You reap the benefits of the FEIE if you're self-employed, as well, operating a small business outside the States, say, or working as an independent contractor for a U.S. or foreign corporation but performing your work, again, outside the United States. Remember, though, that the FEIE applies only to federal income tax. If you're using it as the beginning and the end of your international tax management strategy, you're still liable for Medicare, Social Security, and FICA...which amount to about 7.5% a year. And your employer is required to match your Medicare, Social Security, and FICA contributions, so your situation is costing him about 7.5% as well. Plus, if you're self-employed abroad but operating without a corporation, you're liable for 100% of FICA and Social Security...and you can suffer a reduction of your FEIE based on business expenses you claim. In other words, the FEIE is a great start. But, again, you can do more. To maximize the tax benefits of residing abroad and (legally) minimize your total tax obligation in the United States, here's what you want to do: First, form an offshore corporation in a zero-tax jurisdiction, register that company with the IRS, and open a foreign bank account in its name. Second, draw a salary of up to US$99,200 from that foreign corporation. As long as you qualify for the FEIE, and the company's income is derived from active, not passive, business, you will have no U.S. federal income tax liability on this income. Voliá. The properly registered and domiciled foreign corporation is not responsible for Medicare, Social Security, or FICA. Furthermore, you are now not self-employed; you are an employee of your offshore corporation, and therefore not subject to self-employment taxes either (that is, no Social Security, no Medicare, no FICA). Plus, all the expenses of the offshore corporation are now additional deductions and do not reduce your FEIE. And operating this way, you might be able to retain some or all of the offshore corporation's earnings in excess of the FEIE. Careful planning in this area can allow the deferral of U.S. income tax on active business income inside the corporation. Piece of cake, right? In fact, this international tax stuff can get complicated. Long ago, Lief and I searched for competent, reliable, and, critically, affordable guidance. One guy wrote five- and six-page memos in response to every (we thought simple) question we asked. Then he sent a bill for thousands of dollars per page. We couldn't understand the advice...which was beside the point, because we couldn't afford it anyway. These days, after a decade of searching, we've compiled a team of friends and contacts that I'd argue represent the best minds in the offshore world. We ask them a direct question...they give a direct reply. The good news for you is that our entire team of offshore tax, asset protection, and wealth experts will be joining us this October in Belize for Lief Simon's first-ever Global Asset Protection And Wealth Summit. This is a unique opportunity to work closely with these experts in order to develop a personal, diversified, state-of-the-art global wealth plan of your own...in order to manage your tax burden, to protect your assets, to diversify your life and your investments, and to grow your next egg. You can read more about the unique program we've put together here. Kathleen Peddicord
The one and only true option for an American to eliminate his or her U.S. tax burden is to work overseas earning no more than US$97,600. Do that and you can avail of the foreign earned income exclusion (FEIE, which is US$97,600 for 2013). You have to qualify for the FEIE. You do this by being a bona-fide resident of another country or by spending 330 days or more in another country. Remember, though, that, depending on where you live and how your situation is structured, you could be liable for income taxes in the country where you're living and working.
Obviously, this doesn't work for everyone. Not everyone is looking to move overseas and get a job...and, even if that's your goal, the truth is, it's not easy to get a job in a country where you don't hold a passport.
The bigger tax advantage for you as an American going offshore is to take your business offshore with you. In this case, you can work for yourself, thereby qualifying for the foreign earned income exclusion. Structure things properly, and you can also defer taxes on the profits from your offshore corporation until you pay those profits out in the form of salary or dividends.
This tax deferral is, in fact, similar to contributing to an IRA or 401k except that instead of handing your money over to an anonymous money manager, you're reinvesting in your own business. Note, though, that, as U.S. person running your own business offshore, you still could contribute to an IRA or 401k, taking advantage of those tax-deferral strategies, as well, if you'd like.
IRA contributions are limited if you earn a certain level of income. 401k contributions are limited, too, but these can total up to US$67,000 (US$17,000 personally and US$50,000 from the business). Taking those tax deferrals along with your foreign earned income exclusion means you could move up to US$165,000 out of the business tax-free or tax-deferred annually. Then you can leave whatever profits the business earns beyond those levels in the business...again, deferring any potential U.S. tax.
Meantime, you could take your IRA and your 401k funds offshore if you want. To be able to take your IRA funds offshore, you simply need a custodian who allows for offshore investments. The IRS rules for IRAs limit investments that would qualify as "self-dealing." They do not, however, limit the types or locations of most of your investments (other than collectibles).
Mainstream custodians such as Schwab and Fidelity don't allow you to make offshore investments with IRA funds they're managing for you simply because they only make money when you invest in stocks, bonds, or mutual funds. They aren't set up to administer investments in real estate (foreign or U.S., both of which, again, the IRS does allow). That's why you need a custodian who does allow these kinds of "alternative" investments (Midland IRA is one such custodian).
The easiest way to manage your offshore investments in your IRA is to set up an offshore LLC in which your IRA invests. Then you, as the managing member of the LLC, can direct the investments from there. As far as the custodian is concerned, your IRA is invested in the LLC. That's all the custodian knows and that's all the custodian needs to know. This structure keeps your custodian fees low and allows you greater flexibility and control.
You can invest 401k funds in offshore investments, as well, and, in this case, you don't even need a special custodian. With a solo 401k, you can act as the plan trustee. The main difference between investing IRA funds offshore and investing 401k funds offshore is the tax form filing requirements. With an IRA, your custodian handles all the tax form filings. With a 401k, you have to file the forms (Form 5500 or 5500-EZ).
In both cases, it's important to be aware of the investment constraints. Again, no self-dealing or dealing with immediate family is the biggest no-no. Your IRA cannot buy a piece of investment real estate from you personally, for example. Your IRA also can't lend you money. It can, however, lend money to a third party.
As I said, too late to take advantage of any of these strategies on your 2012 tax return due today. But today is also the day to begin taking action so you can benefit from these opportunities starting with your 2013 tax return and beyond.
P.S. The real estate investor overseas enjoys additional tax advantages, both in the United States (if he's an American) and, sometimes, in the country where he invests, too. These are covered in detail in my wife Kathleen Peddicord's new book, "How To Buy Real Estate Overseas," released last week and available online here.
April 15, 2013:
"Kathleen, when you are talking about Spain, you really should make it clear that in January 2013 Spain instituted a program of worldwide asset reporting, a prelude to a wealth tax. Many Brits, who had lived there for years, are packing up and moving out, which will further depress prices and make for an inhospitable retirement climate.
"Spain will not have much success in this, and it certainly made me look elsewhere for retirement."
--Linden L., United Kingdom
"Kathleen, I have been a traveler all my life, being my parents were unique. My father was American of German descent, and my mother is of Scottish/Italian descent born in Cali, Colombia. I have been all over South America but especially Colombia. As a matter of fact my wife is from Bogota.
"We read your newsletter all the time about Medellin. My wife wants to know why you have no one on the ground in and around Bogota? I see real estate opportunities there all the time, and it has similar malls and upscale neighborhoods worth knowing about. Not to mention the many colonial towns in and not far from the capital.
"When we eventually get established in Colombia we plan to keep our place in Florida/Miami area and go back and forth as we please. When we are in the capital one day we will e-mail you things of use for your newsletter. As I said before, Bogota is overlooked in many ways."
--Ernest P., United States
Thank you for taking time to write in, and we hope you will, indeed, send more information on opportunities in Bogota. We agree. It's another interesting and appealing choice in Colombia and one that we will highlight at our upcoming Live and Invest in Colombia Conference. More details on the program we're planning for this event are here.
In the end, he had no choice but to pay the resulting US$50,000 fine...and, then, to hope no further surprises awaited him down the line.
I joke now and then in these dispatches about how mind-numbingly complicated, as I like to say, this international tax and structure stuff can be.
It is. And it doesn't have to be.
At first, when you're starting out, making your first foreign real estate purchase or setting up your first offshore corporation, it's intimidating. You don't know what you don't know. You fear you'll end up like my friend, breaking some tax law you didn't know existed.
I've been lucky on this front. I married an accountant, who, since we've been living outside the States, has made it his business to understand the ins and outs of U.S. tax code as it relates to the non-resident American. Lief can quote IRS rules, regs, form numbers, and exemptions by heart.
And he's taken the time to research and to understand the relevant tax issues in every jurisdiction where we've invested money, done business, or held an asset.
I'm not sure he enjoys the side-line, but, when we left the States, Lief felt he had no choice. It was either figure it out himself or pay some "expert" tens of thousands of dollars to figure it out for us.
Lief's investment of time and energy has paid off, not only because it has saved us considerable money over the past decade...but also because it means we understand (well, at least he does) how we're structured. He's made all the decisions and choices himself. And we've erred on the side of disclosing and reporting even when we're not certain it's required...and paying the tax even when we're not sure it's due.
This way, we sleep better.
And, even within the context of our ultra-conservative approach, Lief has been able to control our overall tax burden. Using the foreign-earned income exemption and other straightforward exclusions, exemptions, and deductions, our overall net effective rate of tax is considerably less than it would be if we were full-time U.S. residents.
Of course, you don't have the benefit of Lief's personal assistance in your own offshore affairs (however I should point out that readers of Lief's Offshore Living Letter are privy to his expertise twice a week).
I have, though, learned a few things myself that I hope can help. Here you go: Six things I wish someone had told me before I bought my first piece of foreign property or opened my first offshore company:
Kathleen PeddicordContinue Reading:
Image source: Johnacastro2012
Dear Live and Invest Overseas Reader,
We didn't move from the United States to Ireland 14 years ago to save on taxes. And that's not why we moved to Panama four years ago this month either.
Still, no question, controlling your tax liability can make a big difference in your standard of living. Reduce your tax bill from, say, 40% a year to, say, 20% a year and it's like giving yourself a raise and super-charging your investment portfolios. You're earning no more, but you've got a whole lot more disposable income.
So, again, we haven't made any of our international moves with the primary agenda of reducing our tax burden, and neither should you. You don't want to organize your life according to tax code. But you don't want to ignore it either.
We Americans have it double tough. No matter where we go, our obligations to Uncle Sam follow. When we take up residence in a foreign jurisdiction, we're at risk of acquiring double the tax masters, with obligations to both the IRS and the local tax collector.
We must understand the tax requirements on both sides, and we must file annual tax returns in both jurisdictions...but that is not to say we must pay double the taxes.
This is a critical point. As an American abroad, you retain your IRS obligation, but, strictly speaking, that obligation is to do with reporting...not, necessarily, with owing tax.
This is where things can get interesting...and complicated.
Don't worry. You don't have to become an international tax guru to manage this part of your new life in paradise. After more than 27 years researching this stuff and more than 14 years as an American abroad, paying taxes in multiple jurisdictions, I'm still no expert. But I've been fortunate enough to get to know people who are.
Which leads to my first and probably most important piece of advice on this subject: When planning to move, retire, invest, or do business overseas, don't try to become a global tax authority. Hire one.
In fact, hire two. One in the jurisdiction where you're planning to live or invest...and another in your home country.
During one of our scouting trips to Ireland before our move years ago, we met with Ernst & Young in Dublin. We didn't know what we didn't know, but we knew enough to ask for help.
At the time, Ireland taxed its residents on a remittance basis. That is, living in Ireland, you paid tax only on whatever money you earned or brought into the country. You could earn hundreds of thousands of dollars a year. But if you brought (remitted) only US$50,000 per year into the Emerald Isle...the Irish tax authorities expected their cut of that US$50,000 only. Maybe you owed other tax authorities in other countries other tax on other pieces of your total income...but Ireland cared only about the piece of your income that flowed into Ireland.
The Ernst & Young tax guy we met with explained this to us and then he made a critical recommendation. He told us to organize ourselves so that all assets held prior to our move to Ireland were lodged in separate accounts from any assets we might ever bring into Ireland. This way, there could be no confusion. The Irish tax collectors could never lay claim to any assets clearly separate from other assets that might ever be remitted to Ireland.
And, then, he said, as long as you're living in Ireland, make sure that money you don't intend to remit to Ireland goes into those other accounts. Make sure everything is clearly separate from the start...and keep it that way.
We followed his advice.
In addition, as Americans residing abroad, Lief and I both were able to take advantage of the Foreign Earned Income Exemption, meaning that our first US$80,000 to US$85,000 of income each year apiece (the amount of the exemption is increased annually and stands today for 2012 at US$95,100) was free from U.S. tax.
Plus, Ireland and the U.S. have a double-taxation agreement, meaning we didn't owe tax in the States on any income taxed in Ireland.
Bottom line, by organizing ourselves carefully, as Irish residents, we were able to reduce our effective rate of tax to less than 20% per year.
The tax laws in the Emerald Isle have changed significantly since we were full-time residents, and Ireland no longer taxes its residents on a remittance basis. Today, Ireland taxes residents on their worldwide income...just as the United States does (with some complicated exceptions).
As I said, we're not resident today in Panama because of its tax laws...but it hasn't escaped our notice that this country's position on taxing its foreign residents is about as good as it gets. As a foreign resident in Panama, you pay tax only on the money you earn in Panama. You gotta' love that.
Panama is not the only tax-advantaged jurisdiction worth a close look right now. Belize is another place where, as a resident, you pay tax locally only on the money you earn locally. This is the case, as well, in Uruguay and Malaysia.
It's not always straightforward, and, again, you'll want an expert to help you organize yourself properly and compliantly. But the idea of becoming a full-time resident of a foreign jurisdiction for tax purposes is not only possible, it's also legal and safe...and it can cut your overall annual tax burden dramatically, even in half.
Don't Google "foreign tax specialist" or "international tax advisor." You'll find lots of resources that way...but none you should trust. The Internet is awash with guys who'll set you up with offshore structures for a fee and who'll be glad to help you get one over on the IRS.
You don't want to get one over on the IRS. You just don't want to pay that U.S. government agency US$1 more of your income than you have to each year.
You don't necessarily want offshore structures either.
I have no idea what you do want...or need. And, maybe, neither do you. But I can tell you this: Take the advice of some offshore expert you find with the help of Google, and your chances of ending up someplace you don't want to be (engaged in a one-on-one conversation with a representative of the IRS, for example) are probably increased.
Neither should you dash off an e-mail to your U.S. accountant or attorney asking for help managing the tax consequences of your new life or investments abroad. He won't have answers for you, and your questions will make him nervous.
My U.S. tax advisor at the time I made my initial move overseas, to Ireland, told me not to mess around with the Foreign Earned Income Exclusion for Americans living abroad. "It's too risky," he counseled me. "Better just to pay what you owe in full and not to try to get away with anything."
I understood almost nothing about any of this at the time, but I knew enough to know he didn't know enough. He's no longer my tax advisor.
I didn't replace him immediately or easily, though not for lack of trying. I began looking for a competent, experienced, and open-minded U.S. tax advisor as soon as I realized my advisor of many years was none of those things when it came to the issues faced by Americans living and investing abroad.
I did, though, over time, replace him, with a team of advisors with, together, decades of experience counseling Americans abroad in how best to manage and mitigate their U.S. tax burdens. It's this team that will be joining us in Panama City next week to help us host our Emergency Offshore Summit.
I'm looking forward to spending time with them during what has turned out to be, given continued developments in the United States and elsewhere, a very timely event.
P.S. I made the point that you need not one, but two global tax authorities, one to manage tax, reporting, and structure issues for you in the States...and one to manage those things in your jurisdiction of residency.
For us, the Panama side of things is managed by longtime friend and counselor Rainelda Mata-Kelly. Rainelda will be joining us on stage, as well, next week, for our Offshore Summit. We've invited other legal and tax advisors from other key offshore jurisdictions, too, including Belize, Colombia, and Uruguay. Continue Reading:
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Kathleen Peddicord is the founder of the Live and Invest Overseas publishing group. With more than 25 years experience covering this beat, Kathleen reports daily on current opportunities for living, retiring, and investing overseas in her free e-letter.
Her book, How To Retire Overseas—Everything You Need To Know To Live Well Abroad For Less, was recently released by Penguin Books.
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