Tag Archive for: offshore company

Foreign Pension
Christian Reeves

The Foreign Pension Tax Trap

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If you’re working abroad for a foreign company, watch out for the foreign pension tax trap.  If you get caught, you might be paying double tax on your retirement income… once when earned by the U.S. and once at distribution in your country of residence.

First, let me say that this is not meant as a definitive guide on foreign pensions.  A proper analysis would review every tax treaty out there and thus be longer than War and Peace.  My intent is to identify the issues faced by U.S. expats with a foreign pension so that you may go to your local tax person, or Human Resources department, to discuss how to avoid the foreign pension trap.

Second, these issues do not concern expat entrepreneurs or business owners.  Presumably, you would utilize a U.S. qualified pension plan or defined benefit plan for yourself and avoid these problems.

Of course, if you are operating a small business, and your income is less than the Foreign Earned Income Exclusion ($99,200 in 2014), you don’t need to be concerned with a pension, be it foreign or domestic.

Now that I’ve buried the lead in the 5th paragraph, let’s talk about the foreign pension tax trap.  If you work for a foreign company, and have the option of taking a foreign pension, you need to understand the general rules (described here), the foreign tax credits available, timing issues, and specific tax treaty provisions between your country of employment and the United States, before agreeing to put cash in to a retirement program.

The reason a foreign pension can become a tax trap for the American expat is:

1) some foreign pensions are not compatible with the U.S. tax codes, 2) no treaty applies, and 3) your income is taxed in the U.S. as earned and taxed at distribution in your country of residence, which means the foreign tax credit may not be available.

So, while the foreign pension may appear to give you better tax treatment in your country of employment, if may result in double taxation.  Here’s why:

The general rule is that a foreign pension is not a qualified retirement plan (QRP) for U.S. tax purposes.  Therefore, contributions are not deductible on your U.S. tax return.

Because you are taxed on your worldwide income as earned, and because the income which flows in to the nonqualified plan is not deductible, it is included in your U.S. adjusted gross income and taxable here.

So, if you are earning $50,000 in salary and 15,000 in retirement benefits in France, the income reported on your U.S. tax return is $65,000.  You might have foreign tax credits to offset the $50,000, but no credits to cover the $15,000.

Then, when you withdraw that $15,000 from your account in France, you pay tax on it there.  Well, more than three years has likely passed and you are no longer able to amend your U.S. personal income tax returns to claim this credit.  So, you were taxed once in the U.S. when earned and then again in France when distributed.

That is to say, these general rules require a U.S. expat in a foreign pension plan to include in income the amount of the contributions made by him or her, as well as any contributions made by the employer to the extent vested.  Because you will probably need to pay tax in the foreign country when you take a distribution from the plan, it is possible that the contribution will be double taxed… but at different times.  This timing issue creates a mismatch of income and the availability of the foreign tax credit in the United States.

Relief may be available to some U.S. expats, but not all.  Several U.S. tax treaties cover foreign pension plans and, at least, eliminate double taxation.  You should discuss the availability of a tax treaty with your pension coordinator before signing up and getting caught in the foreign pension tax trap.

And, even if these treaty provisions exist, they will be limited to U.S. IRA amounts.  That is to say, they are limited to U.S. QRP levels of contribution from you and your employer, AGI limitations, and will have distribution requirements.  If your foreign pension is more generous, or has terms that are significantly different than a U.S. IRA, you are in for a very complex tax situation.

If you’re really lucky, you’re working in a country with an advanced pension treaty.  These exclude contributions to a foreign pension plan from your U.S. income, just as if the plan were in the United States.  Though, such treaties are typically with countries that offer retirement plans on terms similar to those found in the U.S., and whose tax rate is higher or about the same as in America.

At the time of this post, the countries with advanced pension provisions in their tax treaties are the U.K., Germany, the Netherlands and Belgium.

Another area of concern with a foreign pension is whether a withholding tax will be levied on you by your country of employment.  As an expat worker in a foreign land, it is likely the government will want to ensure your compliance by withholding any taxes payable… especially if you have returned to the U.S. after retiring or completing your work contract.

In many cases, the default rate of withholding is 30%.  If a tax treaty applies, this might be reduced to 15% (such as in the U.S. – Canada treaty).  There are even some treaties that eliminate the withholding tax all together, so be sure to discuss this issue with your representative.

The last consideration facing expats with foreign pensions are your U.S. reporting obligations.  It is possible you will need to file a foreign trust return (IRS Form 3520 and 3520 – A) to report the existence of the foreign pension.  If you have signature authority over the account, you probably need to report it on your Foreign Bank Account Report.  In some cases, IRS Forms 8938 and 8606 may apply.  Your filing obligations on your country’s applicable treaty and how your foreign pension is structured.  All I can tell you with certainty is that you should look carefully before getting in to a foreign pension arrangement and seek out the counsel of a qualified representative.

As you can see, tax planning for a foreign pension or foreign retirement plan is a complex business.  We at Premier do not offer foreign pension plans.  We can help the U.S. entrepreneur to form his own U.S. QRP or defined benefit plan and maximize the value of being offshore.

Likewise, if you already have a U.S. retirement plan, and are moving or investing offshore, we can help get your IRA out of the United States.  This is usually done by forming an offshore LLC or Panama Foundation and investing your U.S. IRA in to that structure.  Once this is complete, you’ll have checkbook control over the account and your investments.  Though, you are required to follow U.S. rules governing investments, act as the fiduciary of the account, and on distribution.

If you would like more information on taking a U.S. IRA offshore, pleas see my Self Directed IRA page (upper right menu of this site).  If you would like to set up an offshore corporation, or create a QRP for your international business, and you qualify for the Foreign Earned Income Exclusion (are a U.S. expat), we will be happy to work with you.  Please give us a call or send an email to info@premieroffshore.com.

U.S. Source Income
Christian Reeves

What is U.S. Source Income?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Chile
Christian Reeves

Controlled Foreign Corporation Defined

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

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

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

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

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

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

What Does Being a Controlled Foreign Corporation Mean?

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

Now, let me translate that into English.

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

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

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

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

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

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

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

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

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

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

Best Offshore Company Jurisdiction
Christian Reeves

Which is the Best Offshore Company Jurisdiction?

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Want to know which is the Best Offshore Company Jurisdiction for your business or your assets?  Are you considering living, working or investing abroad?  Then this offshore company guide is a must read.

Please note that, when I refer to the Best Offshore Company Jurisdiction, I mean the best jurisdiction for your offshore structure.  An offshore company can be a corporation, LLC, Foundation, or the manager of an offshore trust.  Please see www.premieroffshore.com for a detailed article on whether an offshore corporation or offshore LLC is better for your situation.  “Offshore Company” is a general term while “Offshore Corporation” and “Offshore LLC” refer to specific types of entities with specific uses and benefits.

In order to determine the Best Offshore Company Jurisdiction, you should consider a number of factors, including:  (1) privacy and protection, (2) professional services and investment management options available, (3) international banking options, (4) for a business, available work force, (5) tax filing and payment obligation, (6) locals audit or reporting requirements, (7) world image/perception, and (8) countries that offer specialized structures (niche markets).  I will consider each of these in turn.

Best Offshore Company Jurisdiction for Privacy and Protection

When new clients ask me which is the Best Offshore Company Jurisdiction, they usually mean which is the most secure – which offers the most privacy and protection for their assets.  As you will see throughout this article, privacy and protection are important, but certainly not the only consideration.

After 10+ years in the industry, it’s my opinion that Belize and Nevis offer the best offshore company laws for the basic corporation or LLC.  Both of these countries have one year look-back statutes, so, after the year is up, it becomes near impossible to attack a structure in these jurisdictions.

Belize and Nevis both have laws which are “client” or “business” friendly rather than “creditor” friendly.  In the U.S. legal system, the emphasis is on paying any creditor who can come up with the most basic excuse to separate you from your savings.  In Belize and Nevis, laws protect you from all claims except those where the transfer is deemed fraudulent.

  • A fraudulent conveyance is when you transfer money or assets out of the U.S. to keep them out of the reach of an existing or reasonably anticipated creditor.  If you injure someone with your car today, and send all of your assets out of the U.S. tomorrow, that is probably a fraudulent conveyance.  If you setup and fund an offshore company in Belize today, and injure someone six months from now, that transfer should be respected/protected.

I say Belize and Nevis are the Best Offshore Company Jurisdictions for basic formations because nominee directors and other advanced planning are not required.  You can form an offshore corporation or LLC in these countries with one person – the beneficial owner.  This makes them perfect for single member offshore companies, as well as for LLCs owned by U.S. IRAs or other types of retirement accounts.  This also means these formations are less expensive to form and maintain lower government fees and no nominees to pay.

The benefit Nevis has over Belize is that anyone wanting to sue a Nevis company must put up a $30,000 bond before they can get in to court.  If the plaintiff loses, this is used to pay the defendant’s legal fees.

While Belize doesn’t require a bond, they have the most modern corporation, LLC and trust statutes available.  Also, lawyers are not allowed to work cross on contingency (getting paid only when they collect from the defendant).  High retainers and legal fees in Belize have much the same chilling effect on litigation as bonds do in Nevis.

Another advantage Belize has over Nevis is a quality offshore banking sector, lead by Caye Bank and Belize Bank.  While it is often recommended that you plant multiple flags offshore, and thus use a bank in a country other than where you are incorporated, I prefer to begin with a structure and bank from Belize and then expand from there.  This is especially true of IRA LLCs and structures owned by U.S. persons because the laws and banks of Belize are very experienced in these areas.

Note that I said Belize and Nevis provide the best in basic privacy and protection without the use of nominees.  If you require max privacy regardless of cost, then I prefer a Panama corporation owned by a Panama foundation.  Both the corporation and foundation may have nominee directors and the beneficial owner (you) is not listed in any public registry.  The only people who know your identity are your incorporation (premier) and your banker.

An added benefit of the Panama corporation/foundation hybrid is that the foundation may act as a trust to deal with any estate planning, bequests and charitable giving you wish to do with your foreign assets.  Depending on your age and the size of your estate, this may provide significant estate tax benefits and giving options.

One drawback of Panama is that it does not have an LLC statute.  This means U.S. retirement accounts can’t incorporate these.  However, you may form an IRA LLC in Belize and then invest in to a Panama corporation.  This corporation now can open accounts or buy rental real estate in Panama.

Best Professional Services for Offshore Companies

If you are looking for more than a checking account offshore, quality professional services may be important and often hard to find.  Here is how I divide up the offshore investment management industry:

The best low risk higher return CD rates are in Panama.  So are some of the best real estate, gold storage and mid-market investment management services.  CDs at 3.25% are common from solid banks and loans are readily available to facilitate real estate investment.

In most cases, banks in Panama offer private banking services to accounts of over $500,000.  I call this mid-market because other jurisdictions like Cayman start these accounts at $2.5 to $5m.

Don’t get me wrong.  Panama does have some excellent high dollar private banks.  In my opinion, the best of these is Andbanc where accounts begin at $2.5m and, while the parent bank is in Andora, the trading desk is in Panama, and thus provides maximum diversification and protection.

For the rest of us non-millionaires, Belize offers a wide range of investment products, multi-currency accounts, gold and metals, as well as investments that lead to residency in a variety of countries.

I’ve found the best of these is Caye Bank and Georgetown Trust.  This bank does not have a minimum account size and Georgetown has investments at all price points.  I suggest managed accounts should begin at $250,000, but some of their best returns are on items like Teak that requires about $15,000 to get in the game.

At the other end of the spectrum is Cayman Islands.  Banks and investment advisors in this jurisdiction focus on the largest trusts, hedge funds, and high dollar private wealth management/family offices.  I won’t take up space here rambling on about Cayman, but I can assure you they offer the best offshore investment management services.  Please see my recent article on Cayman for additional information and baking information.

I note that not all banks and countries treat companies from other jurisdictions fairly.  For example, I believe that the best offshore company jurisdiction in most situations is Belize.  Well, Cayman makes it very difficult for offshore companies from Belize to open accounts at its banks.  Preference is given to countries who make it into Cayman’s “Category III” list.  This includes the U.S., U.K., and Cayman companies (obviously), along with Panama.  While other countries make the list, I’ve found that, if you don’t want to pay the fees to incorporate in Cayman, the Best Offshore Company Jurisdiction to do business in Cayman is Panama.

Other countries have taken similar steps to protect their incorporation industries from low cost competitors like Nevis and Belize.  For example, the make a Belize LLC eligible to do business in Panama costs thousands of dollars and requires a lot of effort.  For this reason, Belize LLCs usually form Panama corporations if they wish to do business there.  (IRAs require and LLC, so the Belize/Panama combo is common for retirement accounts).

Best Offshore Company Jurisdiction for Businesses with Employees

When selecting the Best Offshore Company Jurisdiction from which to operate a business, give very careful consideration to the cost, quality and availability of labor.  I’ve seen many set up in beautiful tax havens or in the very lowest cost markets available only to find out it isn’t the right place for them.

Let me start with an example of what not to do:

I once had a high net worth client who wanted to start an offshore call center business.  Money was no object and he was debating between Cayman Islands and Panama.  He chose Cayman because it’s one of the most beautiful places on earth (certainly true).  I advised him in the strongest terms possible that this was the wrong offshore company jurisdiction for a call center but he decided to go his own way.

After buying a home for $1.5m, leasing expensive office space, investing significant money in IT, and hiring a few employees, he began to understand how difficult it is to open a business in Cayman as a foreigner.  First, the employment laws require a certain number of Cayman citizens per foreign employee.  These locals come at a high cost and, in my client’s experience, low productivity.  Next, he found that the cost of labor in Cayman was higher than the equivalent hire in Los Angeles.  Finally, he quickly learned that lower cost call center sales people are just NOT available.

Combine this with requirements to have local partners and that operating costs turned out to be 35% higher than in California, and he was back at my door licking his wounds within six months of opening his doors in Cayman.

At the other end of the spectrum, several large and experienced companies in the offshore world have found it more efficient to move out of the lower cost regions, such as India, and in to Panama.  For example, Dell, a pioneer in outsourcing tech support, has moved much of its operation to Panama Pacifico, which is about 40 miles outside of Panama City.

While wages are higher in Panama (call center workers earn about $13,000 per year), Panama offers a number of tax incentives to cover the difference.  Also, it’s very easy to get work visas for foreign workers, qualified local labor is plentiful, and you get to operate in the same time zone as your U.S. clients.  Gone are the days of working until 3AM only to have Americans get angry when they hear an Indian accent on the other end of the tech support line.

As you’ve probably figured out by now, I believe Panama is the Best Offshore Company Jurisdiction for a new business with employees.  And I’m not alone in this opinion.  Companies like Citibank, HSBC, MasterCard, and too many bio-tech firms to count, have all made the same choice – move to Panama City for quality lower cost labor, business friendly laws, and tax incentives.

Of course this influx of jobs has pushed up the cost of labor.  What would cost you $800 per month two years ago is now about $1,000 per month (with an annual bonus of one month’s salary, this becomes $13,000 per year).  You will be also find that office space in the best parts of the city will cost about the same as a large U.S. market.  In fact, rents in Panama are higher than in my home city of San Diego.

Even with these higher rents, the cost of operating in Panama can be 50% or less than in the U.S.  One client of mine, also in Panama Pacifico, traded U.S. salaries of $135,000 per year for high-end computer programmers in Los Angeles for Panamanians earning $4,500 per month or $58,000 per year.  After running the Panama office for a year, he tells me his quality and efficiency is the same or better than it was in Los Angeles.

Tax Issues for Offshore Company Formations

When looking for the Best Offshore Company Jurisdiction, a country with low or no tax should be at the top of your checklist.  For U.S. tax purposed, it matters little where you incorporate, where you hold your investments, and where you operate your business from.

The bottom line on U.S. taxation is:

  • If you are living in the U.S., offshore company formations are generally tax neutral.  They should not increase nor decrease your U.S. taxes.
  • If you move an IRA offshore, profits should be tax free (ROTH) or deferred (traditional), just as they would be in the U.S.  For advanced IRA investors, a VBIT blocker corporation may provide significant planners opportunities.
  • If you live outside of the U.S., qualify for the Foreign Earned Income Exclusion, and operate a business through and offshore corporation, you may be able to defer or eliminate all U.S. tax on active business profits.  Significant planning is required.

So if you’re living in the U.S. and investing abroad, you want the most efficient structure that will ensure you pay no local (non U.S.) tax on profits.  As I’ve said before, I believe Belize and Nevis provide the best protection with zero tax and the most efficiency available in an offshore company.

  • If you do pay tax in your country of incorporation or country where you are investing, the U.S. Foreign Tax Credit should eliminate any double tax.

If you are buying real estate in an offshore company, you probably require a company where the property is located.  Want to buy land in Columbia?  Trying to do this with a Belize LLC can be a nightmare… you need a Columbian company.

If you want to invest abroad with your IRA, you must use an LLC.  The only countries I know of with compatible LLC statutes are Nevis, Belize, Anquilla, and Cook Islands.  Of these, Belize is the best suited to the management of retirement accounts.

What if you want to buy real estate in Columbia with your offshore IRA?  You will need both an offshore IRA LLC from Belize and a corporation from Columbia.

This extra entity will make life much easier and provides other benefits.  For example, you can distribute out the share of the Columbian companies, rather than the underlying real estate, when you hit age 70 ½.  This can reduce U.S. tax on a traditional IRA in an offshore LLC.  Please see my various offshore IQA LLC articles for more detailed information on this, as well as how the corporation can act as a UBIT Blocker if you buy the property with IRA money and a non-recourse mortgage.

For the active business, I’ve made the case for Panama.  However, the Best Offshore Company Jurisdiction for a business in Panama, especially one with employees, might not be Panama.  (Confused yet?)

Let’s say you are running a website in Panama that sells books to people living in the U.S.  We can call this business Amazonian.com.  If all the income and profits come in to a company incorporated in Panama, local tax authorities may want to tax your business income.

To eliminate tax in Panama, form an offshore company in Belize and a company in Panama.  The Belize IBC will bill your Amazonian clients and earn most of the profits.  The Panama company will invoice the Belize IBC for its expenses such that it breaks even in Panama and minimizes taxes there.  Of course the Belize IBC will pay no tax in Belize.

Now you are maximizing the benefits of both of the Best Offshore Company Jurisdictions… one for zero tax (Belize) and another to the best business laws and quality lower cost labor (Panama).  You have also maximized the U.S. tax benefits of the Foreign Earned Income Exclusion and the ability to retain profits over and above the Exclusion in a tax free country (Belize).

Local Reporting Requirements

When I plan structures in the Best Offshore Company Jurisdictions, I try to avoid those with local reporting requirements.  For example, all companies in Hong Kong must file audited financial statements each year.  While this is an easy source of revenue for local accounting firms, I don’t see any benefit to the client.  Therefore, I only incorporate in Hong Kong if I need an account on that island, want to do business in China, or to trade in RMB.

In most countries, such as Panama, Cayman and Belize, you are only required to file local (tax) returns if you have employees or are otherwise running a local business.  Of course, of you open a bar on the beach in Belize, or operate a corporation in Panama with 20 employees, you will have local filing obligations.  Otherwise, as an offshore company, you have no reporting requirements.

I note that, as an American living and working abroad, if you are using the residency test to qualify for the Foreign Earned Income Exclusion (as defined in various articles on this site), you should be filing a tax return in your country of residence.  That doesn’t mean you need to pay tax, but you should be filing something.

World Image

There are times when the world image of your offshore company makes a difference.  For example, someone doing business in Singapore, Taiwan and Hong Kong, might find their clients are more comfortable with a Hong Kong corporation than with a Nevis entity.  This is especially true when the jurisdiction of your offshore corporation must be disclosed in contracts or marketing materials.

The same principles apply in the asset protection industry to large family trusts.  Because of the availability of high-end asset managers, the largest and most complex trusts are created in Cayman Islands.  Because Cayman does not have the strongest privacy and protection laws, many of these trusts have a “flight clause” that allows them to escape Cayman for a more secure jurisdiction, such as the Cook Islands, should they come under attack.

For those of us not in the 1%, not named Romney, and not running a business where world image matters to our clients, I again suggest that the Best Offshore Company Jurisdiction in which to plant that first flag offshore is Belize.  If you are concerned that Belize may limit your choices for banking and investment advisors, I suggest that a Panama corporation owned by a Panama Foundation provides maximum privacy and is the most cost effective of the Category III countries.  I also believe the Panama Foundation is the best asset protection entity available.

Offshore Company Specialists

A number of offshore company jurisdictions have become specialists in one niche or another of the incorporation industry.  For example, the offshore asset protection trust, at least for Americans, was “invented” by the Cook Islands.  This tiny country, just off of New Zealand, started the move offshore and out of the reach of U.S. judges who gave such deference to allegedly injured creditors.

To this day, the Cook Islands are the preeminent jurisdiction for asset protection trusts… not the largest in trusts by dollar value, but the best offshore trust jurisdiction for those focused on asset protection.

Side note:  I’ve been working with Cook Islands Trusts for a decade and hold them in the highest regard.  They’ve been thoroughly vetted through the U.S. legal system and are best for those expecting trouble or litigation.  One reason for this assessment is that Cook Islands cases are heard in New Zealand courts.  Therefore, you have legal experts and systems applying Cook Islands law, which means better quality legal representation and processes.

For those not anticipating imminent legal action, a Panama Foundation or Belize Trust may offer similar levels of protection at about half the formation cost and 1/3rd the annual maintenance.

In the niche of Offshore Foundations, the only options are Panama and Liechtenstein.  Of these, Panama offers many advantages in term of banking, privacy and protection.

The Panama Foundation is a hybrid asset protection tool that provides many of the same benefits as a trust, including estate planning, privacy tools, such as the nominee foundation council, and of a corporation, such as the ability to open bank accounts and manage assets directly.  Especially when combined with a Panama Corporation for further diversification and risk segmentation, the Panama Foundation is one of the best offshore company options for after tax investing abroad – I say “after tax” because a U.S. retirement account or IRA can’t be placed in a Foundation, only an offshore LLC.

Another offshore company niche is the captive insurance company.  These are usually based in the Bahamas (the largest) or Cayman, and basically allow a U.S. business to self insure and deduct up to $1.2m per year on their U.S. taxes.

Offshore captives are a complex topic and are best suited to doctors or other self-employed high-net worth individuals who can put away at least $800,000 per year.  If you would like more information on Offshore Captives, please send us a message to info@premieroffshore.com.  All consultations are confidential and free.

Another niche is the Offshore Hedge Fund.  In this vertical, the Best Offshore Company Jurisdiction is the British Virgin Islands (BVI) followed by Cayman.

An offshore hedge fund is setup to allow foreigners (non U.S. persons) and tax preferred investors (IRAs, retirement accounts, pension funds, etc.) to invest in the United States without paying tax here.

For example, if a German citizen and resident were to invest in a U.S. fund or a small business, he would likely need to file and pay U.S. taxes as a result.  If that same person invests in a fund structured in BVI, and the fund invests in the U.S. business, the foreign individual has no U.S. tax obligations.

The same is true of U.S. pension funds and retirement accounts.  If they invest directly in U.S. funds, they will probably have to pay U.S. taxes on the profits.  If they invest in a Cayman hedge fund that then invests in the U.S. business, they can eliminate these tax headaches.

  • If you are wondering how big these “niche” segments are in dollar volume, take a read through my Cayman Islands business guide.

The last niche market segment I will mention is credit card processing and merchant services.  By far, the Best Offshore Company Jurisdiction for merchant accounts is the United Kingdom.  If you form a U.K. corporation, you will be able to access a much larger pool of credit card processors, including those in Europe and Australia, than you will with a Belize or Panama entity.

  • If your business is based in Panama, and you have employees there, you will have access to many local merchant account options.  If you have no presence in Panama, you will be limited to a few rather expensive providers, such as Multibank.

Of course, no one can compete with the low cost providers, including Pay Pal, of the United States.  It might be said that the Best Offshore Company Jurisdiction for credit card processing is right here in America.

Yes, an account in the U.S. can be “offshore.”  Let’s say you are living and working in Panama.  Your parent company for billing purposes is in Belize (to minimize taxes in Panama).  If you are a U.S. citizen with decent credit, have a U.S. mailing address and a U.S. bank account, you should be able to open a U.S. merchant account for about 1/2 or 1/3  of the cost of the same service offshore.

The proceeds of the credit card transactions will flow in to your U.S. bank account.  You then invoice the U.S. Corporation that holds this account from your Belize IBC and wire the funds each month or quarter to Belize.

  • Note that a U.S. corp. is required for the system above because no one will open an account in the U.S. for a foreign entity.

So long as the U.S. company has zero profits at the end of the year, you file your U.S. corporate return, you qualify for the Foreign Earned Income Exclusion, and you have no employees in the U.S. or other issues which create U.S. sourced income, this merchant account is basically an offshore tool.  For additional information see my article on offshore merchant accounts.

I hope you have found this guide to the Best Offshore Company Jurisdiction to be helpful.  Feel free to call or email for a confidential consultation on moving your assets or business offshore.

Cheap offshore Company
Christian Reeves

A Cheap Offshore Company Cost Me $100K

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Chile
Christian Reeves

Should I use an Offshore Corporation or Offshore LLC?

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Which is better, an offshore corporation or offshore LLC? Does an offshore corporation provide more protection than an offshore LLC? What are the benefits of an offshore LLC compared to the benefits of an offshore corporation?

These are the questions I get every day, and the answer is not as simple as you might think. There are a number of important differences between an offshore corporation and an offshore LLC that you should take in to consideration when setting up your offshore structure.

First, there is no difference in the level of protection offered by an offshore corporation or an offshore LLC. They are equal in the eyes of the law. Offshore jurisdictions have always afforded them the same high levels of deference, and U.S. courts have generally maintained that a corporation is equivalent to an LLC for asset protection purposes.

When thinking about how to best use an offshore corporation or offshore LLC, your first instinct should be to put an active business in a corporation and passive investments in an LLC. Here is why:

Benefits of an Offshore Corporation

When you operate an active business in an offshore corporation, you maximize the value of the Foreign Earned Income Exclusion and can retain earnings in excess of the FEIE. This allows you to eliminate or defer U.S. tax on your offshore earnings. You accomplish this by:

1. Drawing a salary from the offshore corporation of up to the FEIE, about $98,000 for 2014, and reporting that salary on your personal return, Form 1040 and Form 2555. If a husband and wife operate the business, they can each draw out the FEIE amount in salary, and thus earn up to about $196,000 free of Federal income tax.

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

2. If your corporate profits exceed the FEIE amount, then you leave (retain) those funds in the corporation. If you take them out in salary, they will be taxable in the U.S. By leaving them in the corporation, you defer U.S. tax until they are distributed as dividends…or possibly as salary in future years.

3. Using an offshore corporation allows you to eliminate Self Employment or social taxes (FICA, Medicare, etc.), which are about 15% on your net profits and not covered by the FEIE.

These tax breaks come at a compliance cost: you must file a detailed offshore corporation return on IRS Form 5471 each year. Because this form includes a profit and loss statement, balance sheet, and many sub forms, the cost to pay someone to prepare it for you should be at least $1,250 per year.

Benefits of an Offshore LLC

The primary benefit of an offshore LLC over an offshore corporation is the lower cost of compliance. An offshore LLC owned by one person, or a husband and wife, will usually files IRS Form 8858, which is much easier to prepare and Form 5471.

Because of this lower (and simpler) filing obligation, offshore LLCs are the best option for passive investments. Whether you are living in the U.S. or abroad, there is no tax break for passive investments in a corporation (these breaks apply only to active businesses income). Passive income is taxed as earned, reduced only by the Foreign Tax Credit, so you might as well make it as easy as possible to report.

  • The Foreign Tax Credit allows you to deduct any money paid in taxes to other countries on your foreign investments. It generally means you will not be double taxed on offshore transactions.

An offshore LLC can’t retain earnings, so it is usually not the best entity for an offshore business. However, if the business will never earn more than the FEIE, then an offshore LLC might do just as well as an offshore corporation.

If you were to operate a business through an offshore LLC, you would report your total net profits on Form 2555, and if those profits exceeded the FEIE amount the excess would be taxable.

To put it another way, if your net profits are $200,000 and you are operating through an offshore LLC while qualifying for the FEIE, then you would get $98,000 in salary tax free and pay U.S. tax on the remaining $102,000. If those same profits were earned in an offshore corporation, you would draw out a salary of $98,000 and leave the balance in the corporation, deferring U.S. tax indefinitely.

If your business earns $50,000, then the full amount would be covered by the FEIE and no tax would be due. Likewise, if a husband and wife both operated the business which earned $200,000, each could draw out $98,000 tax free, leaving only $4,000 for the IRS to take a cut from. So, if your business will always earn less than $98,000 or $200,000, you might as well use an offshore LLC.

I estimate that the cost to have a professional prepare Form 8858 to be $690.00, and that, if you usually prepare your own personal return, then you can prepare 8858 yourself. In other words, if you are experienced in advanced personal return forms like Schedules C, D, or E, or you are used to dealing with complex K-1s, then you will have no problem with Form 8858.

So, when deciding between an offshore corporation or an an offshore LLC, if the structure will hold passive investments or a small business, then you might save a few dollars and simplify your life with an offshore LLC. If you will operate an active business that might someday earn more than $98,000 in profits, you should form an offshore corporation.

benefits of an offshore company
Christian Reeves

Benefits of an Offshore Company

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

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

Offshore Company for Those Living in the U.S.

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

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

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

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

Offshore Company for Those Living and Working Abroad

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Best Offshore Company Jurisdiction
Christian Reeves

Where to Incorporate Your Offshore Company

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Offshore IRA Fees
Christian Reeves

Tax Benefits of Going Offshore

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

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

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

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

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

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

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

Tax Benefits of Going Offshore

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

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

Foreign Earned Income Exclusion

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

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

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

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

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

Take Your Retirement Account Offshore

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Stop Paying Social Taxes

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

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

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

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

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

Defer Tax with Offshore Mutual Funds

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

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

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

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

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

Eliminate Tax in Your Country of Residence

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

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

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

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

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

Retain Earnings Offshore

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

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

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

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

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

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

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

Conclusion

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

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

Offshore Corporation Taxation
Christian Reeves

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

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

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

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

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

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

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

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

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

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

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

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

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

Step 2 – Live and Work Outside of the US

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Step 4 – Gain residency in your new home country

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

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

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

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

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

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

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

International Bank and Brokerage Accounts

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

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

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

Offshore Corporation and Trust Filing Requirements

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

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

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

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

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

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

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

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

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

retained earnings in an offshore corporation
Christian Reeves

How to Manage Retained Earnings in an Offshore Corporation

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

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

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

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

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

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

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

How to get Retained Earnings in an Offshore Corporation

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Rule 2: Have a bona-fide offshore business

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

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

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

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

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

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

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

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

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

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

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

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

Rule 4: Know your reporting requirements

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

  • A foreign corporation or limited liability company should review the default classifications in Form 8832, Entity Classification Election and decide whether to make an election to be treated as a corporation, partnership, or disregarded entity (http://www.irs.gov/pub/irs-pdf/f8832.pdf).

Conclusion

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

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

Recent Articles (External Links)

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

Older Articles (External Links)

Offshore Corporation
Christian Reeves

Tax Traps and Landmines in Your Offshore Corporation

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

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

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

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

Here is the gist of her conversation with the promoter:

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

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

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

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

Q: Can my offshore corporation retain earnings?

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

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

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

Q: Is my offshore bank account private?

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

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

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

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

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

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

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

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

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

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

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

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

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

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