"We have what it takes to take what you have." - Suggested IRS Motto
Countless Americans living abroad own and run their own business. They may be digital entrepreneurs, exploiting global connectivity to reach new markets, or many have simply settled overseas and own and run a business where they live.
There are certain US tax and reporting factors that American citizens should be aware of when owning a business abroad. These include the US tax implications, US reporting requirements, business structure, and where to register the business, which may not necessarily be the country where you currently reside.
As US citizens are taxed on their worldwide income, your business will still be taxable in the US, even if it’s registered abroad. In an ideal scenario, it is better to be aware of the rules before starting out, so that you plan and set up your overseas business to minimize your US reporting and taxes.
In this article, you’ll learn about:
• Choosing a country for your overseas business
• Choosing a corporate structure for your overseas business
• Foreign business account reporting
Choosing a country for your overseas business
When choosing which country to register your business, the first consideration is often whether your business will have a physical premises and employees in the country where you live. If so, it will often make sense to register it in that country. If you are the only employee and your business trades online though, it may make more sense to register it in another jurisdiction.
You can do a certain amount of research yourself, such as looking at which countries have lower corporation tax rates. Some countries in fact have no corporation tax, including:
• Anguilla
• Bahamas
• Bahrain
• Bermuda
• Cayman Islands
• Turks and Caicos Islands
• The British Virgin Islands
Furthermore, several European countries have low rates of 9% - 12.5% (e.g. Hungary, Montenegro, Bulgaria, Gibraltar, Cyprus, and Ireland).
The best course though is to consult your financial and tax advisors at the outset to discuss your options, as investing in advice in this preliminary stage will allow your venture to start out on the best possible trajectory.
Choosing a corporate structure for your overseas business
The factor that can affect your US reporting and tax obligations most, though, is the corporate structure that you choose for your business.
Foreign corporations
For American expats, a foreign corporation is a company that has been registered outside of the United States.
American owners of foreign corporations are required to file Form 5471 every year along with their federal tax return if they meet the following criteria:
• They own 10% or more in a foreign company
• They are an officer or director of a foreign corporation that is at least 10% owned by Americans
• They control a foreign corporation for at least 30 days in a year
"Along with Form 5471, a US citizen is also required to file Form 926 with their individual return if they made any transferred property to a foreign corporation during a financial year, including transfers of cash over $100,000 if the transfer resulted in owning more than 10% of the corporation." - Benjamin Pik, Expand CPA
Furthermore, owners of foreign corporations are taxed on the corporation’s profits in many cases, especially if the corporation is registered in a low tax jurisdiction. There can be workarounds though, such as tax reductions if the foreign corporation has a US parent company. The type and size of the business are important considerations when looking at what structure to use (and where to incorporate), so it’s best to always seek advice on these matters.
Foreign partnerships
Even if a business is classified as a partnership in the country in which it operates, it doesn’t necessarily mean that it will qualify as a foreign partnership for US tax purposes.
A business is considered a foreign partnership by the US if it has more than one owner and at least one partner’s liability is unlimited.
American citizens are required to file Form 8865 along with their individual tax return if they own more than 50 percent in a foreign partnership, or more than 10% per individual and more than 50% total is owned by Americans.
The requirement to file Form 8865 is also applicable in a year where you have disposed of your stake in a foreign partnership.
Foreign LLCs
Limited liability companies limit the risk of the shareholders to the amount of their investment in the business. This means that their personal property can’t be liable for any of the company’s losses or debts.
A single-owner domestic LLC is said to be “disregarded” for tax purposes, meaning that it may not require any separate filing requirements at all, and the profits can just be included in your annual income tax return.
The same treatment can only be applied to a foreign LLC if the American owner does a one-time filing of Form 8832, followed by the annual submission of Form 8858. The advantage of this is that Form 8858 is a much simpler form to file than Form 5471, and it means there’s no separate US corporation tax liability.
Self-employed
For some expats, if you work alone, it can make more sense to be self-employed rather than incorporate your business at all. The filing requirements are more straightforward than the other options, being simply a statement of profit and loss on Schedule C of your tax return.
There are other taxes for self-employed expats though, such as self-employment taxes. As of 2022, you will pay 15.3% of your income as self-employment tax. This breaks down as 12.4% and 2.9%, divided into social security and Medicare taxes, respectively. You may be able to avoid these if you pay foreign social security taxes and live in a country with which the US has signed a Totalization Agreement to avoid double social security taxation though.
Deductible business expenses
In all scenarios, it’s sensible to ensure you list all your deductible expenses. These are the same whether your business is in the US or abroad, and whatever the business structure, including:
• Advertising and promotion
• Contract labor
• Legal and professional services
• Travel
• Car/truck expenses
• Supplies
• Business space and equipment rental
• Taxes and licenses
• Meals and entertainment
Foreign business account reporting
Filing a Foreign Bank Account Report (FBAR) is a mandatory filing requirement if you have financial accounts abroad. It was introduced to reduce tax evaders trying to hide money offshore.
You are obligated to file Form FinCEN 114 electronically every year before October 15th if the total combined balances of all your foreign financial accounts, including business accounts even if the accounts is registered in the business’ rather than your name, exceeded $10,000 any time during the financial year.
The penalties for not filing or incorrectly filing FBARs are high, so it’s one to keep an eye on.
Americans of foreign businesses may also have to report their business on Form 8938 under FACTA foreign asset reporting rules.
Choosing where you register your foreign business and its structure are incredibly important decisions that can make a big difference to your finances and your US reporting, so always seek advice to ensure you are setting up in the most efficient way possible. Investing in advice at this stage will save you a load of time, hassle, and money later.
If you have any questions, don't hesitate to contact us.
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