Q&A on Living in Panama Tax-Free
“I have learned so much from your newsletter, and now I have a question.
“I read that Panama is an offshore investment haven and that I could live in this country tax free, but I am confused. If I relocate to Panama and run a local business or an Internet business, does that mean I pay no Panama taxes or no income taxes at all, including in the United States?”
— Doug H., United States
Yes, you could live in Panama tax-free, even as a U.S. citizen (that is to say, paying no income tax either in Panama or in the United States). However, some work and preparation are required. You have to set yourself up properly.
If you’re retired, you won’t pay taxes on retirement income you bring into Panama or on any dividends or interest income earned outside the country. You would still pay taxes in the United States on the dividends and interest income, and, depending on the source of the retirement income, you’d pay the same tax to the IRS as you would if you lived in the States (although, if you live in a state that taxes retirement income, you’d avoid that tax by moving to Panama).
To live completely income tax free in Panama as a U.S. citizen, you must have a business generating earned income for you as an individual and that income must be derived from outside Panama. Panama taxes residents on income earned in the country only, so your non-Panama business would pay no taxes in Panama, and assuming it is a business where you can legitimately claim that you are earning your income outside the country, your individual income wouldn’t be taxed there. Typically, this means a consulting or an Internet-based business.
If you start an active business in Panama, with sales in Panama to Panama residents, then that income would be taxable in Panama, as would any related personal compensation you receive.
In either case, your salary up to the annual Foreign Earned Income Exclusion limit (US$101,300 for 2016) can be excluded for U.S. income tax purposes. The key is that it be truly earned income.
“Kathleen, I subscribe to your Panama newsletter and receive a lot of great information, and I have been to Panama a few times already.
“I plan to move to Panama in the next two years or sooner. My wife will be retired, and we will use her pension to qualify for the pensionado visa. I plan to continue working and will receive a salary from the United States. Can I set up an offshore company and avoid U.S. state taxes and still continue to pay Social Security? Can you advise? Thank you.”
–Bernard R., United States
Resident offshore guru Lief Simon replies:
When you set up an offshore company that receives payments from your clients and then pays you a salary…and the work you do is outside of the United States (the clients can be in the United States, but the actual work has to be done outside the country), then you could qualify for the Foreign Earned Income Exclusion (FEIE) and pay no tax (neither federal nor state) on your earned income up to US$101,300 (for 2016).
To answer your specific question, assuming this set-up, the offshore company wouldn’t be required to pay Social Security taxes on the salary it pays you and neither would you.
If you’re looking to continue to pay into Social Security to boost your eventual payout from the system, you could simply take the income from your clients directly and file your U.S. taxes each year as a sole proprietor on Form 1040 Schedule C. However, without going into too much detail, that means you’d lose some of your FEIE.