working on your craft. If you aren’t that involved, you are not a trader.

And the IRS realizes that it can be quite difficult for a person trading his own portfolio to prove he is a professional, so they are easy targets…often fish in a barrel.

If you are reporting your business on Schedule C, rather than an onshore or offshore corporation, you have a significantly higher risk of audit compared to someone who is properly structured. The favorite categories on this form are home office deduction, automobile expenses, notoriously hard to prove and often estimated by clients, and meals and entertainment. Did you actually bother to keep all of your receipts and write down who you met with and why? Keep it “simple” and get a corporation.

Why will a corporation reduce your chances of an audit? Let’s say you reported $200,000 on Form 1120. You will be grouped together will all of the other corporate entities. At $200,000, you are probably a small fish in a big pond. But, report that same profit on Schedule C, you are probably a medium to large fish to the self-employed audit group in the IRS. In other words, not many are making $200,000+ on Schedule C, but the number of corporate entities earning more than that is significant.

As someone who has handled hundreds of IRS exams over the years, I believe that these categories cover 90% of the non-random audits. If you want to know how to avoid an IRS audit, focus on compliance and your corporate structure. I will give you a few more examples below, but as we move on, the effect on your chances of an audit get less.

Hobby losses are major red flags, but one most people manage to avoid. You must report income from a hobby (such as horse racing) and you can deduct expenses up to the amount of that income. You are prohibited from deducting expenses in excess of that income. So, if you are considering racing ponies in Panama, don’t deduct them on your U.S. return.

The same is true of gambling. U.S. casinos will report your wins, and you are allowed to deduct your losses to the extent of those wins. You should never take a loss from gambling, though some try on Schedule C by calling it a business. Keeping in mind that you must be able to prove your losses, usually with a gambling log, you can deduct foreign losses against U.S. wins. If you took $100,000 from a lucky streak in Las Vegas, and gave it all back to the Trump Casino in Panama City in the same year, you can net losses against wins to break-even.

Just about any small business has a high risk of audit. This is especially true of bars and restaurants with cash transactions. In fact, these establishments often get hit by the IRS, State tax board, and employment tax board in the same year.

If you are in a business offshore, and pay your employees or consultant’s in cash, you will have a tough time if the tax man comes calling. You must prove all expenses to the U.S. IRS, so you should try to pay by check or wire whenever possible and have an invoice or receipt in the file. If not possible, then a signed receipt may get you by.

I will conclude with this: if you are living, working, or investing offshore, and have been filing all of the proper forms, you have nothing to fear from the IRS. If you have been lax in your reporting, then you might just find yourself at the top of the IRS hit list. Did you miss an FBAR or two? Do you have foreign real estate in a corporation that you did not report? You should get these issued resolved before FACTA arrives in full for on January 1, 2015.

If you are considering filing your delinquent forms, please take a look at my article on the voluntary disclosure program. If you qualify as an expat, and you owe no tax to the IRS, you might get away with zero penalties.

Feel free to contact me for a confidential consultation on any of these issues. You can reach me at info@premieroffshore.com or by calling (619) 483-1708.

Seize Your IRA

Foreign Earned Income Exclusion 2014

Good news for those American’s living and working abroad. The Foreign Earned Income Exclusion in 2014 has been increased to $99,200. This means that you can exclude up to $99,200 in salary for 2014 on Federal income tax return if you are a resident of another country or are abroad for 330 out of 365 days.

  • This article from 2014 contains some valuable information. For 2015 FEIE numbers, please see: FEIE 2015

If a husband and wife both qualify for the Foreign Earned Income Exclusion in 2014, they each may deduct up to $99,200 this year. That means a husband and wife team may earn up to $198,400 from their offshore corporation.

Unfortunately for retirees and investors, this exclusion only applies to earned income, which is income from a business or a salary. If you are drawing that salary from a corporation formed in the United States, social taxes will still apply. If you are operating a business without a corporation, then Self Employment Tax at 15% will still apply.

  • Note that the exclusion applies to salary from any foreign corporation. It does not matter if you own the company or you work for someone else.

The Foreign Earned Income Exclusion for 2014 does not apply to passive investments or capital gains. If you are an American living and working abroad, the U.S. wants its cut of your investment profits. If pay taxes to another country (such as when you sell foreign real estate for a capital gain) you get a dollar for dollar credit and are not double taxed by America. For more information on foreign real estate transactions, see my article U.S. Tax Breaks for Offshore Real Estate.

This amount of $99,200 is the maximum exclusion you can qualify for. If you earn less than the exclusion, you may not carry forward the unused portion. For example, if your salary is $60,000 in 2014, you may only exclude $60,000. You may not carry over the balance of $39,000 to 2015.

If you earn more than $99,200, you must pay tax on the excess for the right to carry that U.S. passport. So, if you earn $299,200 in 2014, you will pay U.S. tax on $200,000 at about 38%, or $76,000. If you are operating a business through an offshore corporation, you might be able to retain earnings in that company and thereby defer U.S. tax. For more information, see: Eliminate U.S. Tax in 5 Steps with an Offshore Corporation.

Since 2006, the FEIE has been pegged to inflation, so we expect it to increase each year ever so slightly. The Foreign Earned Income Exclusion for 2014 increased by about 1.6% from 2013 and about 2.5% from 2012. So, we might expect an increase of 2% in 2015. Which is to say that the Foreign Earned Income Exclusion for 2015 might be about $101,184.

Here are Foreign Earned Income Exclusion amounts from 2014 back to 1998.

  • Tax year 2014: $99,200
  • Tax year 2013: $97,600
  • Tax year 2012: $95,100
  • Tax year 2011: $92,900
  • Tax year 2010: $91,500
  • Tax year 2009: $91,400
  • Tax year 2008: $87,600
  • Tax year 2007: $85,700
  • Tax year 2006: $82,400
  • Tax years 2002-2005: $80,000
  • Tax year 2001: $78,000
  • Tax year 2000: $76,000
  • Tax year 1999: $74,000
  • Tax year 1998: $72,000

I hope you have found this article helpful. If you would like more information, I suggest you read start with the Tax Benefits of Going Offshore. Feel free to contact me at info@premieroffshore.com with any questions or article requests. As always, you may leave questions in the comment section below and I will respond online.