As I said, you can take advantage of this very interesting tax opportunity if you are either an active participant in offshore real estate or what’s termed a “material participant.” As a material participant, you are much more involved and in control than an active participant. As a material participant (sometimes referred to as a “real estate professional”), you are in the active business of real estate and can deduct your expenses against any and all of your other income without limitation.It is relatively easy to qualify as an active participant in offshore real estate but more challenging to be classified as a material participant. However, if you qualify, you’ll find that you’re eligible for bigger international tax breaks and loopholes, especially if you’re also living overseas.Specifically, as a material participant/real estate professional, you can draw a salary from an offshore corporation and qualify for the Foreign Earned Income Exclusion (FEIE). Note, again, that this tax break is available only to material participants offshore and not anyone living or working in the United States. It would be near impossible to qualify as materially involved in properties in Colombia while living in Texas.Qualifying for the FEIE means that you can take out up to US$97,600 (for 2013; the amount is increased each year) in salary from that enterprise free of federal income tax. And, as a material participant in offshore real estate, you could make use of a number of other tax mitigation strategies, as well.To be classified as a material participant or real estate professional you must be active year-round in the operation of your offshore real estate business. You must work on a regular, continuous, and substantial basis, and offshore real estate should be your primary occupation. If you work a full-time job and do real estate on the side, you are probably not a real estate professional. In other words, a qualified offshore real estate professional can deduct his or her expenses against all other income, regardless of source and without limitation and draw out up to US$97,600 in profits free of federal income tax. If a husband and wife both qualify as material participants and for the FEIE, they can each take out an annual salary of US$97,600, for a total of US$195,200 of tax-free money. Chris RuschEditor’s Note: Chris’ complete guide to tax strategies and opportunities related to owning real estate overseas is featured in this month’s issue of the Simon Letter, in production now and due in subscribers’ e-mailboxes next week.Also note that Chris will be among the offshore experts participating in our Offshore Seminar taking place in Panama City Nov. 20-22. More details on this program are here.
As we're American citizens living abroad (that is, Americans legally resident elsewhere), our taxes needn't be postmarked by April 15 each year. We have an additional 60 days (until June 15) to get our returns to Uncle Sam. Nevertheless, Lief applied for a six-month extension for our U.S. tax filing this year. Meaning that, for these past two weeks, our pillow talk has had a lot more to do with foreign-earned-income analysis, foreign tax credits, investment rental write-offs, and mortgage expense than...well, than with anything else. Lief is holed up in his office today with our Panama accountant finalizing our returns. From behind his Do Not Disturb sign he offers the following tips for other Americans abroad keen to keep compliant but eager, as well, to pay no more in U.S. tax each year than absolutely necessary. This is our list of six things we wish someone had told us about international tax planning and asset protection before we set off on our living and investing overseas adventures some 16 years ago: Tax Tip #1: First, maybe you don't need to do anything. Asset protection isn't an issue until you've got assets enough to warrant the investment of time and money to figure out how to protect them, and many retirees overseas don’t need to invest in tax planning either. A move overseas is often a tax-neutral event for someone with only retirement (that is, pension or Social Security) income. Tax Tip #2: Second, whatever you do, it shouldn't cost you tens of thousands of dollars. OK, maybe if you're Bill Gates or Warren Buffet, a big investment in managing your tax and asset issues is warranted. For you and me, it's not. Tax Tip #3: Third, the Foreign Earned Income Exclusion (FEIE) may be the beginning and the end of the tax planning you require. (This is discussed in detail here.) As an American citizen living and working abroad who qualifies for the FEIE, your first US$97,600 (for 2013) of earned income is tax-free in the States. Note, though, that the FEIE applies to earned income only. It’s no help when it comes to investment, dividend, interest, or capital gain income. Tax Tip #4: Fourth, when it comes to purchasing and holding real estate overseas, remember two things: First, the jurisdiction is the key; second, as a result, no attorney in your home country is going to be able to help you figure out what to do. You need a local attorney experienced at working with foreign buyers to help you determine how to purchase and how to hold (in a local corporation, in a foreign corporation, in your own name, in a trust, etc.). In some jurisdictions, you're wise to hold property in a local or an offshore corporation...but not all. Before you do anything, make sure you understand why you're doing it and the real benefit. Tax Tip #5: Fifth, when it comes to addressing the tax issues in any new jurisdiction where you’re considering taking up residence, the key is to research, plan, and take action before taking up residence. Certain options for mitigating your local tax bill can be taken off the table once you've taken a local address. Get local legal advice as early on in your planning as you can. Tax Tip #6: Sixth, you can avoid any local tax issues by being only part-time resident overseas. The particulars differ jurisdiction to jurisdiction, but, generally, spend fewer than six months in a place and you can't be considered full-time resident for tax purposes. This can mean no tax obligation in the country where you’re part-time residing, but it also means that you will need to use the 330 Day Test, and not the Residency Test, to qualify for the FEIE. This means you can spend only up to 35 days per year in the United States (as I said, not an issue if you don’t have earned income). I'm lucky. I happen to be married to the most international tax-savvy guy I know. Well, one of the two. The other is Chris Rusch, who has an MBA and a U.S. law degree with an emphasis on international taxation. Lief and I met Chris about eight years ago. We've met a lot of international tax advisors in our careers. Most of them are the reason Lief has become as expert in this area as he is. The "experts" we’ve found typically haven’t been worth the fees they’ve charged. International tax experts tend to over-complicate, to miss simple but important strategies, then to bill by the hour or the page. Chris, on the other hand, seeks out the most straightforward approach, issue by issue. You explain to him what you want to do. He lets you know if, in fact, what you think you want to do makes any sense. Maybe you don't need to do anything... But, if you do, Chris quotes you not an hourly or a per-page rate but a flat fee for the project. You can send him as many e-mails as you like, ask him as many questions as you want. In nearly 30 years covering this beat and 16 years of filing tax returns as an American abroad, I've not met another tax advisor who compares. Well, other than my husband. If I didn't have Lief, Chris'd be the guy I'd turn to for help. You can contact him here. Kathleen Peddicord P.S. Chris Rusch will be among the team of advisors joining us for ourOffshore Summit in November. If you’re grappling with global tax, asset, banking, residency, citizenship, investment, or business questions, this is the place to come to get them all answered by the pros. More information on this unique going-offshore program are here.
Business income and expense from your new endeavor is reported to the IRS on your personal tax return, Schedule C, with no complex corporate forms required. Then, once the business gets going, you can seek professional advice, incorporate, and get your ducks in a row. If you are living and working abroad, and plan on qualifying for the Foreign Earned Income Exclusion (FEIE), then this easy road is fraught with trouble and simply does not work. Here's why:In most cases, it is not possible to open an offshore bank account under a business name without forming a corporation or LLC. While you could run your business with a U.S. bank account or a personal account offshore, doing so will create a problem when tax day rolls around. This is because, as in the example above, your offshore business will land on your Schedule C and get sliced apart by the tax man faster than you can blink.An offshore business without a corporate structure is reported on Schedule C, while an offshore corporation is reported on Form 5471. When an offshore business is reported on Schedule C, it reduces your FEIE proportion to your business expenses, drastically increasing your U.S. tax bill. For example, if your business expenses are 50% of your gross sales, then your FEIE will be cut in half. So, if gross income is US$200,000, and expenses are US$100,000, then net taxable income is US$100,000. If you were operating through an offshore corporation, you would deduct US$97,600 (the maximum amount of the FEIE) from this income and pay tax on only US$2,400. Without a corporation, your FEIE is cut down to US$48,800 (US$97,600 divided by 2) and you get the joy of paying U.S. taxes on the remaining US$51,200 (US$100,000 minus US$48,800). But it gets worse. The Foreign Earned Income Exclusion applies only to Federal Income tax. It does not reduce social taxes, such as Self Employment (SE) tax. When you report net profits on Schedule C, they are subject to SE tax, which is about 15%. Taking a salary from an offshore corporation eliminates this expense. So, if you have a net profit of US$100,000, Self Employment tax will be around US$15,000, regardless of whether you qualify for the FEIE. If a husband and wife are joint operators of a business, and the profits are US$200,000, you could be paying US$30,000 in combined SE tax. What if your business is a resounding success and you earn more than the FEIE? What if, say, you and your spouse net US$400,000 in a year? Without an offshore structure, you will pay U.S. tax on the net profits in excess of the FEIE. You will be unable to retain earnings in a corporation, meaning all net profits will be taxable in the year earned. Let's assume your business has zero expenses (which would be awesome, right?), and you get to take the full FEIE. Your net profit is US$400,000, reduced by the FEIE for both husband and wife, or US$195,200. This leaves US$204,800 available to the IRS. If you were using a corporation, however, these earnings could qualify to be retained by the company and not be taxed until distributed. This is a big deal.Finally, to add insult to injury, that US$204,800 would be taxed at the highest rate available. Since Jan. 1, 2006, when the Tax Increase Prevention and Reconciliation Act of 2005 came into effect, those claiming the Foreign Earned Income Exclusion have been paying at the tax rates that would have applied had they not claimed the exclusion. That means that, instead of having your income taxed starting at the lowest rate (around 10%), most expatriates are taxed starting at the 25%+ tax bracket.Christian ReevesEditor's Note: Strategies and opportunities for minimizing your tax burden as an entrepreneur overseas will be one important topic of discussion at theOffshore Summit we're planning to take place in Panama City in November. We'll begin taking registration for this important event tomorrow. However, you have 24 hours remaining to get your name on the pre-registration list for special discounts and VIP attendee status. Do that here now.
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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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