Income Tax Planning for Expat Entrepreneurs Olivier Wagner, CPA - - PowerPoint PPT Presentation

Income Tax Planning for Expat Entrepreneurs

Olivier Wagner, CPA
 1040 Abroad

Who is this presentation addressed to?

u US Citizens and green card holders u Living outside the US u Self-employed or start-up

What to think about (taxes beyond income tax)

u Income tax - the USA taxes your income no matter

where you live or work

u Self-employment tax (or Social Security tax) -

the tax on your profit from self-employment

u Paperwork - lots of it, and complicated, too u Penalties - the default is “$10,000 and up” for

international-related penalties

Where Tax Savings Come From

Is Taxed… Why it works Example Never Specific reason for zero tax is built into the tax laws Foreign Earned Income Exclusion Less Lower tax rates built into the tax laws Long-term capital gains Later “Time value of money” using tax laws as designed by Congress Rental property (and depreciation)

Foreign Earned Income Exclusion

u Up to $100,800 (2015) of foreign earned income u Plus some housing expense (amount varies)

How to Win at Form 2555 –
 Requirement #1

u “Tax Home” - an itinerant contractor working in

• ne place after another has a tax home wherever

he/she is.
 Deamer v. Commissioner, 752 F .2d 337 (2012).
 You win without trying.

How to Win at Form 2555 –
 Requirement #2

u “Physical Presence” - days you are outside the

United States (needed: 330 days in a 12-month period)


• Be OCD. Track the days. Keep the evidence.

— OR —

u “Bona Fide Residence” - you really live in a

foreign country


• You don’t have to track your days outside the USA

How to Win at Form 2555 –
 Requirement #3

u Have “foreign earned income” u “Foreign earned income” means your body was

• utside the United States when you did the work

that made the money

Your foreign earned income

Bona Fide Residence Test

u Why you want this

u You can stay more than 35 days a year in the United States u You don’t have to deal with tracking your life and where you were

every day

Bona Fide Residence Test

u Full year only

u The bona fide residence rule only applies to full years

u If you were a bona fide resident of a foreign country or countries

during the entire year, you get the entire foreign earned income exclusion amount for the year

u For partial years, you will have to use the physical presence test

(aka “count the days”)

What does “bona fide resident” mean?

u Intention to remain indefinitely u Intention is shown by what you say and what you

do

u What you do is more important that what you say

Problem with the bona fide residence test

u It depends on your intentions (which can be hard to

prove)

u Do I intend to remain a resident of this place for an

indefinite time, eventually to return to the USA?

u Unless you have the right visa status to live and work

in another country, it is easy to prove that you are not a bona fide resident of that country

u An audit is an all-or-nothing event — expensive to lose!

Moment of Truth: Form 2555, Line 13

u “Please give me a tourist visa to LovelyCountry.

I’m only staying for 3 months. I’m sightseeing and enjoying your fabulous beaches. Not working. Srsly.”

u “Hey IRS, I really live in LovelyCountry. Srsly.”

What does applying for a tourist visa say?

u Publication 54, page 14: u Statement to foreign authorities. You are not

considered a bona fide resident of a foreign country if you make a statement to the authorities of that country that you are not a resident of that country, and the authorities:

• Hold that you are not subject to their income tax

laws as a resident, or

• Have not made a final decision on your status.

Something better than a tourist visa

u If you get a better visa — one that allows you to

live in the country — you answer correctly

u But now you are on the radar to pay income tax in

that country

Bona fide resident? Only if you really are

u Claiming the bona fide resident test is unsafe unless you

really are a resident of the other country

• You have the proper visa to live there, putting you
• n the radar for paying income tax
• Losing on this point means you do not qualify

for the foreign earned income exclusion at all. The results are binary, and your tax cost goes from zero to very large

u The “day count” method is safer

Physical Presence Test

u 330 days fully outside the USA in any 12 month

period

Do you get it, and if so, how much?

u The physical presence test serves two purposes

• Do you get the foreign earned income exclusion

at all?

• Assuming you do qualify, how much income is

excluded?

Counting the days

u Pick any starting date. It need not be January 1

and it need not be in the current year

• Pick the day before that date, 12 months ahead
• Count the full days outside the USA
• 330 or more? You qualify for the foreign earned

income exclusion

• Now we just have to figure out how much foreign

earned income you get to exclude for 2015

First year outside the United States

u March 1, 2015 - December 31, 2015 = 306 days u 306/365 x $100,800 = $84,506 is not taxable

Full Year: $100,800 of Income Not Taxed

A new 12-month period starts every day

You can overlap 12-month periods
 (used in 2 separate tax returns)

Even one day will work

u 1/365 x $100,800 = $276 income excluded

How to win a day-count audit

u Prove days in the USA, outside the USA, and

traveling to/from the USA with:

• Passport - those unintelligible rubber stamps

that are never in the right order

• Airline tickets/receipts – better
• Credit card records
• Moral: keep good records

Self-Employment Tax

u The self-employed person’s version of Social

Security Tax

• Schedule SE
• 15.3% of your net profit from self-employment
• n the first $118,500 of net profit
• The foreign earned income exclusion eliminates

income tax, not self-employment tax

Let’s Get Really Tax-Free

How to eliminate self-employment tax

Method the First - totalization agreement

u Live in a country that has a Social Security tax treaty

with the USA

• Do some paperwork
• Contribute to the Social Security system of the

country you are living in, not the USA

• No net tax savings — you’re paying tax to another

country instead of the USA

Method the First - totalization agreement

u Which countries? uNot China

Australia Denmark Ireland Norway Spain
 Belgium Finland Italy Poland Sweden
 Canada France Japan Portugal Switzerland
 Chile Germany Luxembourg Slovak Republic United Kingdom Czech Republic Greece Netherlands South Korea

Method the Second - be the boss of you

Method the Second - what you do

u Form a foreign corporation, make $100,000 profit u Pay yourself a salary of $100,000 (all the profit) u No corporate income tax (no taxable profit!) u No income tax to you (keep your salary under

$100,800) because it is foreign earned income

u No self-employment tax because you are not self-

employed — you’re a wage slave working for The Man

You cannot use a U.S. corporation

u Wages paid to you by a U.S. employer can be tax-

free foreign earned income — no income tax

u But wages paid to you by a U.S. employer are

subject to Social Security tax

u If you are looking to save self-employment tax by

being an employee of your own corporation and working abroad, setting up a Delaware corporation will not help you

Going completely tax-free . . .

. . . at what price?

Should you do “My Corporation Hires Me”?

u Tax savings: about $15,000 at $100,000 net profit

from self-employment

u What will you pay to buy $15,000 of cash?

The money part of the price you pay

First Year Following Years Projected Tax Savings 15,000 15,000 Formation cost

• 2,000

Annual fees

• 1,000
• 1,000

U.S. tax work

• 500
• 500

Net Tax Savings 11,500 13,500

Other money costs

u Penalty risk for screwing up Form 5471 or Form

926

u Additional accounting and tax return preparation

fees

u Banking, merchant account, etc. complexities —

how will your customers pay you? Can you take credit cards? What are the fees on your merchant account?

Someday you will be old

u And you will want Social Security u And you will want Medicare u Don’t engage in short-term thinking

Your focus and attention is valuable

u If you want to build a business, you can create

$10,000 (and indeed some multiple of that) by creating new customers for your products — no upper limit on what you can generate from X hours plus Y dollars

u Your time spent on tax savings has a maximum

value of $10,000

u Your purpose in life is to create a customer

Foreign Tax Credit

u It’s either/or. You can not take the Foreign Tax

Credit on income which was excluded using the Foreign Earned Income Exclusion

(although it is possible to combine the Foreign Earned Income exclusion with the Foreign Tax Credit for income not excluded (i.e. not “foreign earned” or in excess of the limit)

Foreign Tax Credit

u In many cases, more valuable. Must pay more tax

to home country than owing to the US (and have documentation to prove it).

u Carryovers to future years u Can offset all kinds of income u Ability to claim the Additional Child Tax Credit u Less invasive to your privacy

Foreign Tax Credit

u How does it work?

u Foreign Tax paid is allocated between General Category

and Passive Category income

u US tax owing is also allocated between General

Category and Passive Category income

u Excess is carried forward within that category of income

Foreign Tax Credit

u Example #1

uChinese sourced wages: $100,000 uChinese tax paid on wages: $30,000 uUS tax owing on wages: $25,000

Foreign Tax Credit

u General category

u Income: $100,000 u Foreign Tax: $30,000 u Foreign Tax Credit claimed in 2015: $25,000 u Carryforward (up to 10 years): $5,000

Foreign Tax Credit

u End result: zero tax owing plus:

u Carryforward (up to 10 years): $5,000 u Possibility to claim the Additional Child Tax Credit u Whereas the Foreign Earned Income Exclusion would

• nly bring you down to zero

Foreign Tax Credit

u Disadvantage

uThe standard deduction is prorated (hence the part

paid on the category on which foreign tax credit is applied is lost)

Foreign Tax Credit

u Example #2

uChinese sourced wages: $90,000 uChinese tax paid on wages: $27,000 uUS tax owing on wages: $22,000 uCapital gains: $10,000 uChinese tax paid on capital gains: zero uUS tax owing on capital gains: $1,500

Foreign Tax Credit

u General category

u Income: $90,000 u Foreign Tax: $27,000 u Foreign Tax Credit claimed in 2015: $22,000 u Carryforward (up to 10 years): $5,000

Foreign Tax Credit

u Passive category

u Income: $10,000 u Standard deduction (6,200 X 10%) = $620 u Personal exemption: $4,000 u Taxable income: $5,380

Foreign Tax Credit

u Passive category (continued)

u Foreign Tax: zero u Foreign Tax Credit claimed in 2015: zero (ain’t not

foreign tax to claim)

u Carryforward (up to 10 years): zero u Tax payable: (5,380 X 15%) = $807

Foreign Tax Credit

u Example #2 (with the Foreign Earned Income Exclusion)

u Total income: $100,000


(wages of 90,000 + capital gains of 10,000)

u Minus Foreign Earned Income: 100,000 – 90,000 = 10,000 u Minus Standard Deduction + Personal Exemption: 10,000

– (6,300 + 4,000) = -300

u Taxable income: zero (it doesn’t go negative) u Tax: zero

Finally

Why Good Bookkeeping is More Valuable Than Good Tax Lawyering

The problem is bookkeeping, not clever tax tricks

The cost of not capturing a business expense

u Don’t capture a $100 expense? u Your profit is $100 higher u Tax is just self-employment tax at 15.3% u You spent the $100 on a real business expense u And you paid an avoidable $15-ish in extra

selfemployment tax

u That business expense cost you 115% of reality

The cost of bad bookkeeping

u You lose tax deductions, so your income is higher,

so your tax is higher

u Your tax return preparer has to work harder

because your accounting data is poopy, so you pay higher professional fees

u You cannot document your expenses; you guess. If

you are audited, you pay more tax, plus penalties and interest

Stop doing low ROI activities

u

Use Freshbooks / xero.com, not QuickBooks

u

Dedicated bank account(s), credit card(s), PayPal account for business transactions only

u

Never run personal expenses through business accounts

u

A smartphone app to capture expenses (make it sync to Freshbooks / Xero)

u

Hire a bookkeeper; do not DIY

Summary

u Use the “count the days” method to get the

foreign earned income exclusion

u Bookkeeping will keep you sane and distraction

free.

u Your focus is valuable. u Ignore any strategy you think is clever

Thanks! And now for questions. . . .

Olivier Wagner 1040 Abroad | International Tax 1040abroad.com

• wagner@1040abroad.com