BlogEntrepreneur Abroad? The Business Tax Guide for Expats
Posted about 2 years ago

Entrepreneur Abroad? The Business Tax Guide for Expats

Expat Living Abroad

Not all American expats are employed by big companies. Actually, many run their own business while living outside the USA.

If you own a business overseas or run your US business from abroad, this Guide to Business Taxes for Expats is for you. It explains tax implications and tax savings opportunities for American business owners abroad.

In this comprehensive guide, we cover the following:

  • The Best Business Structure for US Expat Entrepreneurs
  • Self-Employed Abroad as Sole Proprietor
  • Having an LLC When Living Abroad
  • Setting Up a Corporation as American Abroad
  • Doing Foreign Business as a Partnership
  • Setting Up an Offshore Business Structure
  • Benefits of US Entities
  • Advantages of an Offshore Company
  • US Tax on Foreign Business Income
  • Taking Advantage of Business Deductions
  • Business Records and Bookkeeping
  • Tax Treaties and Totalization Agreements
  • Foreign Bank Account Reporting for Business Owners
  • Tax Deadlines for Expat Business Owners
  • Get Expert Help

(If you are not a US citizen or Green Card holder, your US tax situation will be different. Please check out our US tax guide for non-US owners here instead. COMING SOON)

The Best Business Structure for US Expat Entrepreneurs

How you structure your business will have a big impact on your tax filing requirements.

You can set up your company in the United States or offshore, or a combination of both. Let’s have a quick overview of some typical small business structures.

They are:

  • Sole Proprietor
  • LLC – Domestic or Foreign
  • Corporation – S-Corp, C-Corp, Foreign Corporation
  • Partnership
  • Other offshore structures

Let’s look at each in more detail:

Self-Employed Abroad as Sole Proprietor

Freelancers, consultants, and other self-employed expats and digital nomads often operate without registering a business. They are classified as Sole Proprietors and file US taxes as an individual.

Sole proprietors abroad use Schedule C on Form 1040 to report profits and deductions from the business.

The US taxes self-employment income the same, no matter whether you earn it abroad or in the US. Unless you have incorporated a business, you owe self-employment taxes.

Self-employment taxes are 15.3% and cover Social Security and Medicare. Fortunately, you may be able to reduce your self-employment taxes with the right business structure.

Other things US expats need to know when self-employed abroad:

The filing threshold for self-employment income is very low at $400. That means, even if you only make a few thousand dollars, you must file a tax return.

If you’re contracting for non-US companies that don’t issue a Form 1099-NEC, then you need to self-report your foreign self-employment income.

Also, as a self-employed expat you may need to make quarterly estimated tax payments.

And if you are also a tax resident in another country, you may also need to file and pay taxes there.

Luckily, when living abroad you can also use the Foreign Earned Income Exclusion and/or the Foreign Tax Credit to lower your US tax bill. The Foreign Earned Income Exclusion can lower or eliminate income tax on the earnings you make abroad. However, it only applies to income tax, not self-employment tax.

Read our Guide To US Expat Tax to find out more.

Having an LLC When Living Abroad

A US LLC is a “disregarded entity” in the United States. This means that any income from the business flows through to the owner. The LLC owner must report it on their own individual tax return (Form 1040).

From a US tax perspective, it is the same as a Sole Proprietor or being self-employed.

You can elect to have your US LLC taxed as an S-Corporation though. This helps to reduce self-employment tax. More about this in a moment.

A foreign LLC does not automatically have the status of a disregarded entity. You must elect the disregarded entity status by filing Form 8832. Otherwise, the IRS will treat the foreign LLC as a corporation.

This can lead to further complexities with filing Form 5471 and potentially paying GILTI tax. If you elect disregarded entity status, you must file Form 8858 every year to maintain the status.

Form 8832 can also be used to classify the foreign LLC as a partnership or corporation. We explain those entity forms next.

Setting Up a Corporation as American Abroad

American expats can own both US or foreign corporations. The tax implications vary widely.

A US corporation is taxed at 21% whereas a foreign corporation can be taxed as low as 0%. This depends on the jurisdiction, nationality and ownership of other shareholders, and the type of business.

With these structures come complex filing requirements. They can include a Form 1120 (US C Corp), 5471 (Foreign corporation), as well as other disclosures such as Form 926 (transfer of ownership), etc.

It is important to not only have the right structure in place but also do the correct reporting. These forms can carry penalties of $10,000 for inaccurate information or not filing.

We have worked extensively with expat business owners and helped them set up the best structure for their situation. Schedule a consultation with our experts at Global Expat Advisors.

Doing Foreign Business as a Partnership

Sometimes when you own a foreign business with someone else, the IRS treats it as a partnership. This is ultimately dependent on whether it has two or more owners and at least one of the owners has unlimited liability with respect to the entity’s affairs.

This is important to note because even if an entity is considered a partnership under the laws of a foreign country, it may be considered something else in the US for tax purposes, such as a corporation.

For a foreign partnership, you file Form 8865, along with Schedule K-1. It is similar to a US partnership tax return (Form 1065). It informs the IRS which type of foreign partnership you have and explains business activities.

Form 8865 has four different filing categories, and each category has different documentation to attach. It is also possible to be in multiple categories simultaneously.

Setting Up an Offshore Business Structure

In some cases, it is more beneficial to set up a more complex business structure that can involve both US and foreign entities.

For a US citizen abroad who has a global business with employees and customers around the world, and no US presence or effectively connected income, a typical structure is a C Corporation owning a non-US company.

Under this structure, you must use the C Corp as a holding company (no transactions) and run everything through the foreign company. The foreign company is the operating company. It runs the operations and pays the employees.

With this structure, you will pay 10.5% corporate tax on all earnings of the offshore company (owned by the C Corp).

You should also pay yourself up to a $120k annual salary subject to the Foreign Earned Income Exclusion. It is important you pay this salary monthly and regularly. And it must be in cash basis accounting.

If you want to take out more than this amount, you should take it as dividends from the C Corp holding company (not from the foreign subsidiary). It is subject to up to 23.8% additional dividend tax.

Selecting the right jurisdiction(s) and structure depends on a variety of factors. This structure is not for everyone and may not apply to your situation. We are giving a broad strategy and you must determine if this structure is applicable to you and your business under the IRS code.

To choose the best business structure for your situation, speak to an experienced accountant. You can schedule a consultation with the offshore business structuring experts at Global Expat Advisors.

Benefits of US Entities

A US LLC is easy to set up and manage. It has fewer reporting requirements and less paperwork than other types of entities.

Plus, your LLC earnings flow through to your individual tax return Form 1040. This means you can avoid the costly and time-consuming returns and reports associated with other entities.

The biggest disadvantage of a US LLC for an American? You still owe US self-employment taxes (see above).

As your business grows, a different entity type (like an S-Corp) may be more beneficial. Above about $40,000 in net income, you should consider switching your LLC to an S-Corp. Talk to an experienced tax accountant to run the numbers for you.

Advantages of an Offshore Company

Offshore entities aren’t just for large corporations—small businesses and entrepreneurs can benefit, too.

In fact, for many expats a tax-optimized offshore business structure can result in significant tax savings. (The article explains how three different types of entities affect an entrepreneur’s tax burden).

Why are offshore companies so beneficial?

Zero US FICA/Medicare taxes because you’re paid by a foreign company.

A reduced GILTI tax rate of 10.5% if your foreign entity is owned by a US C Corp.

Pay yourself a $120,000 salary, income tax-free by claiming the FEIE.

These are examples of the potential benefits. Every situation is unique, so please consult an expert. Your income, type of business, and where you incorporate and live can all make a difference.

Check out our guide The Secret to Choosing the Right Jurisdiction, for more information.

Foreign entities have disadvantages too.

They have extra reporting requirements and additional tax rules. Offshore entities are also more costly to set up and maintain.

Before opening a foreign company, work with a US tax expert to avoid these 7 common costly mistakes.

US Tax on Foreign Business Income

If you are considering opening an offshore company, you’ve probably wondered:

“Do I have to pay taxes if I have a business in another country?”

“Do foreign businesses pay US taxes?”

The answer is yes. Expats may owe tax on foreign business income. Simply opening a foreign entity doesn’t mean you’re free from the IRS.

As a US person who owns a foreign entity, you may need to file Form 5471 or Form 8865 for your company. In some cases, US taxpayers also need to file Form 926.

These are all forms with multiple categories, types of filing, currency translation, and tax law interpretation, which makes them complicated for the average taxpayer.

The IRS estimates that it takes approximately 38 hours on average to prepare Form 5471 (aside from the record-keeping time and the time required to learn about the relevant law and instructions). The learning time could be much longer for someone who is not familiar with the pertinent sections of the tax law.

IRS estimates that the average time required for record-keeping to prepare the form is 82.5 hours and that the average time required for learning about the form is 16 hours. And that does not include the separate time estimates for schedules J, M, N, and O.

In addition, if you have authority over your entity’s foreign bank account then you likely need to file FBAR. Failure to comply with these requirements can result in hefty fines.

Taking Advantage of Business Deductions

Reasonable business expenses abroad can be used to reduce your taxable income.

You can deduct expenses such as:

  • Advertising
  • Marketing and branding
  • Payments to contractors
  • Supplies
  • Home office and office expenses
  • Computer equipment
  • And more.

You can even deduct the cost of travel that requires you to be away from home.

To deduct the cost of travel you need a fixed tax home. In other words, if you’re a digital nomad this might be difficult to claim.

A percentage of your business meal expenses is also deductible.

These deductions apply to Amazon sellers and other e-commerce entrepreneurs, too. In addition to the above list, you can also include expenses like Amazon fees, inventory, and shipping costs.

Remember, to claim these deductions you’ll need to keep clear records of your expenses.

Business Records and Bookkeeping

Maintaining accurate records is a crucial part of your business taxes, not only for claiming all deductions. For some tax filings, balance sheets and income statements are required, as well as tracking the distributions to shareholders and the associated shareholder basis.

This requires intricate knowledge and tracking because it ultimately affects each shareholder’s individual tax return.

Even as a sole proprietor or LLC owner, at a minimum open a separate bank account for your business expenses. Do not intermingle personal and business transactions.

(If you’re a US citizen with a foreign bank account, you may need to file the FBAR).

Another way to simplify record keeping?

Consider hiring a bookkeeper. A bookkeeper can save you time and prevent mistakes.

Plus, some US states and foreign jurisdictions require you keep accurate books.

Tax Treaties and Totalization Agreements

Tax treaties and totalization agreements are another way to reduce your tax burden.

Many countries have tax treaties with the US that protect Americans abroad from double taxation on income.

Likewise, some countries (like Spain and Canada) have totalization agreements that can protect you from owing social security taxes in two countries.

Foreign Bank Account Reporting for Business Owners

If you’re an experienced expat you are probably familiar with the Foreign Bank Account Report (FBAR).

But did you know that the FBAR applies to businesses too?

If the combined value of your foreign financial accounts exceeds $10,000 at any time during the year, then your business must file an FBAR.

This includes all financial accounts that you have signature authority over, including your business accounts. And it applies to American and foreign entities.

Don’t forget the final FBAR deadline in October.

Tax Deadlines for Expat Business Owners

Business owners have more than a few tax deadlines to be aware of.

Here are the most common:

January 31 – Deadline to send Form 1099-NEC to contractors

March 15 – Initial due date for Form 1065 with Schedule K-1 for partnerships and Form 1120S with Schedule K-1 for S corporations.

April 15 – Initial deadline for Form 5472 and Form 1120

April 15 – Initial deadline to file C Corporation tax returns.

Keep in mind that you can request an extension for some of these deadlines.

Be sure to check out our US tax deadline calendar and speak with your accountant to find out which due dates apply to you.

Get Expert Help

Finding a US tax expert who truly understands your tax situation will make a huge difference in your tax burden.

Published in Member Blogs, Uncategorized