Tag Archive for: International Tax

Offshore Corporation

Tax Traps and Landmines in Your Offshore Corporation

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

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

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

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

Here is the gist of her conversation with the promoter:

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

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

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

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

Q: Can my offshore corporation retain earnings?

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

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

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

Q: Is my offshore bank account private?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Offshore Filing Requirements

One of the most misunderstood areas of living, investing or operating a business abroad are the U.S. tax filing and reporting requirements. The purpose of this summary is to review the basic requirements and I recommend that you consult an international tax expert as to how they fit your particular situation.

One of the foundations of the United States tax system is that U.S. citizens and residents are taxed on their worldwide income. When handled properly, an active business, conducted outside of the United States, may have significant tax deferral and savings opportunities.

International Bank and Brokerage Accounts

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

The law imposes a civil penalty for not disclosing an offshore bank account or offshore credit card up to $25,000 or the greatest of 50% of the balance in the account at the time of the violation or $100,000. Criminal penalties for willful failure to file an FBAR can also apply in certain situations. Note that these penalties can be imposed for each year.

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

Corporate and Trust Filing Requirements

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

  • Form 5471 – Information Return of U.S. Persons With Respect to Certain Foreign Corporations must be filed by U.S. persons (which includes individuals, partnerships, corporations, estates and trusts) who owns a certain proportion of the stock of a foreign corporation or are officers, directors or shareholders in Controlled Foreign Corporation (CFC). If you prefer not to be treated as a foreign corporation for U.S. tax reporting, you may be eligible to use Forms 8832 and 8858 below. http://www.irs.gov/pub/irs-pdf/f5471.pdf
  • A foreign corporation or limited liability company should review the default classifications in Form 8832, Entity Classification Election and decide whether or not to make an election to be treated as a corporation, partnership, or disregarded entity. Making an election is optional and must be done on or before March 15 (i.e. 75 days after the end of the first taxable year). http://www.irs.gov/pub/irs-pdf/f8832.pdf
  • Form 8858 – Information Return of U.S. Persons with Respect to Foreign Disregarded Entities was introduced in 2004 and is to be filed with your personal income tax return if making the election on Form 8832. A $10,000 penalty is imposed for each year this form is not filed. http://www.irs.gov/pub/irs-pdf/f8858.pdf
  • Form 3520 – Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts is required when a U.S. person:Form 3520-A – Annual Information Return of Foreign Trust is required of any foreign trust with a U.S. Owner (Grantor). Failure to file this form can result in a penalty of 5% of the gross value of the U.S. person’s portion of the trust. http://www.irs.gov/pub/irs-pdf/f3520a.pdf
    1. Creates or transfers money or property to a foreign trust,
    2. Receives (directly or indirectly) any distributions from a foreign trust, or
    3. Receives certain gifts or bequests from foreign entities. http://www.irs.gov/pub/irs-pdf/f3520.pdf
  • Form 5472 – Information Return of a 25% Foreign-Owned U.S. Corporation is required to be filed by a “reporting corporation” that has “reportable transactions” with foreign or domestic related parties. A reporting corporation is either a U.S. corporation that is a 25% foreign-owned or a foreign corporation engaged in a trade or business within the United States. A corporation is 25% foreign-owned if it has at least one direct or indirect 25% foreign shareholder at any time during the tax year. http://www.irs.gov/pub/irs-pdf/f5472.pdf
  • Form 926 – Return by a U.S. Transferor of Property to a Foreign Corporation is required to be filed by each U.S. person who transfers property to a foreign corporation if, immediately after the transfer, the U.S. person holds directly or indirectly 10% of the voting power or value of the foreign corporation. Generally, this form is required for transfers of property in exchange for stock in the foreign corporation, but there is an assortment of tax code sections that may require the filing of this form. The penalty for failing to file is 10% of the fair market value of the property at the time to transfer. http://www.irs.gov/pub/irs-pdf/f926.pdf
  • Form 8938 – Statement of Foreign Financial Assets is new for tax year 2011 and must be filed by anyone with significant assets outside of the United States. Who must file is complex, but, if you live in the U.S. and have an interest in assets worth more than $50,000, or you live abroad and have assets in excess of $400,000, you probably need to file. If you are a U.S. citizen or resident with assets abroad, you must consult the instructions to Form 8938 for more information. Determining who must file is a complex matter. See http://www.irs.gov/uac/Form-8938,-Statement-of-Foreign-Financial-Assets for additional information.

U.S. Tax for Business Owners & Self Employed

This section is an introduction to the benefits of an offshore corporation for U.S. citizens living and working abroad. It is not meant for those living abroad on their pension (retirees) or those with passive investment income.

Most Expats know that the U.S. taxes its citizens on their worldwide income and that all U.S. citizens must file a U.S. tax return every year. What most do not know is that a foreign corporation, in a zero tax jurisdiction, can legally and legitimately be used to reduce, defer or eliminate U.S. tax on their business income.

As discussed in Section one, your first line of defense is the Foreign Earned Income Exclusion (FEIE or exclusion). This exclusion was covered in detail in Section One, and can be summarized for our purpose here as follows: The FEIE excludes from your U.S. income tax the first $95,100 for 2012 of wage or self-employment income earned by a U.S. citizen who is a “resident” of another country or who was outside of the U.S. for at least 330 of any 365 day period.

The FEIE can be used to reduce or eliminate U.S. Federal income tax on wages paid to you by a U.S. corporation or a foreign corporation. It does not matter if you are the owner of the corporation…the FEIE still applies as long as you are an employee of that company drawing a salary.

The exclusion can also be used to reduce federal income tax on self-employment income paid to you while you are living and working abroad. “Self-employed” generally refers to someone operating a small business without the protection of a corporation.

Now, that you have become an expert on the FEIE by reading this book, let’s look at the practical applications to the employee and the self-employed person.


Let’s say you are the employee of a U.S. corporation and live outside of the U.S. You receive a Form W-2, and may have had reduced withholding of your federal income tax, or will file a claim for a refund with the IRS because of the exclusion. However, the exclusion only applies to income tax, thus you still get to pay Medicare, Social Security, and FICA tax…which, for our purposes, I will estimate at about 7.5%, or $6,855 on a salary of $95,100. In addition, your employer is required to match your Medicare, Social Security and FICA contributions, which is a cost to him of about 7.5%. Therefore, the total cost is about 15%. Again, these numbers are rounded off for this example.

Now, let’s say you are an employee of foreign corporation, rather than a U.S. corporation. This foreign corporation can be owned by you, or be a subsidiary of your U.S. employer. In that case, you would not have a Form W-2 sent to the IRS, might not have any U.S. withholding, and may not be required to contribute to the U.S. Medicare, Social Security, or FICA programs (unless the foreign corporation opted in to the U.S. system).

In addition to the benefits to the employee, the employer incorporated offshore is not required to pay in to these U.S. programs, thereby resulting in a total savings of about 15%.

Please note that I have assumed that the foreign entity is incorporated in an offshore jurisdiction that will not tax its income or levy a Social Security tax. Also note that I assume it is a corporation, and not a partnership or Limited Liability Company.


Now for the self-employed person operating without a corporation: The IRS and the entrepreneur will (or should) receive a Form 1099 from each payment over $500 done for a U.S. company or person. Presumably, there will be no report for work done for non-US businesses, though this does not impact your tax obligations. You then report your business income and expenses on Schedule C and use the foreign earned income exclusion to reduce your federal income tax…and that is where things go horribly wrong.

First, the FEIE does not reduce self-employment tax, which is about 15%, similar to the tax charged to the employee and employer above. Unfortunately for the self-employed person, he must pay the entire tax, rather than only half, as he would as an employee.

Second, the exclusion is reduced in proportion to your Schedule C business expenses. This roughly means that, if your gross income is $182,800, and your business expenses are $95,100, your exclusion is reduced by about 50% to $45,700. Thus you are paying federal income tax on $45,700, or about 50% of your net business income, in addition to paying 15% self-employment tax on $95,100.

Ok, so that is rough, but the IRS is not done with you yet! Since January 1, 2006, when the Tax Increase Prevention and Reconciliation Act of 2005 came into effect, taxpayers claiming the foreign earned income exclusion have been paying tax at the tax rates that would apply had they not claimed the exclusion. That means, instead of having your income taxed starting at the 10% rate, most expatriates are taxed starting at the 25% tax bracket.

Therefore, if you have a Schedule C business operating at a 50% net profit margin with sales of $182,800 your tax bill might be $24,835 ($91,400 x 15% + $45,700 x 25%). This is a very rough, back of the envelope, example, but you get the idea.

If a husband and wife both operate the same business, and sales are doubled, with the same 50% margin, the cost of reporting the business on Schedule C, rather than through a properly structured offshore corporation, could be around $49,000.

Tax Benefits of Incorporating

If you are self-employed and living and working abroad you do have options.

For example, had the same self-employed person above operated through a properly domiciled and structured offshore corporation, he or she may have eliminated just about all of the tax on net active business profits of $95,100…to say nothing of the benefits of limited liability. This is accomplished as follows:

First, form an offshore corporation in a zero tax jurisdiction, open a foreign bank account, and resister that company with the IRS.

Second, draw a salary of up to $95,100 for 2012 from that foreign corporation. As long as you qualify for the FEIE and the company’s income is derived from active, not passive business, there will be no federal income tax on this income.

Third, the properly registered and domiciled foreign corporation is not responsible for Medicare, Social Security, or FICA taxes.

Fourth, you are not considered self-employed; you are an employee of your offshore corporation, and not subject to self-employment tax.

Fifth, the expenses of the offshore corporation do not reduce your foreign earned income exclusion.

Sixth, you might be able to retain some or all of the offshore corporation’s earnings in excess of the exclusion. Careful planning in this area might allow the deferral of U.S. income tax on active business income inside the corporation.

Therefore, the use of an offshore corporation by an international business with net profits of $95,100 and one employee saves about $24,000 in U.S. taxes. If the corporation’s net profits are $190,200, and there are two employees, such as a husband and wife, the total savings might be as high as $48,000.

When planning an international business, be it large or small, you should consult with a qualified U.S. licensed tax attorney experienced in forming and advising international businesses.


OVERSEAS TAX FAQ #1: How can an offshore corporation be used to reduce U.S. taxation?

If you live in the United States while you do your work, you will pay U.S. tax on the income you earn. Using a foreign corporation while you are physically present in the U.S. does not affect your U.S. tax situation.

If you retire to a foreign country and your only income is from a pension, investments, Social Security, etc., you will continue to pay tax in the States. There is no tax benefit to retiring abroad.

If you live abroad, work for either a U.S. company or a foreign employer, and meet the foreign earned income exclusion requirements, up to US$95,100 in wage income (for 2012; the amount is adjusted upward each year) will be free of U.S. federal income tax.

If you run a business or are self-employed, live and work abroad, meet the foreign earned income exclusion requirements, and operate through an offshore corporation, you could be able to reduce or even eliminate all U.S. tax on your ordinary income.

If you operate a business from and reside in a country that does not tax foreign-source income, and your clients are outside that country, you could be able to operate free of tax in that country as well, meaning it could be possible for you to live completely income tax free.

OVERSEAS TAX FAQ #2: What if I set up an offshore corporation but continue living in the United States? Could I have foreign clients wire money to my offshore corporation, then pay U.S. tax on that income only when it is brought into the States?

No. This is one of the most common types of tax fraud…a strategy for going to prison.

If you are present in the United States while you work, all income you earn is taxable in the United States when received. When money is sent to an offshore corporation that you own or control, it is deemed received. It does not matter if you use nominee directors or add some other layer of complexity.

Of course, there are legitimate benefits to incorporating offshore. For example, you could have access to better or more diverse investment options, you could enjoy better asset protection than available in a domestic vehicle, and your customers could prefer to do business with a non-U.S. entity.

I am asked this question all the time by people seeking tax advice. Typically, they are looking for honest counsel and have no intention of breaking the law. However, you must understand that, when you call an offshore attorney or an online incorporator, you often receive no guidance and often can be given misleading information.

OVERSEAS TAX FAQ #3: If I retire overseas, will I owe income on my retirement or pension income?

U.S. retirement and pension income was earned while you were working in the United States. In many cases, you were allowed to defer income on the pension component of your wages.

Now that you are ready to take that income, it is taxable in the country where it was earned. The foreign earned income excision and other international tax tools do not apply.

The same is true of most types of investment income. Income from stocks sold, dividends received, rental income, and bank interest does not qualify for the foreign earned income exclusion and is taxed as if you were living in the United States.

OVERSEAS TAX FAQ #4: Living overseas, must I still pay Social Security, Medicare, and FICA?

If you live abroad but work for a U.S. corporation, you qualify for the foreign earned income exclusion and can exclude up to US$95,100 in wage income (for 2012) from federal income tax.

However, you still must pay Social Security, Medicare, and FICA. This usually amounts to 7.5% paid by you and 7.5% paid by your employer. For the purposes of this conversation, I’m ignoring Social Security treaties, which are country-specific.

Also, you could still be required to pay state tax if your spouse is living in the United States while you are working abroad. For example, if your spouse lives in California, which does not have the foreign earned income exclusion, the state would tax 50% of your income under a community property tax rule.

If you are employed by a non-U.S. corporation, the foreign earned income exclusion rules are as I’ve described, but you do not pay U.S. Social Security, Medicare, or FICA taxes. This is the case even if the foreign corporation is a subsidiary of a U.S. company (unless that subsidiary elects into the U.S. social tax system, which is extremely rare).

OVERSEAS TAX FAQ #5: What is my U.S. tax obligation operating a business or being self-employed outside the States?

If you are self-employed or operate a business outside the United States and qualify for the foreign earned income exclusion, you can use that exclusion to reduce the amount of federal income tax you owe. If you operate your business without a corporation or through a single-member LLC that does not file an election with the IRS, you must pay U.S. self-employment tax on your income. This amounts to about 15% tax of your income.

Making things worse, your business is reported to the IRS on the “Schedule C” form, and your business expenses proportionately reduce your foreign earned income exclusion. For example, if your total sales for 2012 were US$300,000 and your expenses were US$150,000, your foreign earned income exclusion is reduced by 50%. Thus, you can reduce your income for the purposes of figuring the tax you owe by only US$95,100 divided by 2, or US$47,550.

Adding insult to injury, you must pay U.S. income tax on the amount over the allowed foreign earned income exclusion. In our example, that is US$150,000 of net income, minus the remaining FEIE of US$47,550 equals US$102,450 of taxable income.

All three of these problems can be managed by operating your business through a foreign corporation.

First, operating this way, you are a non-U.S. corporation and not required to pay Social Security, Medicare, or FICA taxes.

Second, you can draw a salary from your corporation of US$95,100, avoiding the issue of a reduced exclusion because of business expenses.

Third, you may be able to retain net profits in excess of the foreign earned income exclusion and pay U.S. income tax on that money only when you take it out of the corporation.

OVERSEAS TAX FAQ #6: If I operate a business in a foreign jurisdiction (such as Panama), what is my local tax obligation?

Several countries, including Panama, do not tax foreign source income. These jurisdictions tax only domestic income (profits you make by selling to people in that country).

Therefore, you can mitigate income tax in your country of residence if you sell to people or businesses outside that nation. For example, from a base in Panama, you could offer products or services over the Internet to clients in the United States. If you don’t take orders from people in Panama, this is foreign-source income in Panama and not taxable by that country.

Note: Selling to customers in the United States does not affect your foreign earned income exclusion or your ability to retain earnings in your corporation. These tax rules require only that you live outside the United States and otherwise qualify for the foreign earned income exclusion.

As discussed above, you must take a salary from your foreign corporation to maximize the benefits of living and operating a business abroad. If you draw a salary from your Panama corporation while you are living in Panama, you could be subject to Panama’s various income, payroll, and social taxes.

You can comply with your U.S. obligations by selling through a second foreign corporation, such as one incorporated in Cayman or Nevis, drawing a salary from that entity, and then passing funds sufficient to pay business expenses in Panama up to your Panama company.

In this way, you mitigate tax in Panama on your salary, and your domestic (Panamanian) entity breaks even for domestic tax purposes.

As long as you report both entities and all non-U.S. bank accounts to the U.S. government, you remain in compliance with your U.S. tax obligations. If you take a salary less than or equal to the foreign earned income exclusion, and retain the balance in your offshore structure, you could eliminate or defer U.S. tax on up to 100% of your revenues.

Where to Incorporate

Once you have decided to incorporate your business offshore, the next big issue is where. Here are my suggestions.

The first step in the process is to decide if you want to focus on privacy, transparency, or on a country that will make a good impression on those who contract with your business. There are several good choices available for each of these three focal points, but I tend to limit my formations to countries where I have experience, have personal relationships, and where I have spent time researching and debating their business, tax, and privacy laws.

With that said, if the primary component is privacy, I typically suggest a Nevis or Cook Islands corporation or limited liability company (LLC). Both of these countries have exceptional privacy laws, well tested legal systems, and a long history in the asset protection industry. Again, there are other jurisdictions, but these two work well, so I do not see a need to search further.

I expect most readers are familiar with Nevis, so I will say a few words about the Cook Islands (CI). The CI have long been a leader in international asset protection trusts, and just recently passed the “The Cook Islands International Limited Liability Companies Act 2008.” This Act, modeled after Nevis, integrates CI’s long standing trust and creditor laws, and their corresponding lack of a bankruptcy statute, into an LLC statute which maximizes both privacy and asset protection.

Other clients, especially those who are officers or directors of large U.S. based businesses, or who will operate an offshore hedge fund with U.S. investments, require a country that is fully compliant with the U.S. Fyi…compliant generally means that the IRS and SEC can easily find the beneficial owner and gain access the company’s books, records, and foreign bank accounts.

Where transparency is required, I prefer Cayman Islands corporations and licensed hedge funds. This jurisdiction is more expensive than its competitor, the British Virgin Islands, but I believe that the availability of quality legal and accounting professionals on Grand Cayman is worth the cost. Since most clients seeking such transparency are operating significant businesses or investment portfolios, cost should not be a primary factor.

The third category, a country that will make a good impression on those who contract with your business, is harder to define. After all, beauty is in the eye of the beholder. With that in mind, here are three suggestions:

If money is no object, and image is everything, I suggest a Swiss holding company with Cayman or BVI subsidiaries. This generally allows you to operate from Switzerland, hold yourself out as a Swiss company, and contract through offshore subsidiaries, without incurring Swiss tax on international (holding company) profits.

Unfortunately, operating in Switzerland can be expensive. The typical annual maintenance of a Swiss holding company, including a Swiss director, is $10,000+, compared to about $850 for a Nevis IBC or LLC without a foreign director. In addition, a lot of planning and complex structuring is required to work through the dividend withholding section of the Swiss tax code.

For those on a budget, I recommend Hong Kong or Panama. Hong Kong is an excellent place for a holding company, has a wealth of qualified legal and accounting professionals, balances privacy and business image well, allows for nominee directors, and most banks are comfortable with corporations domiciled in Hong Kong.

The drawbacks of Hong Kong are that the directors monitor the company’s activities closely, which results in higher than average annual bills, the time difference with the U.S. often delays communications and transactions by about 24 hours, and you must travel to Honk Kong in order to open a bank account there. If you prefer not to travel, an account can be opened in the Isle of Man. Also, while the directors are active, they are typically well qualified and handle your business in a professional manner.

Finally, I believe Panama is the best jurisdiction for someone who will operate a business outside of the U.S. with employees, an office, and business assets. The Panamanian economy is strong, qualified labor is relatively inexpensive, the costs of firing an employee are minimal compared to Europe, telephone and internet services are cost effective and of a high quality (certainly superior to all Caribbean islands and most Latin American countries), several local banks provide reasonable service and do not have branches in the United States, and Panama’s primary currency is the U.S. dollar, so your Panamanian bank can accept checks from U.S. clients.

In addition to the business benefits above, from a privacy standpoint, Panama allows for nominee directors and shareholders. Also, the shares in a Panama company can be held by a Panama foundation, thereby maximizing asset protection.

Shelf Companies

I am frequently asked about the use of offshore “shelf” corporations in international business. Some claim they are useless, while others market them as the greatest invention since the numbered bank account. I would like to take this opportunity to put my two cents worth in to the debate.

Bottom Line: I believe offshore shelf corporations can be helpful if you are marketing a business because they improve your image. Since this can be accomplished without backdating any documents, or doing anything improper, I support shelf companies.

First, what is a shelf company? It is a corporation formed months or years ago that has been sitting on the incorporator’s shelf, unused. Because it has no history of operation, no bank account, and no creditors, there should be no risk in purchasing a shelf company.

The legitimate benefits of an offshore shelf corporation are:

  1. The company is ready to use off the shelf. You do not need to wait for the company to be formed, the name to be approved, or for the directors to be assigned.
  2. You can market the name and age of the shelf company. For example, your letterhead and marketing materials can refer to “International Marketing Services (Panama), S.A., Established 2006,” if you bought a corporation by that name formed in Panama in October of 2006.

Of course, the abuses of shelf companies are well documented. Many purchase these entities and then ask the director to sign back dated documents. While you can find some less scrupulous directors who are willing to provide this service, such a practice is obviously improper.

Because of the nature of the industry, it is difficult to find a shelf company older than about 14 months. This is because these companies are usually formed by the incorporator on behalf of a particular client. The client does not pay the incorporation fee, so the entity sits on the shelf to be sold to someone else. After 12 months, the annual dues must be paid, which the incorporator is not willing to do. Around the 14th to 16th month, the company is closed by the government registrar.

The only significant exception that I have found is in Switzerland. There, it is possible to purchase a company formed many years ago, revive that company in the government registry, let it sit on the shelf for about 2 years to eliminate any potential creditors and then file for a tax clearance. The result is a clean shell with the original incorporation date attached.

So, while a shelf company may help in marketing your business, it has no tax benefit.

International Foundations

Many offshore promoters are pushing Liechtenstein Foundations on the very wealthy and Panamanian Foundations on the rest of us.

Note: Foundations are more commonly used in asset protection, but some operate offshore businesses under them, thus their inclusion in this book.

Many are taken in by the term “foundation,” hoping or believing that it makes the structure a charitable foundation which is tax exempt. This is simply not true. For an entity to be tax exempt, it must be registered with the IRS as such, under IRC §501(c)(3)., and this applies to both foreign and domestic entities.

Tax tip: Only donations to charities licensed by the U.S. are deductable on your personal tax return. You can donate money to any charity or group around the world, but, if they do not have the IRS’s blessing, you are not entitled to a deduction.

Adding to the confusion, Foundations typically have multiple levels of nominee directors and boards which allegedly control the Foundation’s assets. Some promoters’ claim that, because you gave up control of your assets, you are not taxed on the interest, dividends, and earnings of the foundation. Again, this is not true. You remain the beneficial owner and have indirect control, which equals ownership in the U.S. tax code.

Most accept that a simple foreign corporation with a nominee director, or an offshore trust with a foreign trustee, does not reduce U.S. tax on earnings. But, change the ending from Inc. to foundation; add a few layers of directors, and many are willing to believe the impossible.

Taking it one step further, some foreign attorneys will issue an option stating that the Foundation is not a grantor trust under the U.S. rules. I do not see anything inherently incorrect in this statement. It seems possible that the Foundation can be classified as something other than a grantor trust. However, these statements are often used to confuse and mislead the U.S. client in to believing that there is some tax benefit to such a classification.

All of the opinions I have read say something like this: “The design and structure of the Foundation is to achieve an entity classification as other than a trust such as a partnership, corporation or disregarded entity for U.S. tax purposes.”

Keeping in mind that the U.S. citizen is taxed on his or her worldwide income, and if we agree that the foundation is not some magical tax exempt structure, the classification does not make a tax difference. Under all options, income to the foundation will be taxed in the U.S. as earned, transfers to the entity will be reportable events, and (most) transfers of appreciated property will be deemed sales.

Some opinions also have the following clause: “Furthermore, there is the option of seeking a private letter ruling from the Internal Revenue Service confirming the proper entity classification of the Foundation.” Such a statement should cause alarm…it means that the IRS has not classified the Panamanian or Lichtenstein Foundation and that U.S. citizens have no certainty regarding when, what, and how to file returns for a foundation.

What would happen if you assumed the foundation was a corporation, filed foreign corporate returns, and then it was classified as a trust? I have no idea, but I would not want to find out! In my opinion, Panamanian and Lichtenstein Foundations are potential options and competitors of the offshore Asset Protection Trust. However, I will not recommend them until the IRS provides some clarity on their status and filing requirements.

I am a big fan of Panama as a country in which to operate an international business and I hope these issues are resolved, and that promoters take a more realistic view of U.S. taxation, so that Panamanian Foundations can become legitimate Asset Protection tools.

Taxation of Foreign Real Estate Investments

EDITORS NOTE: This article was published in 2010 and has some valuable information. For a more recent and detailed article on this same site, click here.


When it comes to investing in property overseas, there is often little difference than if you were investing in U.S. property. Three situations bear investigation:

1. The first is the purchase of raw land or a building for speculation. In this scenario, the investor buys a property overseas and plans on holding it for a period of time to later sell for a profit. The result is a capital gain taxed by both the U.S. government and, in some cases, the state of domicile of the taxpayer. The U.S. has favorable tax rates (currently 15%) if the holding period is over one year. There may also be a capital gains tax in the country that the property is located in. If this is the case, a credit can be used to offset U.S. taxes.

In this situation, there is no difference in how the U.S. taxes the sale of an investment property in the U.S. and one outside of the U.S.

2. Let’s look at the same scenario, except this time, instead of selling the property outright you want to exchange it into another property. This can be accomplished by using the provisions of section 1031 of the IRS code. Under this section, you can defer some or all of the gain from the sale of one property by simultaneously purchasing another property of “like kind.” Here again, there is no difference in the taxation of property inside the U.S. and outside the U.S.

What we must look at in this situation is the exact definition of “like kind.” When dealing with real property, the government gives quite a bit of latitude in what is considered “like kind.” Examples are raw land, a single family house, a condo, an apartment building, a restraint, etc. As long as you’re selling real estate to buy real estate, you will generally be allowed to perform a 1031 exchange.

The main thing to be aware of is that foreign real property and U.S. real property is not considered to be like kind. For instance, you cannot exchange a rental property in California into a rental property in France or to raw land in Costa Rica (or vice versa).You could however exchange the rental property in France into raw land in Costa Rica. What this boils down to for you, the investor, is that, if you want to move an investment back into the U.S. you will have to pay taxes on any gains you made.

If a property qualifies as “like kind” then you must also qualify the exchange. There are complexities involved with this type of transaction, and you should hire a tax consultant to facilitate the transaction and make sure that you don’t do anything to disqualify the non-recognition of gain. Another critical point is that your new property needs to be more expensive and have a larger note on it. Otherwise a portion of the gain will be recognized and taxable. For more information, see the “Nontaxable Exchanges” section of IRS Publication 544 Sale or Other Dispositions of Assets available at www.irs.gov/pub/irs-pdf/p544.pdf.

3. The third consideration is when you have a rental property overseas. In this case, it is much the same as a rental situation within the U.S. The main consideration is that rental activities are considered passive. This means that losses from your passive rental activities can only offset income from other passive sources. If you do not have any other passive income, the losses are suspended until such time that you have passive income or you sell the property—at which time the losses are released and can offset other types of income.

An exception to this rule applies to active participants in the management of real property. As an “active participant,” you must share in the management decisions for the property, arranging for others to provide services like repairs, etc. Owning property in a foreign country makes it more difficult, but not impossible, to qualify as an active participant. If you meet this requirement, you can deduct the losses from your rental property against your other income (like wages, self-employment, interest, and dividends).

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

  • You must own more than 10% of the property.
  • You cannot be a limited partner.
  • You must be an active participant in the year of the loss and the year that the loss is deducted. The benefit phases out at an adjusted gross income of between $100,000 and $150,000.

Finally, you will only be allowed straight line depreciation on property outside of the U.S. You are not eligible for the various accelerated depreciation methods.

Implications of Your “Tax Home”

If you only have one tax home regardless of whether you reside in the U.S. or overseas, there are few, if any, complications.

For people with multiple homes or multiple business ventures at which they spend varying amounts of time, it gets trickier. These situations are decided on a case-by-case basis, according to individual circumstances. Some of the facts that will be looked at are:

  • Total business time spent at the different locations.
  • The amount of business activity that is carried on at each location.
  • The significance of the business activity to the taxpayer’s return (where is more money made and what percentage of the total income does it represent?)

Let’s look at some examples of how the tax home concept can affect the taxes of the international real estate investor.

Example 1—Bob and Jane live in the United States and work close to their home. They own some real estate outside the U.S.

In this case, their tax home is their residence and all expenses they incur when visiting their realestate (whether rental property or investment property) are deductible against the income fromthat property.

Example 2—Bob and Jane live in the United States and work close to their home. They spend part of the year at their foreign property—a small house in France with a vineyard.

In this case, whether they can deduct all their living expenses (travel, meals, utilities, incidentals) as “away-from-home” expenses in pursuit of a business is dependent on the facts. Which home do they spend more time at? Where do they make more of their money? How much of their time at the foreign home is devoted to the vineyard business?

If it is determined that more time is spent at the foreign location, the deductions will not be allowed. This is exactly what happened in the case of Bowles v. United States. The taxpayers claimed away-from-home expenses for their grape-growing business, but the IRS and then the courts ruled that, since more of the couple’s time was spent at the vineyard, the vineyard was their tax home and the deductions weren’t allowed.

Example 3—Bob and Jane live in the United States and work close to their home. They own a seasonal B&B in Europe, which they spend the summer operating.

In this case, if Bob and Jane can prove that their tax home is in the United States, all of their living expenses can be deducted as away-from-home expenses (in any case the direct expenses of operating the business are allowed).

What is important to note is that you need to plan your actions beforehand. If you are going to operate a business, or own real estate overseas, and you want to deduct your overseas living expenses as away-from-home expenses, you need to make sure that you create a fact pattern consistent with a tax home in the U.S. Direct expenses of the business or investment are always deductible and are not dependent on where your tax home is.

Note: There is an important distinction in the concept of “tax home” for purposes of deducting away-from-home expenses and qualifying for the foreign earned income exclusion. Multiple homes may cause the loss of the away-from-home expenses but, as long as they are all overseas, you may still qualify for the earned income exclusion and the housing exclusion.


EDITORS NOTE: This article was published in 2010 and has some valuable information. For a more recent and detailed article on this same site, click here.


The Rules for Americans Overseas

Foreign Income Must be Reported

As an American citizen overseas—regardless of where you live or work—you are generally required to file a U.S. tax return, reporting any income generated abroad, in addition to your earnings on the U.S. side.

You are also subject to the same filing requirements that apply to U.S. citizens or residents living in the U.S. As long as you meet the gross income requirement, there’s no escaping the IRS.

You are also eligible for just about all of the deductions. You can choose to take the standard deduction, or itemize on Schedule A. If you itemize, you may deduct mortgage interest, property tax, investment interest, etc. The only major issue is charitable contributions made to a non-U.S. church or organization.

In order for a charitable contribution to be deductible, it must be made to an IRS approved organization. In other words, the charity must qualify under Code Section 501(c)(3). Only the largest of international charities have gone through this approval process, thus, it is unlikely that a contribution to your local non-U.S. church or group is deductible on your U.S. tax return.

Certain deductions may also be reduced by the foreign housing exclusion for the foreign earned income exclusion. However, this is rare and you will need to consult with a tax professional for further guidance.

Even if you determine that your federal tax obligation is zero, you must still complete and file the forms. The IRS changes the filing thresholds slightly each year. In general, once you have the following gross income amounts for 2012, the law requires you to file a federal tax return with the IRS:

Single . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $9,500

65 or older . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,950

Head of household . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $12,200

65 or older . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $13,650

Married filing jointly . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $19,000

One spouse 65 or older . . . . . . . . . . . . . . . . . . . . . . . . . $20,150

Both spouses 65 or older . . . . . . . . . . . . . . . . . . . . . . . . $21,300

Married filing separately . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,700

Qualifying widower . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $15,300

65 or older . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $16,450

To determine if you meet the gross income requirement for filing purposes, you must include all income you receive from foreign sources as well as your U.S. income.

This is true even if:

The income is paid in foreign money.

The foreign country imposes an income tax on that income.

The income is excludable under the foreign earned income exclusion.

If you are self-employed, and generate more than $400 of net self-employment earnings in a single year, you must file a U.S. income tax return, regardless of your age. Net earnings from self-employment include the income earned both in a foreign country and in the U.S.

You must pay self-employment tax on your net self-employment income, even if it is earned in a foreign country and is excludable as foreign earned income in figuring your income tax. This is an important point worth repeating: the foreign earned income exclusion helps reduce the income tax—not the self-employment tax. The only way to reduce self-employment tax is with ordinary business expenses incurred in the self-employment activity or to operate the business through a foreign corporation.

The Standard Deductions for tax year 2012 are as follows:

Married, Filing Joint Return. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,900

Head of Household. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ………. $8,700

Unmarried (not S.S. or H.H.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,950

Married, Filing Separate Return. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,950

Tax Advantages for Americans Overseas

The good news is that you may be able to exclude from your income some or all of your foreign earned income. Earned income includes salary, wages, and self-employment earnings. You may also be able either to exclude or to deduct from gross income a “housing amount.” And—depending on your situation—you may qualify for a foreign tax credit or deduction for the local taxes paid to a foreign country. Based on your own particular circumstances, these advantages may reduce—or sometimes eliminate—your federal tax liability.

While exclusions and credits can reduce your tax liability to Uncle Sam, the United States has concluded tax treaties—and other international agreements—with many foreign countries which may help reduce your foreign tax liability, as well.

In theory, the foreign earned income exclusion, the credit or deduction for foreign income taxes, and the application of tax treaty provisions are designed to prevent overseas Americans from paying taxes to both the U.S. and a foreign country on the same income. In other words, they are designed to avoid double taxation. If you are fortunate enough to live in a foreign country that—for one reason or another—doesn’t tax your income, and your salary while abroad is less than or equal to the foreign earned income exclusion amount, this exclusion may allow you to escape income taxes altogether

Foreign Earned Income Exclusion

The most important tool in the expat’s U.S. tax toolbox is the Foreign Earned Income Exclusion (FEIE or Exclusion). If you qualify, you can exclude up to $95,100 in 2012 of foreign earned income free from U.S. Federal income tax. If you are married, and both spouses qualify for the exclusion, your total exclusion may be $182,800.

Foreign Earned Income

As I said above, only income that is both foreign and earned can be excluded from Federal income tax. Income that is foreign is that which is earned while you are physically present outside of the United States. Income that is earned is wages, salaries, professional fees and other amounts received as compensation for personal services actually rendered when your tax home was located in a foreign country and you meet either the bona fide residence or physical presence test. Wages can come from a U.S. corporation or a foreign corporation, including an offshore corporation, and it does not matter that you are also a shareholder or owner of that corporation.

Earned Income does not include interest, dividends, or other investment or passive income.

To qualify for the exclusion, you must first prove that your “tax home” is outside of the United States. Second, you must meet the requirements of either the residency or 330 day tests.

Your tax home is where your principal place of business is located, regardless of where you maintain your residence. In most cases, if you live and work outside of the United States, your tax home is located there.

The concept of a tax home can become complicated in a few, specific instances, such as when someone works in Mexico and lives in the U.S. (ie. commutes from the U.S. to Mexico each day). In that circumstance, your tax home is the U.S. and the FEIE is not available.

In the vast majority of cases, one’s tax home is not a major consideration, therefore, I will not go in to more detail here. For more information, contact a tax professional or see Code Section 911(d)(3) and the related regulations and examples.

Once you have established that your tax home is outside of the United States, you must meet the requirements of either the 330 day test or the residency test.

1. 330 Day Test: You must be outside of the United States for 330 out of any 365 day period. It does not matter if the 330 days is over two calendar years (example: between November 1, 2011 to October 31, 2012) and a special extension to file your tax return is available to give you time to meet this requirement.

2. Bona Fide Residency Test: Residency is achieved by moving to another country and making it your “home.” You can intend to return to the United States in the future, but you must move to the foreign country for an “indefinite” or “extended” period of time, which must include one entire calendar year. This is discussed in detail below.

As you can see, the 330 day test is fact based, while the residency test turns on your intentions and is therefore more difficult to use and prove. I often recommend relying on the 330 day test in the first year you claim the Exclusion, and then moving to the residency test after applying for or gaining residency in your new home.

Also, the exclusion is computed on a daily basis. Therefore, the maximum limit must be reduced for each day during the calendar year that you do not qualify. The exclusion is also limited to the excess of your foreign earned income for the year over your foreign housing exclusion.

Bona Fide Residency Test

The bona fide residency test is one of the most misunderstood and misused sections of the tax code by those working and living abroad…especially by contractors on “temporary” assignments and those in combat zones.

You are a bona fide resident if you move to a foreign country and make it your home. You do this by filing and paying taxes in that country, moving there and planning to stay indefinitely, and generally becoming part of the local community.

The perfect example of a resident is someone who moves to a foreign country, does not intend to return to the U.S., files and pays taxes in that country, is on a long term visa that allows them to work in that country, applies for residency and/or citizenship if possible, sell their U.S. home and buys one in the foreign country, and if they are married or have children, those family members relocate with them.

The problem with the residency test is that very few cases are perfect. For example, a husband might move to France to work indefinitely, leaving his family in California, where he returns to visit for 40 days per year. He also plans on returning to California when it is financially possible. This taxpayer must use the residency test and convince the IRS that his tax home is in France, while his wife’s tax home is in the U.S. This can be a challenging tax issue.

Also, being out of the U.S. for one calendar year does not make you a resident of a foreign country. For example, if you go to a foreign country to work on a particular construction job for a specified period of time, say 14 months, you ordinarily will not be regarded as a bona fide resident of that country even though you work there for one tax year or longer. The length of your stay and the nature of your job are only some of the factors to be considered in determining whether you meet the bona fide residence test.

If the residency test is so complex, why use it? Because qualifying under this test, rather than physical presence, allows you to return to the U.S. for a few months each year rather than only 35 days. Second, once you qualify as a resident of a foreign country, you will remain a resident of that country for U.S. tax purposes until you give up your residency. With the 330 day test, you must be out of the country for 330 of each 365 day period.

Finally, with the residency test, you can qualify for all or part of a year. Here is an example:

Andy is a U.S. citizen who qualifies for the FEIE using the physical presence test by living in Costa Rica for all of 2011. He spent no days working in the United States and received $78,000 in salary. Assuming he claimed no foreign housing exclusion, Andy is able to exclude all of this salary from his gross income because it is less than the Foreign Earned Income Exclusion amount for 2011 of $92,900. Andy continues to work in Costa Rica until October 31, 2012, when his employer permanently reassigns him to the United States. During this time, Andy received a salary of $95,000 for his work in Costa Rica in 2012. Assuming he claimed no foreign housing exclusion, the maximum amount of foreign earned income he can exclude from his gross income in 2012 is $79,467 ($95,100 multiplied by ratio of the number of days he was working in Costa Rica (305/365)).

Perpetual Traveler

One major issue I see time and time again, especially with retiree’s living abroad, is the “perpetual traveler.” This is someone who is never in any one place long enough to lay down roots. They travel from place to place, possibly residing in one city for a few days, or a few months.

As stated above, the residency test is based on your intent to move to a particular place and make it your home. If you have no home base, or are not a part of any community in particular, you may not be eligible to use the residency test.

In my opinion, the perpetual traveler is forced to use the 330 day test. Therefore, they must be outside of the U.S. for 330 out of each 365 day period. This may limit the perpetual traveler’s ability to visit family or vacation in the States.

Simply gaining residency in a nation, such as Belize that only requires you to be in their country a few months each year, will not suffice for U.S. tax purposes. The residency test is based on a number of facts and circumstances, and having a residency permit is only one factor.

However, once you establish residency in one place, you will not lose that status in the U.S. tax system, until you give it up (also stated above). Therefore, if you move to a foreign country for a year or two, with the intent of making it your home, and then become a perpetual traveler, you should maintain your foreign residency status.

Travel Days

Since about 2008, it has been the IRS’s position that travel days, and time spent in international waters or airspace are not days outside of the U.S. for the purposes of the FEIE. This argument has been supported by a few U.S. tax court cases.

What does this mean to you? If you are using the 330 day test, you must count days traveling to and from the U.S., as days in the U.S., and not foreign days.

If you are in a business, such as a ship captain or airline pilot, that requires you to spend time in international waters, then you have a problem. If you have no residency, and are required to use the 330 day test, you may not be eligible for the FEIE. If this applies to you, you should contact a tax professional.

Forced Out

Relief from either the residency or the 330 day test is available if you are forced to flee a foreign country because of civil unrest, war, or other adverse conditions. To qualify, you must have been a bona fide resident of, or present in, the foreign country on or before the date the IRS determines that adverse conditions exist. In addition, you must establish that you could reasonably be expected to have satisfied the residency requirements had the adverse conditions not arisen. The IRS publishes the names of countries for which this waiver is available annually.

I note that the adverse conditions must arise after you moved to the country in question. Each year I have contractors working in war zones ask if they can use this clause to get out of their contracts and still use the FEIE. Of course, the answer is no. Anyone who travels to a country on the list is on notice and the exception is not available.

Use it or Lose It

In a perfect world, all U.S. citizens file their U.S. tax returns on April 15 and make use of all the proper exclusions and deductions. Of course, that is not the case. In fact, the majority of returns I prepare for those living abroad are delinquent.

This can be extremely costly for those using the foreign earned income exclusion. If you file late, and you are audited by the IRS, you might lose the foreign earned income exclusion, and pay tax on 100% of your foreign earned income!

Generally, a qualifying individual’s initial choice of the foreign earned income exclusion must be made with one of the following income tax returns:

  • A return filed by the due date (including any extensions),
  • A return amending a timely-filed return. Amended returns generally must be filed by the later of 3 years after the filing date of the original return or 2 years after the tax is paid, or
  • A return filed within 1 year from the original due date of the return (determined without regard to any extensions)

An exception to this rule will be made provided that:

  • You owe no federal tax after accounting for the exclusion, or
  • Prior to the IRS discovering you failed to elect/utilize the exclusion.

If you owe tax after taking the FEIE into account, and the IRS discovers your failure to use the FEIE, then you may request relief by requesting a private letter ruling under Income Tax Regulation 301.9100-3 and Revenue Procedure 2009-1.

Having handled several of these cases, I can tell you that negotiating a settlement, or securing a letter ruling, will be a very costly and time consuming battle. It is possible to have about $1 million in untaxed income at issue, where a husband and wife failed to file a return for 6 or 7 tax years and would have been eligible for the full FEIE.

What if I am not overseas for a full tax year?

If during a tax year, you are overseas for only part of one tax year, but not long enough to qualify for the exclusion based on either physical presence or bona fide residence, you have four options:

1. If you paid foreign income tax, claim the foreign tax credit if it means you can avoid paying any U.S. income tax. In general, this applies when the tax rate of your foreign country is higher than, or equal to the U.S. tax rate.

(Caution: This option should be made only with the advice of a tax professional. It is not entirely clear at this time whether claiming a foreign tax credit when you could have chosen the foreign earned income exclusion will automatically revoke your election to take the exclusion for the following five years without the approval of the IRS.)

2. File your tax return for the year without claiming the exclusion. Then, once the physical presence or bona fide residence qualifying period is reached in the following year, you can file an amended return to claim a pro-rated exclusion for the part-year.

3. Those who were overseas for the last three months of the year (let’s say in 2010 for this example) and expect to be overseas for the first nine months of the following year, can file an IRS Form 4868 and if necessary the applicable state return filing extension request for automatic extensions to October 15. This will allow time to meet the 12 month physical presence test before the extended due dates of the returns. Once the 12 month period is reached, the 2010 tax returns can be filed claiming the partial exclusion for the time spent overseas in 2010.

4. File a Form 2350—a further application for extension of time to file beyond October 15. This allows you sufficient time to qualify under either of the two time requirements, plus 30 days to file the return for the year in which you qualified for only the part-year exclusion. In choosing your strategy, you need to consider the consequences involved. If financial concerns are paramount, then you should seek advice from a tax professional. If you have a considerable amount to pay on the original return—most of which you will recover on an amended return—you may prefer to wait out the qualification period and file one return.


If your tax home is in a foreign country—and you meet either the bona fide residence test or the physical presence test—you may be able to claim an exclusion or deduction from gross income for housing provided by your employer. Employees claim an exclusion, whereas a deduction is claimed by those who are self-employed.

For the exclusion, foreign housing is provided by an employer if any amount is paid or incurred by the employer on your behalf and included in your foreign earned income (for example, housing allowance or reimbursement).

A housing amount is determined as the excess, if any, of your allowable housing expenses for the tax year over a base amount which increases each year. For 2012 the qualifying daily rate is $36.47 or $13,314 for an entire year of qualifying days (this is 16% of the total FEIE). Allowable housing expenses are the “reasonable” expenses incurred by you and your family such as:

  • Rent paid on your foreign property.
  • Utility charges incurred (other than telephone charges).
  • Real and personal property insurance for foreign housing.

Items that are not considered “allowable housing expenses” include:

    • The cost of home purchase or other capital items.
    • Wages of domestic servants.(Note: Under certain circumstances, such wages may qualify as “childcare expenses.”)
    • Deductible interest and taxes.

You can also include the allowable housing expenses of a second foreign household for your spouse and dependents if they did not live with you because of adverse living conditions at your tax home.

The base amount is figured on a daily basis. Your allowable housing amount is the IRS-determined base amount times the number of days during the year that you meet the bona fide residence or physical presence test. The base amount, which changes each year, is shown on each year’s Form 2555. It is found on line 32 of the Form 2555 for 2011.

Determining your housing

You can exclude or deduct (within the lower and upper limits) your entire housing amount from income if it is considered paid for with employer-provided amounts. Employer-provided amounts are any amounts paid to you—or on your behalf—by your employer, including salary, housing reimbursements, and the fair market value of pay given in the form of goods and services.

If you have no self-employment income, your entire housing amount is considered paid for with employer-provided amounts. If you claim the exclusion, you cannot claim any credits or deductions related to excluded income, including a credit or deduction for any foreign income tax paid on the excluded income.

If you are self-employed—and your housing amount is not provided by an employer—you can deduct the housing amount to arrive at your adjusted gross income.

However, the deduction cannot be more than your foreign earned income for the tax year, minus the total of your excluded foreign earned income and the foreign housing deduction amounts.

If you are an overseas employee who also carries on an overseas self-employment activity, the rules are more complicated. To determine the net self-employment income for both income and self-employment tax purposes, you should consult a tax professional.

Second foreign household

Ordinarily, if you maintain two foreign households, your reasonable foreign housing expenses include only costs for the household that bears the closer relationship (not necessarily geographic) to your tax home. However, if you maintain a second, separate household outside the United States for your spouse or dependents because living conditions near your tax home are dangerous, unhealthful, or otherwise adverse, include the expenses for the second household in your reasonable foreign housing expenses.

You cannot include expenses for more than one second foreign household at the same time. If you maintain two households and you exclude the value of one because it is provided by your employer, you can still include the expenses for the second household in figuring a foreign housing exclusion or deduction.

Adverse living conditions include:

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


You make separate choices to exclude foreign earned income and/or to exclude or deduct your foreign housing amount. If you choose to take both the foreign housing exclusion and the foreign earned income exclusion, you must figure your foreign housing exclusion first.

Your foreign earned income exclusion is then limited to the smaller of (a) your annual exclusion limit, or (b) the excess of your foreign earned income over your foreign housing exclusion. This limitation is automatically computed on the Form 2555.

It is often difficult to follow the interplay of the lines on tax forms because forms are generally designed by mathematicians whereas the rules are most often written by lawyers. A simpler way of looking at it is that your combined earned income exclusion and housing exclusion cannot exceed your total overseas earnings.

Once you choose to exclude your foreign earned income and/or housing amount, that choice remains in effect for that year and all future years unless you revoke it. You can revoke your choice for any tax year. However, if you revoke your choice in one tax year, you cannot claim the exclusion again for your next five tax years without the approval of the IRS. For more information on revoking the exclusion, see (1) Effect of Choosing the Exclusion and (2) Revoking the Exclusion, both of which are found on page 20 of the 2012 Publication 54.

After reading these two sections, you may reach the conclusion that simply taking a foreign tax credit when you could have chosen the exclusion will automatically disqualify you from claiming the exclusion for the next five years without the approval of the IRS.

If, in your case, a foreign tax credit would be far more beneficial than claiming the exclusion, you should discuss your situation with a tax professional.

For a consultation, you can reach a us at (619) 483-1708 or by email to info@premieroffshore.com.

FORM 2555 OR FORM 2555EZ?

The Form 2555EZ is a shorter, simpler version of the Form 2555 but may be used only if you meet all of the following requirements:

  • Total foreign earned income is $91,400 or less.
  • The return being filed is for a full calendar year.
  • You have no self-employment income.
  • You have no business or moving expenses.
  • You are not claiming the foreign housing exclusion or deduction.

There is no need to memorize the above conditions. They are printed on the top of page one of the Form 2555EZ.


If both you and your spouse are eligible for either the foreign earned income or housing exclusion, you can file separate Form 2555s (or 2555EZs) and claim separate exclusion amounts. For further details on married couples filing separate 2555s, see Chapter Four of Publication 54.

If you are married and residing either in a foreign country with community property laws or a domiciliary of a U.S state with community property laws, you need to consult a tax expert.


Disruption of the qualifying time period because of war, civil unrest, or similar adverse conditions in the foreign country would not preclude you from claiming at least part of the exclusion. However, there are special rules to determining a reduced amount of the exclusion. Here again, you should refer to Publication 593 or Publication 54, or consult with a tax professional.


If your work requires you to live in a camp in a foreign country that is provided by or for your employer, you can exclude the value of any meals and lodging furnished to you, your spouse, and your dependents. For more details, see Publication 593 or Publication 54.

Withholding income tax and social security tax

If you are an employee of a U.S. company overseas, your employer may withhold income and social security taxes from your pay. In certain circumstances, it may be to your advantage to have your employer discontinue withholding income tax from all or part of your wages. You might do this if you expect to qualify for the income exclusions under either the bona fide residence test or the physical presence test. See Publication 54 for more information on withholding income tax.

See the U.S. security taxes section below for the requirements for employer withholding of social security taxes.

If a U.S. employer does not withhold income taxes from your foreign wages—or if not enough tax is withheld—you may have to pay estimated tax. Your estimated tax is the total of your estimated income tax and self-employment tax for the year, minus your expected withholding for the year.

When estimating gross income, do not include the income that you expect to exclude. In figuring your estimated tax liability, you can subtract from income your estimated housing exclusion or deduction. However, if the actual exclusion or deduction is less than you expected, you may be subject to a penalty for underpayment. You can use Form 1040-ES (Estimated Tax for Individuals) to estimate your tax due for the year. The requirements for filing and paying estimated tax are generally the same as those you would follow if you were in the U.S.


U.S. payers of benefits from employer deferred compensation plans (such as employer pensions, annuities, or profit-sharing plans), individual retirement plans, and commercial annuities are generally required to withhold income tax from these payments or distributions. This will apply unless you choose an exemption from withholding.

To qualify for this withholding exemption, you must provide the payer of the benefits with a residence address in the U.S. (or U.S. possession), or certify to the payer that you are not a U.S. citizen, resident alien, or someone who left the United States with the principal purpose of avoiding U.S tax.

For rules that apply to non-periodic distributions from qualified employer plans and tax-sheltered annuity plans, refer to Publication 575 (“Pension and Annuity Income”).

Although the U.S. Social Security Administration (SSA) is not required to withhold federal income tax on benefit payments to American recipients residing in the U.S. or overseas, benefit recipients may request voluntary income tax withholding. Based on rules too complicated to discuss here, some of the benefit payments may be subject to U.S. income tax and the recipients may prefer to have the income tax withheld. You should check with a tax expert to determine if any of your benefit payments will be subject to U.S. income tax and whether or not it is advisable to have the tax withheld by the SSA.

Note: Some foreign countries may tax your benefit payments in spite of the fact the payments are also subject to U.S. tax. Although the many U.S. income tax treaties provide for taxation of certain income by the U.S. alone, you will need to be familiar with the laws of the foreign country in which you reside.


Under certain circumstances, you may be required to pay social security taxes to both the U.S. and a foreign country on the same income. For example, when Bob, an employee of a U.S. company, moves overseas on a foreign assignment, the employer is liable for the employer’s share and Bob is liable for his share of U.S. social security taxes on his wages. At the same time, the foreign tax laws may require that Bob’s employer pay the foreign social security taxes on the wages paid to Bob while he is living in that country.

Unless certain arrangements are made with the SSA, the same situation would occur if the U.S. company assigns Bob to work for a foreign subsidiary of which the American company is a principal owner.

The SSA is responsible for administering “totalization agreements,” which are similar to the U.S. tax treaties.

At time of writing, the U.S. has totalization agreements with the following nations: Australia, Austria, Belgium, Canada, Chile, Finland, France, Germany, Greece, Ireland, Italy, Japan, Korea (South), Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom.

An agreement is under discussion with Poland. Agreements with the Czech Republic, Denmark, and Mexico have been signed but have not yet come into force. (See Appendix C for full details.)

On the other hand, if you have the option of working overseas for employers other than U.S. companies—or principally owned foreign subsidiaries of U.S. companies—you will avoid any double taxation on the social security side because you will no longer be liable for the U.S. social security taxes.

If you or your employer needs more information, contact the Social Security Administration online at www.ssa.gov. Its welcome page has a “Contact Us” link that provides a variety of means of getting in touch with a representative.

Credits and Deductions on Foreign Income Taxes

In filing your U.S. returns, you can take either a credit or a deduction for income taxes imposed on you by a foreign country. Taken as a deduction, foreign income taxes reduce your taxable income. Taken as a credit, foreign income taxes reduce your tax liability.

There is no rule to determine which approach is better. Generally, it is to your advantage to take the credit, which is subtracted directly from your U.S. tax liability. Your credit cannot be more than the part of your U.S. income tax liability allocable to taxable foreign income. In other words, if you have no U.S. income tax liability, or if all your foreign income is excludable, you will not be able to claim a foreign tax credit.

If foreign income taxes were imposed at a high rate, and the proportion of foreign income to U.S. income is small, a lower final tax may result from taking the foreign income tax deduction. You must treat all foreign income taxes in the same way—you generally cannot deduct some taxes and take a credit for others.

If you choose to credit foreign taxes against your tax liability, you will need to complete Form 1116 (unless you meet the requirements outlined below), and attach it to your U.S. income tax return.

Caution: Do not include the foreign taxes paid or accrued as withheld taxes on the second page of the 2012 Form 1040 at line 63.

If the foreign taxes you paid or incurred during the year exceed the limit on your credit for the current year, you can carry back the unused foreign taxes as credits to the two previous tax years, and then carry forward any remaining unused foreign taxes to the next five tax years.

You will not be subject to this limit, and may be able to claim the credit without using Form 1116, if the following requirements are met:

  1. You are filing as an individual.
  2. Your only foreign source income for the tax year is passive income coming from sources such as dividends, interest, and royalties, which are reported to you on a payee statement such as a Form 1099-DIV or 1099-INT.
  3. Your qualified foreign taxes for the tax year are not more than $300 ($600 if filing a joint return) and are reported on a payee statement.
  4. You elect this procedure for the tax year. (If you make this election, you cannot carry back or carry over any unused foreign tax to or from this tax year.)

If you choose to deduct all foreign income taxes on your U.S. income tax return, you need to itemize the deduction on Form 1040 Schedule A.

The foreign tax credit and deduction, their limits, and the carry back and carry over provisions are discussed in detail in IRS Publication 514.

Foreign Currency: The foreign income, expenses, and credits must be converted from foreign currency using an appropriate exchange rate and reported on the U.S. return in U.S. dollars.


If you incur expenses when relocating overseas, you may qualify for a deduction of “reasonable” moving expenses. Keep in mind that moving expenses relate to the income earned after the move and you cannot claim expenses attributed to excluded income. For example, if you are an employee and move overseas, your unreimbursed moving expenses are generally deductible. However, if you are able to exclude all of your overseas earnings in the year of the move, the following year you cannot claim any of the unreimbursed moving expenses regardless of whether or not they are reasonable. See Publication 54 for more details.


If you have paid foreign taxes on the earnings that qualify for the earned income exclusion, you will have to make a choice of taking the exclusion, taking the tax credit/deduction, or taking a combination of the two.

A good tax software program should allow you to prepare a complete return claiming the income exclusion, housing exclusion/deduction, and the foreign tax credit. Once the return is prepared, the program should allow you to easily produce two duplicate computer copies. These can be produced individually using the other two options for comparison to figure out which option produces the best results. As mentioned earlier, you need to do the math.

If you claim the exclusion, you cannot claim any credits or deductions that are related to the excluded income—the concept being that you can’t get a double benefit. Nor can you claim the earned income credit, which is to benefit low income earners. In other words, someone who earned $100,000 overseas and excluded $91,400 is not the same as an individual whose total earnings are only $8,600.

Also, for Individual Retirement Account (IRA) purposes, the excluded income is not considered compensation and, for figuring deductible contributions when you are covered by an employer retirement plan, the excluded income is included in your modified adjusted gross income.


If a “double taxation” treaty exists between the United States and the country in which a U.S. citizen resides, then the tax treaty supersedes the Internal Revenue Code (IRC), and the language of the treaty governs. As a general rule, tax treaties allow you to offset foreign tax paid against what your federal tax liability would have been.

This means that if your foreign taxes are higher than your U.S. federal tax, no U.S. tax is due. If your foreign taxes are lower, then the difference would generally still be due to Uncle Sam, unless it was exempted under the rules for foreign earned income exclusion.

Treaties generally provide U.S. students, teachers, and trainees with special exemptions from the foreign treaty country’s income tax.

Publication 901 contains detailed information on tax treaties and tells you where you can get copies of them. Click here for additional information: http://www.irs.gov/publications/p901/index.html

Foreign Bank Accounts Must be Reported

If you had any financial interest in, or signature or other authority over a bank account, securities account, or other financial account in a foreign country at any time during the tax year, you may have to complete Form 90-22.1 and file it with the Department of the Treasury. You need not file this form if the combined assets in the account(s) are $10,000 or less during the entire year, or if the assets are with a U.S. military banking facility operated by a U.S. financial institution. The deadline for filing is June 30 of each calendar year.

There are no extensions and an extension to file the federal income tax return does not extend the deadline for filing the Form 90-22.1. If you have a foreign account, you must also file a Form 1040 Schedule B and complete Part III regarding foreign bank accounts—regardless of whether you are required to file a Form 90-22.1, or have any interest or dividend income to report on the Schedule B.

This requirement to report your foreign bank account is one of the most important obligations you have as a U.S. citizen living abroad. The law imposes a civil penalty for not disclosing an offshore bank account or offshore credit card up to $25,000 or the greatest of 50% of the balance in the account at the time of the violation or $100,000. Criminal penalties for willful failure to file an FBAR can also apply in certain situations. Note that these penalties can be imposed for each year.

In addition to the FBAR penalties above, intentionally failing to check the box on Schedule B to report a foreign account is a Felony. It is possible for a single violation to result in 6 to 12 months in prison!

I have personally handled many FBAR and Schedule B related cases and can tell you with certainly that the IRS is very aggressive in prosecuting these matters. For example, in one case in 2010 a client plead guilty to a single count of failing to check the box on Schedule B, and was given 6 months of confinement. In addition to the criminal case, the IRS initiated a civil audit which, when taxes, fines, interest and penalties were calculated, the client was wiped out financially. Finally, to add insult to injury, the State of California came in with their taxes, interest, and penalties.

The Schedule B rules and the FBAR are no joke, and they are not just used against money launders and drug dealers. Prosecutions and civil fines have become a major revenue sources for the IRS.

Filing Deadlines, Extensions, and Penalties

If your tax year is the calendar year, the due date for filing your income tax return is April 15 of the following year—unless that date falls on a weekend day or holiday, which would allow you an additional day or two.


The good news is that overseas Americans are automatically granted a two-month extension to June 15 to file (and pay their tax).You don’t have to request this extension in advance. When the time comes to file, simply attach a statement to your return explaining that you were either:

1) Living outside the U.S. and Puerto Rico and that your main place of business or post of duty was outside the U.S. and Puerto Rico; or

2) In the military or naval service on duty outside the U.S. or Puerto Rico.

Note: If you are filing electronically (I’ll discuss this later), you will need to check your software instructions or check with your software provider on how to electronically file the extension form or to add the required statement to the return.

What to do if you need more time

Better still is the Form 4868 (“Application for Automatic Extension of Time to File U.S. Individual Income Tax Return”). This form will get you a full six-month extension.

No signature and no reason will be required for the six-month extension to October 15 (or the alternate date under the weekend and holiday rule).


With the exception of the automatic two-month extension for overseas Americans, an extension of time to file does not mean an extension of time to pay the tax. Although you will be required to pay interest on any payment made after April 15, you will not be required to pay the late payment penalty (see below) for the period April 15 to June 15.


If you claim the foreign earned income exclusion or the foreign housing exclusion or deduction on a paper tax return, you should file your return with the Internal Revenue Service, Austin, Texas 73301-0215.

Electronic filing has its own set of filing rules that are not treated here. A good software program with the electronic filing feature allows you to send the federal and, if applicable, the state income tax return to the relevant processing center.


If you have the option, paperless filing is the way to go. All you need is a computer, tax preparation software with the electronic filing feature, and Internet access. You complete your return (and with some software programs the Form 4868 as well), send it over the wires, and await confirmation from the IRS or a state tax department that your return was accepted. If rejected, you should receive an error message that either tells how to correct the error(s) for resubmission or a statement of why the return cannot be accepted for electronic filing. The deadline for electronic filing is April 15, or October 15 (or the alternate date under the weekend and holiday rule) if you file an extension. You may not file a late return electronically.

The rules that relate to formatting, what information must be included on the return, and what forms or schedules if included in the return forms will disqualify the return from electronic filing, are mind-boggling. However, as with any good software program, the computer does most of the analytical work. And, if you mess up, the programs are generally designed to alert you to your mistakes or provide other reminders to help you through the process.

Most software programs allow you to complete the state tax return along with the federal return, saving time spent on duplicating data entries. The state return in most cases is produced automatically as an offshoot of the 1040. Part-year return (or even a non-resident return), if your situation warrants one, takes a little extra time because there are additional data entry steps. You will be required to allocate the annual income taxable on the federal return to the lesser amount taxable by a state for part-year residency or non-residency.

An additional benefit of tax preparation software is that, once you go through the process for the first year, most of the routine—and often tedious—data entries that apply year after year are carried forward to save you time in future years.

You’ll find a variety of good tax preparation software programs on the market. Two of the most popular are TurboTax and TaxCut.

I’d recommend that you do some research on the Internet to compare prices and availability. And make sure that whichever software program you purchase has the electronic filing capability. There are also some companies offering to prepare your taxes online, through their website, without your downloading and installing their programs. These include Intuit and H&R Block.


Generally, the IRS treats payments made—and tax returns filed—as received by the IRS on the date they are received by the U.S. Postal Service or a domestic courier service. Penalties could be applied by the IRS on late payments and, if applicable, late filed returns under certain circumstances including those received from overseas.

Consult a tax professional if sending tax documents from countries whose mail or courier systems are subject to lengthy delays. You should keep in mind that electronic filing is one means of avoiding mailing delays and possible penalties resulting from such delays. I generally recommend the electronic filing method to my clients overseas.


If you are late in filing your taxes, avoid filing altogether, or underpay taxes—whether intentionally or unintentionally—the IRS may impose a penalty. If the 1040 has no tax due, there are generally no penalties whether you filed or did not file.

Even if there are penalties, the IRS may waive them if the delay is due to “reasonable cause.” The IRS doesn’t like to pin itself down by trying to define the term reasonable cause—you have to write in with an explanation and hope for the best! The instructions for requesting elimination of a penalty for reasonable cause are found in Notice 433 on the IRS website.

The two more common penalties are the late filing and the late payment penalties. The penalty for late filing (or failing to file) a tax return is a percentage of the tax due but unpaid, unless the reason for the late filing or failure to file is due to reasonable cause. The penalty is 5% of the underpayment per month, or any part of the month, up to the maximum of 25%. If the return is not filed within 60 days of the due date (considering extensions), there is a minimum penalty which is the lesser of $100 or the tax due on the return. There is an interaction of the late filing penalty and the late payment penalty discussed below.

The late payment penalty is 0.5% for each month, or any part of a month, the tax due on a return remains unpaid. The maximum penalty is 25%.

The interaction between these two penalties in effect limits both penalties combined to the 25% maximum. For each month that both penalties apply, the late filing penalty is reduced to 4.5%.

Consequently, a return filed four months and one day late is subject to the late filing penalty of 4.5% times 5 (22.5%), and a late payment penalty of 0.5% times 5 (2.5%), for a total of 25% (the maximum).

However, if the return is filed on time but there is tax due, the late payment penalty is 0.5 per month of any fraction thereof until paid. These penalties are in addition to the interest charged for unpaid taxes. The IRS is required to determine the interest rate quarterly. For the latest information on interest rates, check with the IRS or a tax professional.

U.S. State Taxation of Foreign Income

If you have a choice of where to live and work overseas, it is important to understand how your last state of residency, the U.S., and your new home country will tax your income. High state or foreign tax rates, or lack of tax exemptions for income earned inside and outside of a new home country, can easily negate any tax advantages provided to overseas Americans under the U.S. federal tax laws.

Before we delve into state income taxes, it is important to understand the distinction between residency and domicile—although most states use these terms interchangeably. For tax purposes, your residence is generally where you currently live and work. Your domicile on the other hand may be the place you presently live, or previously lived and have a definite intention to return after living elsewhere.

Your domicile may also be a state in which you formerly lived, but failed to fulfill the conditions to abandon domicile when you moved elsewhere. For most of us, we are residents and domicile of the same state regardless of whether that state is a U.S. state or a foreign country.

Residence and domicile are important distinctions for those states that subject both their residents and their domiciliaries to state income tax. For example you may have moved to another state and established residency in that new state, but still have to file tax returns in your former state (where you are officially domiciled).


Liability for state income taxes is a complicated matter. There are 51 jurisdictions including the 50 states and the District of Columbia and consequently 51 different sets of rules.

If you move from one of the more popular non-taxing states such as Florida and Texas, you needn’t ordinarily worry about liability for state income taxes while living overseas.

Other states such as Oregon, New York, and Missouri to name a few will not tax an individual who is otherwise considered a domiciliary of the state, but maintains a permanent residence elsewhere (in the U.S. or overseas) and spends less than 30 days a year in the state. Also, New Hampshire and Tennessee only tax interest and dividend income.

Then there are those states desperate for money, like California. This state has no foreign earned income exclusion, is aggressive in determining “residency” for those abroad, and, when one spouse is abroad and one is in California, this state will tax the international spouse’s income under a “community property” argument. If you live in an aggressive state, and you can first move to a non-taxing state, and then move abroad, I strongly recommend you do so.

Finding a complete listing of states who do not tax domiciliaries living outside the state is beyond the purpose of this guide. A good starting point is a very comprehensive website for finding all kinds of information on taxation. Try www.taxsites.com and click on “state links” in the tax column to check out your state of interest.

Don’t be misled by the advice that you can make a quick trip to one of the non-taxing states, set up a local address, get a driver’s license, and register to vote thereby establishing residency and domicile in that state. It doesn’t work that way. The fact that many have done exactly that without being questioned is a matter of inadequate enforcement by state tax authorities, rather than a good faith compliance with the rules for establishing and abandoning state residency.

If you think you may be taxed by a former state as a domiciliary, you need to be aware of what elements that state will look at to determine your liability for its income taxes. Some of the most important are as follows:

  • Where you live.
  • Where and how you vote.
  • What state driver’s license you carry.
  • Where your bank accounts are located.
  • The location of any real property you own.
  • Where your family is living if not with you.
  • Whether or not you have a fixed intention of returning to a particular state if you are living elsewhere at the present time.

There is no magic formula for determining what combination of the above listed items will prompt your former state to subject your income to taxation. Some combinations are more important than others. Where you live; whether you vote in national but not state elections; which driver’s license you carry; and where your real property (if any) is located are often very critical elements. However, the most important and critical is the final point. A fixed intention to return to a particular state will always subject you to that state’s income taxes, in those states that tax as residents not only those who physically reside within the state but also its domiciliaries.


Unlike in foreign countries, there is no such thing as a national U.S. residency or domicile. Residency and domicile apply to states only. So, if you don’t have the fixed or definite intention to return to a particular state, but do have a fixed or definite intention to return to the U.S., you may still be able to abandon domicile in a particular state.

This is an important distinction when it comes to voting in U.S. elections. However, the Overseas Citizens Voting Rights Act allows U.S. citizens living outside the country who are presently not residents or domiciliaries of any U.S. state to vote in the federal elections (see U.S. Code 42, 1973ff).

To obtain the specific instructions and to download the form to request an absentee ballot, go to www.fvap.gov. On the opening web page you will see a large white block with the heading The Basic Absentee Voting Process. Just follow the simple instructions.

Expat Taxes

Filing Tax Returns—The Basics

The following page applies to U.S. citizens and residents living and/or working outside of the United States.

U.S. persons (citizens and permanent residents/Green Card holders) are required to file a tax return each year, no matter where they live, if their income is above US$9,350 when filing as single, or US$18,700 if filing as married (2010 thresholds).

Failure to file your U.S. personal income tax return can result in the loss of your Foreign Earned Income Exclusion, creating a disastrous situation for any U.S. citizen living abroad. As this exclusion can legally eliminate the income tax on your income earned outside the U.S., you don’t want to lose it.

You can qualify for the Foreign Earned Income Exclusion through either the Bona Fide Residency Test or the Physical Presence Test. The maximum amount to qualify was US$91,400 in 2009, and it’s currently US$91,500 for 2010.

The Physical Presence Test mandates that you must be outside of the United States for 330 out of any 365-day period. You meet the Bona Fide Residency Test if you are out of the United States for one full calendar year and move to a country with the intention of making it your home for the foreseeable future.

In addition, those living abroad are generally required to file a Foreign Bank Account Report with the United States Treasury. Failure to file this form can result in extremely severe penalties of up to US$100,000 per violation.

It is common for people living and working abroad to have neglected to file income tax returns for five, 10, or even 20 years. Because our computer system and the workflow we set up are designed to handle the preparation of multiple years of delinquent returns in a quick and efficient manner, in order to minimize the tax due, we are proud to say that we have successfully represented many expats and achieved excellent results.

Preparing and filing past delinquent returns (i.e., becoming compliant) is the first step towards an Offer in Compromise or an Installment Agreement with the IRS.

Also, the collection process is more complex for those living abroad. Because there are no standardized expenses, you must prove the necessity of each item. Also, the IRS may levy certain international banks and lien property in some countries, which makes experienced planning and preparation the key ingredients for success.

The expertise required to prepare international returns and the risks facing expats are unique. Our international tax group is headed by the U.S.-licensed tax attorney Christian Reeves, the author of the 2010 International Tax Bible, published by International Living, an expert in the field of international taxation. Together with him we will guide you through the maze of IRS collections in a professional and efficient manner.

Click here

Note:Because everyone’s tax preparation needs are unique, sign-up and payment must be made by phone, e-mail, fax, or regular mail.It is not available through our website shopping cart.

2013 Tax Increase

The Spoils of War – Big Time Tax Increases for 2013

The mêlée at the edge of the fiscal cliff is over and the Democrats have scored a decisive victory.

The battle lines were simple: Democrats wanted to raise taxes while Republicans wanted to cut spending. When the fighting was over, tax revenues were up by $620 billion against only $15 billion in spending cuts…a massacre if there ever was one.

And you can be sure there are hidden landmines and random scud missiles on the way – in the form of concessions on unemployment insurance, Social Security, FICA, et al and the inheritance tax. When taken in total, revenues may be increased by as much as $800 billion.

As it stands today, the fiscal cliff deal resulted in $1 dollar of spending cuts for every $41 in tax increases…possibly the most one sided victory since the Battle of Little Bighorn in 1876. By comparison, when President Ronald Regan increased taxes, he secured $3 in spending cuts for every $1 in tax hikes. When George H. Bush was at the helm, he negotiated $2 in spending cuts for every $1 in tax hikes.

Most of the casualties in this battle royale are individuals with incomes over $400,000 and couples making over $450,000, but there will be significant pain and suffering for those with incomes as low as $250,000.

I also note that any hope of a tax system which treats married couples and single persons with some level of equality was blown to hell. Two single persons could earn $800,000 combined before being smashed by the tax hikes, compared to only $450,000 for a married couple.

Here are the casualties by the numbers:

  • Tax rates will shoot up to 39.6 percent from 35 percent for individual incomes over $400,000 and couples over $450,000.
  • Tax rates on dividends and capital gains would also rise, to 20 percent from 15 percent, on income over $400,000 for single people and $450,000 for couples.
  • Personal exemptions and deductions will be phased out, beginning at single people earning $250,000 and $300,000 for couples.
  • The estate tax will increase, but less than Democrats had wanted. The value of estates over $5 million will be taxed at 40 percent, up from 35 percent. Democrats had wanted a 45 percent rate on inheritances over $3.5 million.

Under the deal, these new rates on income, investment and inheritances are permanent.

Among all of the explosions and cries of anguish, there was good news for the American abroad: The Foreign Earned Income Exclusion survived, and even got a little bump up for the cost of living. If you are living and working abroad, you can earn $97,600 in 2013, up from $95,100 in 2012.

Also, the self-employed Expat can avoid the Unemployment, Social Security and FICA tax increases (also called self-employment taxes) by incorporating offshore and qualifying for the FEIE. By operating your business through an offshore corporation, you might eliminate these taxes completely, a savings of about 15%.

But be careful: the 2013 tax increases and phase-outs will apply to any ordinary income over $97,600 and all passive / investment income.

Because the tax brackets ignore the FEIE, and Expats are taxed on their worldwide capital gains (now at 20% rather than 15%), many higher earning Americans abroad will be shocked by their 2013 tax bill. For additional information on these issues, please see: http://premieroffshore.com/offshore-tax-international-tax/

For the self-employed, there are a number of planning opportunities. For example, you can retain earnings over the FEIE amount in your offshore corporation or utilize a Solo 401-K to shelter income in a retirement plan.

For the investor, you can make tax advantaged investments offshore through your IRA and thumb your nose at the 20% short term capital gains tax. In fact, there are a number of tax advantages for the sophisticated offshore IRA investor – just ask Mitt Romney.

As tax rates go up, so does the need for competent tax and business advice. I strongly recommend you contact your international advisor as early as possible this year to develop a plan of action.

And remember, so long as you hold a U.S. passport, you must file Federal returns and abide by these laws. Regardless of which country you call home, make sure your global tax plan is approved by a U.S. tax expert.

For additional information on this article, or for a free international tax consultation, please contact us at info@premieroffshore.com or call (619) 483-1708.

Foreign Earned Income Exclusion 2013

Foreign Earned Income Exclusion 2013 Amount

The Foreign Earned Income Exclusion 2013 amount got a little bump up for inflation and managed to avoid the financial cliff. The Foreign Earned Income Exclusion 2013 amount is $97,600, up from $95,100 in 2012.

As an American citizen living overseas, you are subject to the same U.S. tax laws as a United States resident. One of the only personal tax benefits you get for living abroad is the Foreign Earned Income Exclusion. If you are out of the U.S. for 330 days, or are a resident of another country, you can exclude up to $97,600 of earned income from your U.S. personal return using the Foreign Earned Income Exclusion 2013 amount via Form 2555.

Note: My website has a number of resources explaining the Foreign Earned Income Exclusion 2013 amount and use. Please click here for an in-depth article on international taxation for Americans.

Earned income is active income and is defined as wages, salaries, commissions and professional fees. It does not include investment, rental, or other types of passive income.

If you earn more than the Foreign Earned Income Exclusion 2013 amount, you will pay Federal tax on the excess. However, if you are operating a business, or are self-employed, you may be able to eliminate this tax by using an offshore corporation and retaining earnings in the entity over and above the Foreign Earned Income Exclusion 2013 amount.

Note: Yes, the ability to retain earnings offshore also survived the fiscal cliff and will be the topic of a future article. For additional information, check out this article from Bloomberg.

Foreign Earned Income Exclusion 2013 and Prior

Historically, the Foreign Earned Income Exclusion has increased with inflation, with the exception of 2002 through 2005, when it was stuck at $80,000.

  • 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

Sources: IR-2012-78, Oct. 18, 2012 for the 2013 amount, Revenue Procedure 2011-52 (PDF) for the 2012 amount, Revenue Procedure 2010-40 (PDF) for the 2011 amount, Revenue Procedure 2009-50 (PDF) for the 2010 amount, Revenue Procedure 2008-66 (PDF) for the 2009 amount, Revenue Procedure 2007-66 (PDF) for 2008 amount, Revenue Procedure 2006-53 (PDF) for 2007 amount, Revenue Procedure 2006-51 (PDF) for 2006 amount, Internal Revenue Code Section 911 for the tax law concerning the foreign earned income exclusion.

Remember that the Foreign Earned Income Exclusion is a “use it or lose it” tax break. If you are living abroad, do not file your returns, and are audited, you may lose the Foreign Earned Income exclusion. This means that 100% of your worldwide income will be taxable in the US.

If you are delinquent on your U.S. tax filing obligations, catch up before the IRS gets a hold of you. For information on our Expat tax filing services, please call us at (619) 483-1708 or email info@premieroffshore.com for a confidential consultation.

For the current FEIE amount, see Foreign Earned Income Exclusion 2020

IRS Voluntary Disclosure Program Gives Big Breaks to ExPats

IRS Voluntary Disclosure Program is great news for some Expats and dual-nationals

As an ExPat American, you know that you are required to file a U.S. tax return each year and report your foreign bank accounts if you have more than $10,000 offshore. If you have failed to file these forms, and want to get back in to the good graces of the IRS, the IRS Voluntary Disclosure Program may be for you.

Unless you have been living under a rock in Bangladesh, you also know that the IRS has been pushing hard to force disclosure, compliance and payment. The drive for increased revenues started in 2003 when the IRS began investigating offshore credit cards. At that time, it was about compliance. The government had not yet figured out that putting people in jail for tax crimes would generate a lot of news, thus cause many more thousands to come forward, and bring in a truckload of money…and promotions.

In 2008 the U.S. government began its attack on UBS in Switzerland, eventually forcing the Swiss to disclose 4,450 names of U.S. citizens with unreported accounts. The U.S. followed this up by prosecuting a few people in each State or region of the country to ensure maximum news coverage and created the voluntary disclosure program to capitalize on their campaign.

So far, there have been three IRS Voluntary Disclosure Programs allowing people to come forward and voluntarily report their offshore bank accounts. As of June 26, 2012, the IRS brought in over $5 billion in new taxes, interest and penalties.

The third, and current IRS Voluntary Disclosure Program came into effect on September 1, 2012 and has several benefits for what it considers “low-risk” persons. These are U.S. citizens, including dual-citizens, who currently reside overseas, who owe little or no U.S. taxes. The objective is to convince these people to report the value and locations of their money and assets in exchange for not being hit with excessive civil penalties.

These low-risk persons will be able to file three years of delinquent U.S. tax returns (including required information reporting forms) and six years of FBARs without the imposition of program penalties. Whether a taxpayer is “low-risk” will depend on a number of factors, but will primarily require that the tax due is less than US$1,500 for each of the covered years, that the person was living and working outside of the U.S. during these years, and that the person did not take steps to conceal their income from the U.S.

It should be noted that this procedure will provide no protection from the risk of criminal prosecution. The IRS website indicates the following regarding criminal prosecution: “The IRS Voluntary Disclosure Program has a longstanding practice of IRS Criminal Investigation whereby CI takes timely, accurate, and complete voluntary disclosures into account in deciding whether to recommend to the Department of Justice that a taxpayer be criminally prosecuted. It enables noncompliant taxpayers to resolve their tax liabilities and minimize their chance of criminal prosecution. When a taxpayer truthfully, timely, and completely complies with all provisions of the voluntary disclosure practice, the IRS will not recommend criminal prosecution to the Department of Justice.”

Because the tax due amount within the IRS Voluntary Disclosure Program takes the Foreign Earned Income Exclusion and Foreign Tax Credit in to consideration, most Expats and foreign residents will qualify as low risk. For example, anyone who is employed in a high tax country (a country with a tax rate equal to or greater than the U.S.), should be in the clear, as will most people earning less than $80,000 to $95,000 per year who are living in a low tax country. Those at risk are entrepreneurs living in low tax countries, high net worth individuals with significant untaxed capital gains or passive income, and just about any self-employed person who was not operating through a foreign corporation and is thus subject to self-employment tax.

There are two groups of ExPats that are excluded from this IRS Voluntary Disclosure Program: 1) if your account is at a bank that is currently under investigation by the U.S., you may not be eligible, and 2) if you attempt to fight the release of your banking information from your foreign bank, you will not be eligible for this program. For example, if the U.S. issues a summons to Bank ABC in Lichtenstein requesting all U.S. accounts, and you fight the request, you are disqualified from this program.

In addition, the IRS may announce that certain groups of taxpayers that have or had accounts at specific offshore banks will be ineligible to participate in the IRS Voluntary Disclosure Program due to pending US government actions in connection with those specific institutions. Details regarding eligibility or ineligibility of specific taxpayer groups connected to such institutions will be posted to the IRS website.

The IRS says: “US persons with undeclared bank accounts are reminded that the 2012 IRS Voluntary Disclosure Program gives taxpayers with unreported foreign bank accounts a chance to come clean while mitigating the risk of criminal prosecution, and that they should consider remedying any past non-compliance with their US tax and information reporting obligations while there is still an opportunity to do so.”

If you are a U.S. citizen who has been living and working abroad, and are willing to disclose your accounts and assets, now is the best time to evaluate your rights.
I recommend the following three step plan of action:

  1. discuss your situation with a qualified tax attorney to evaluate your risks of criminal prosecution,
  2. have your attorney prepare U.S. tax returns to determine the amount of taxes due, and
  3. if you qualify as a low-risk citizen, join the voluntary disclosure program program as soon as possible and before your bank comes under attack or you are disqualified for another reason.

If you do not qualify as a low-risk taxpayer, you may still participate in the current IRS Voluntary Disclosure Program. However, you will be subject to substantial taxes and program penalties, which are more severe than those levied by previous initiatives.

In addition to the standard tax, interest and penalties associated with your delinquent returns, the following penalties will be assessed, and must be paid or you will be disqualified from the program:

  • 20% accuracy-related penalties on the full amount of your offshore-related underpayments of tax for all years;
  • Pay failure to file penalties, which are up to 25% of the unpaid tax, if applicable;
  • Pay failure to pay penalties, which are up to 25% of the unpaid tax, if applicable;
  • Pay, in lieu of all other penalties that may apply to your undisclosed foreign assets and entities, including FBAR and offshore-related information return penalties and tax liabilities for years prior to the voluntary disclosure period, a penalty equal to 27.5% (or in limited cases 12.5% or 5%) of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the period covered by the voluntary disclosure;

Note that this penalty includes the value of all foreign assets, including real estate.
As you can see, the penalties are very severe if you do not qualify as a low-risk taxpayer. However, getting back in to the system and removing the risk of criminal prosecution will motivate many to come forward, pay up, and sleep better at night knowing that Uncle Sam will not come knocking…not yet, anyway.

If you have unreported accounts or questions about your U.S. Expat taxes, please contact me for for a free and confidential consultation regarding the IRS Voluntary Disclosure Program. I can be reached at (619) 483-1708, or info@premieroffshore.com.

The IRS has no Problem Using Weapons of Mass Destruction

IRS Attacks Forcing High Net Worth Americans out of the Country

The number of American expatriations is at a record high as tens of thousands of Americans a year are moving abroad in search of better lives. A root cause is how the U.S. government is treating its citizens these days.

At least 1,788 Americans officially threw away their U.S. citizenship in 2011, exceeding the totals from 2007, 2008, and 2009 combined. The Internal Revenue Service has been keeping a tally of U.S. citizens driven to renouncing that title since only 1998, but last year’s number has officially raised the bar when it comes to calling America quits.

Out of the 34 countries that belong to the Organization for Economic Cooperation and Development, the United States is the only nation that taxes its citizens no matter where they reside on Earth. As long as a person maintains citizen status, they are expected to send the United States government pennies on every dollar earned no matter where they live. The good old U.S. of A is also one of the only countries in the world that locks up its citizens in boxes for failing to pay up.

As the U.S. government works ever-more-aggressively to find ways to fund the deficit and as their worldwide bullying continues to create a backlash for us Americans trying to diversify offshore, more and more of us Americans who understand the importance of diversifying offshore are considering the idea of saying thanks, but, no, thanks, Uncle Sam. Here’s your passport back.

Just about every call I get now related to expatriation is from someone either battling the IRS or afraid of winding up in a clash with the Government.

Why are so many citizens concerned? I believe it is because the tone of the Internal Revenue Service has changed dramatically in the last five years.

Historically, if an average American failed to report his income accurately and completely it was a civil or a financial issue…he or she had to pay the taxes and penalties. Increasingly, the IRS is turning those sections of the tax code enacted to go after drug dealers and mafia kingpins (think Al Capone) on ordinary citizens, all in the name of increasing revenues.

These weapons of mass destruction (which, in this case, the U.S. government has no trouble finding) put regular people in jail for years for failing to file a form or to report income. They are being used not only to go after multi-millionaires and billionaires with huge accounts offshore, but everyday hard-working Americans, as well.

Here are three examples from my clients. There are hundreds of similar cases being argued throughout the United States right now.

Example #1 – Offshore Account

I know a single father of three who makes about US$80,000 a year as a self-employed consultant. Eight years ago, he moved some money offshore, to diversify and for asset protection. He never filed the necessary IRS forms, and he failed to report the account on his tax return.

Unfortunately for him, the account was at UBS Switzerland. He was reported to the IRS, which has decided to prosecute him.

Here is the rub: He did not have any unreported or untaxed income…which is to say, the account did not earn any interest, and the guy would not have had to pay any additional U.S. tax had he reported it.

That’s irrelevant now. In settlement negotiations, the man is facing up to one year in jail and a fine of US$540,000.
He has little money left and will never be able to pay the fine.
What is the point of the prosecution? The IRS gets to issue a press release showing a conviction in this city. This press release will forget to mention that there is no tax loss in the case, but it may induce many others to come forward…thereby increasing revenues on the back of an everyday citizen who made a mistake.

Example #2 – Cash Transactions

A retired U.S. citizen I know, living in California, age 60, is concerned about a major devaluation of the U.S. dollar. He decided a while ago that he wanted to purchase gold. He owns a condo with some equity and has a few hundred thousand dollars in retirement money.

As a regular guy, he can´t afford to buy large amounts of gold bullion, so he purchased gold coins from a local dealer. He paid cash for these coins so the dealer would not have to wait for a check to clear before handing over the merchandise. He has never sold any of his coins, thus there is no tax issue.

What did he do wrong? He took cash out of his account once or twice a week, always less than US $10,000 at a time, to make the gold purchases. To the IRS, this can qualify as “Structuring,” which is a crime.

The man’s bank sent two suspicious transaction reports to the IRS and closed his account. He had been a client of this bank for more than 30 years, yet the bank made no effort to warn him in advance of the reports they made to the IRS or to offer any assistance. They just turned him in.

As a result, the man is looking at a fine of up to US$100,000 and possible criminal charges that could incarcerate him for up to five years. Add to this a minimum of US$100,000 in potential legal fees, and the reality for this guy is that he and his family could be wiped out. Again, this is all the result of an innocent mistake.
Example #3 – Dual Citizen

Another client is a 55-year-old engineer who has been working at the same job for 20 years. He is a dual citizen of the United States and the United Kingdom. When he moved to the States, he rented out his U.K. home. Ever since, he has deposited this rental income in a U.K. account.

The man has filed tax returns in the U.K. reporting the rental property, but he did not report it, or the U.K. account, to the IRS. Had he reported the property and the related rental income all along, it would not have made any tax difference in the United States.
In fact, reporting the rental could have reduced his U.S. tax, thanks to the depreciation he could have claimed.

In 2009, this man learned of the requirement to file an FBAR form and entered the IRS Voluntary Disclosure Program. As a result, this story has a happier ending than the others. This guy will not face criminal charges.
He will, though, pay a fine of approximately US$22,000.

Cases like these and the hundreds of others currently being argued have changed the way that tax attorneys deal with clients. While we once would say, ‘Come clean, be honest, and let’s get through this,’ now we advise, ‘Be afraid…be very afraid.’

It is this culture of fear that is pushing many Americans to look around the world for places where they might live better, freer, and less fearfully.

I’ll note that these changes are not the result of one political party or another. They represent a permanent change in perspective by the U.S. government in general, in how both parties view their citizens. Changes to the tax laws, and in the ways the laws are interpreted, began under George Bush II with the Patriot Act and continue under Barack Obama with the Bank Secrecy Act and the HIRE Act.

In the face of a troubled U.S. economy and out-of-control spending, the U.S. government desperately needs to expand its tax revenues, and the IRS has decided that it can raise more money with fear and violence than with honey.

It’s a situation that qualifies as dire, and sensible Americans are looking to escape it as quickly as they can.