I’m a U.S. accountant who works with Americans who live abroad, ask me anything!

Hi everyone,

If you have a U.S. tax question or would like some U.S. tax insight on your business/structure, ask away!

I have been preparing tax returns for US citizens abroad since 2012. I can answer any question in US tax with an international flavor. I operate 1040abroad.com and I have maintained a blog at taxsamurai.com

I look forward to answering all your questions. And if you are in Ho Chi Minh City in December, let’s meet !!!

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Thanks, I have a question… how does the Foreign Income Exclusion work when you have your offshore business… if FIE for people working in a job overseas… or is the first 98k plus or so exempt from your businesses taxes?

Thanks.

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Hi travelguyny,

The FEIE can be applied to both self-employment income and wages. if you happen to work thru a foreign corporation (your own corporation), I would advise you to pay yourself a salary.
Please specify what you mean by “business”: self-employed? A US corporation? or a foreign corporation?

Best,
The Tax Samurai

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I mean by a corporation you setup somewhere else… Hong Kong, Singapore, Caribbean islands… and it is registered in your name… I haven’t tried to do anything with it… hell with FACTA i’m having a hard time opening a bank account anywhere outside the U.S.

This is also about the FEIE. How and how strictly does the IRS enforce the 330 days in another country rule? What’s your experience with clients being audited for claiming the FEIE?

@travelguyny:
Yes, you would create the foreign company and the foreign company would then pay you the net income in the form of wages , so as to avoid Subpart F issues (undistributed earnings in a foreign corporation, for now let’s just say that you want to avoid that).
The wages you would receive can then be excluded under the FEIE. Also, such a setup would allow you to avoid Social Security taxes (as I discussed in Do US citizens living outside the US have to pay into the US Social Security System? & Should a digital nomad, or other self-employed US citizen working abroad, pay social security taxes? - but watch out for lack of SS benefits comes retirement time.

@digimon:
If you can’t convince the IRS that you were in a foreign country for the 330 days, you would lose the audit.
On the audits I’ve been, we had a nice stack of documentation to substantiate the time spent in a foreign country, and the agent was convinced without going thru all of it.
But you want to document your time in a foreign country and you want your trips to match the information the IRS already has (hint: the airlines share this info to Homeland Security, Homeland Security can then share it with the IRS).

That’s an audit you don’t want to lose, the income would become taxable at regular rates, so we’re talking about at least $20k

Thanks opwagner! I’m just wondering because I might be cutting it close to the requirement. How common are audits on this? I’m guessing like other audits they’re more likely to target those with higher incomes?

Hi digimon,
I can not advise you on illegal strategies nor can I comment on the “audit lottery”. What I will tell you is that to qualify for the physical presence test, you need to spend 330 days in a foreign country during a 12 month period. This 12 month period can be any 12 month period, starting any day. Also, you can have overlapping periods from one tax return to the one used the following year.
I would invite you to give me your exact days in and out of the US in 2014 & 2015 either here or by email to [email protected] and I’ll let you know if you qualify for FEIE under the physical presence test.
Of course, if you are a permanent resident in a country and would be liable for income tax there, you can use the bona fide residence test even if you spent more than 35 days in the US.

Hey @opwagner — I am a US Resident Alien, living in CA (renting) for three years, married to a US Citizen from MI where we rented prior to that. If we were to travel we would obviously be better off ‘residing’ in MI, where my in-laws live, or even in NV where we have friends and possibility of at least a mailing address… Since we do not own a house and won’t actually be living in any of those states. We would probably pack up from CA with little intention of returning. Do you have any suggestions for making the transition and subsequently filing with the IRS? We would be leaving pretty much in the middle of the tax year.

Hi @rickydazla,
While it would be best to move to a no income tax state (cut your ties with CA, then get a mailing address, register to vote, get a driving license in that state), you can still avoid taxation in CA if you meet their safe-harbor rule (see page 3 in Publication 1031) to be “considered a nonresident” even if you are a resident).
That’s nice but that only affects state taxation, it won’t affect the filing with the IRS (except that if you put a CA address on the 1040, the FTB could use that as an indication that you’re a resident).

When it comes to the IRS, and assuming that you won’t pay enough taxes to a foreign country to make the Foreign Tax Credit worthwhile, you will make sure that you qualify for the Foreign Earned Income Exclusion (FEIE) to exclude earned income (wages and similar) from taxation - basic rule is that you have to be in a foreign country for 330 days out of a 12 month period. If you leave mid-year, you won’t have met that requirement comes June 15 (you get an automatic 2 month extension for being outside the US on April 15), you would therefore have to request an extension in order to file your 1040 and qualify for the FEIE.
It’s any 12 month period - July 12 N thru July 11 N+1 would be one such 12 month period.

What kind of documentation? I would assume that my passport, with it’s exit and entry stamps would work, but also bank statements with charges in other countries, airline/hotel/airbnb reservations, etc.? It’s something I’ve not really seen addressed too much.

@wanderingdev Yes, passport stamps to start, copies of plane tickets (or better boarding passes) would come next, then any receipt that required you being present (credit card receipts). I would keep passport stamps and photos/scans of boarding passes specifically for that purpose. Then, in case of an audit, you might find that some of the docs for your business expenses also serve that purpose, so you can supplement with that.

so photos would work? no way am I carrying around all that paper. I’d run out of space in my bag.

Yes, legible photos taken with your smart phone would work. If you can, an actual scan with a flat scanner would beat that, however.

You really only need to substantiate the position you took in your tax return. In theory, you can skip the whole thing and have your 8 closest friends testify as to where you were ; won’t fly with the IRS, but might well fly with the tax court. That’s the Cohan rule.

Bottom line: you need to substantiate your position, and legible smart phone photos will do.

While the self employed can still use the FEIE they still have the SE tax to deal with right?

I haven’t seen a way to eliminate that without setting up a legal business entity and advising my clients to now pay my foreign entity. But there are trade offs to running a foreign business entity like filling and reporting costs opposed to the US qualified joint partnership that we currently use, as my spouse and I are able to maximize individual 401k plans plus the traditional IRA contributions to reduce our taxable income to only owing the SE tax, which can’t be reduced.

The SE tax is calculated on the total income before the FEIE correct?

I could be wrong, but if we are operating a foreign legal entity I don’t think we can contribute as much to retirement accounts to reduce tax burden, right? But there might be other ways to get that money tax free, like through the FEIE and taking it as salary. I guess that all depends on the the jurisdiction of the foreign entity, if it’s in a no tax country for foreign income, and the earnings are passed through on the salary if under the FEIE limit right?

I feel like I come across as whining when I try to understand how to reduce my tax rate from around 12% of gross, since many have a greater tax burden.

We are in a no income tax state, so we only have US Federal income to deal with. For us, it’s still a larger number than we’d like to pay, that we’d like to ultimately reduce or redirect without having to drop US citizenship and still have social security earnings reported and submitted (secondary goal). It’s the only system we qualify for and we do not have earnings or a pension in another system or country.

Without specific values I know it’s hard to understand, but our federal income tax (currently only SE tax) burden is our largest expense, annually. Out of these four expenses making a 100% pie chart, our family health care is 25%, housing 35% (mortgage 22% + property tax 12%), federal income tax is 40%. We have other expenses, but those are our most expensive and the others will not change dramatically if we relocate to Europe.

So here is the scenario and a long way to get to a question I guess.

Conditions

  1. (Same housing costs) If we (US/EU dual citizens) were renting/living in Europe, our desired location our housing costs would be about the same, as we were successful with that budget for a 5 month trial in 2014 when the EUR to USD was much more expensive.
  2. (Recovery of 40% - SE Tax) If we are not considered a tax resident in any country (not staying put for more than 90 days in most instances).
  3. (Recovery of 40% - SE Tax) If we setup a legal business entity in a low reporting, low/no tax haven.
  4. (Recovery of 40% - SE Tax) If we are claiming the FEIE from income from our foreign entity that has no tax burden.
  5. (Recovery of 12% - Property Tax) If we sold our property here, we save the property tax too.
  6. (Recovery of 25% - healthcare insurance) If we are covered on our EU healthcare we’d recover that expense as well.

Although the down side:
D1. No taxable income reported for the social security pension
D2. My clients would have to start paying a foreign entity. Not sure how to mitigate that.

Q1>> We’d essentially have the savings from the federal income/SE Tax and no tax burden?

Q2>> Is that a legal and viable tax strategy?

If that is legal and viable, I guess it would make sense to see what those savings would total and start crunching numbers. Here is my quick math.

How much would you have to save yourself if you decided to abandon the SS system, and to match the projected social security pension of ~$2200/mo (at full retirement age 67 for me) with a pension/annuity, if earnings continue this way for the next 25+ years since all of our credits have long been earned?

It seems that an annuity earning 2% annually and paid out over 30 years (at age 67 for SS full retirement age for full payout amount - 97) at a monthly rate of ~$2200, you’d need to fund it with $600,000. Of course you don’t need to use the annuity vehicle and have this invested in a diversified brokerage account of laddered CDs for deflation protection/minimal growth % where you could limit/throttle the withdrawls if you are self controlled and able.

In this scenario, it would take less than 12 years at current earnings without any interest to save from just these recovery items (SE tax, property tax, healthcare expenses), 24 years if setting this up for my spouse as well. I am 25+ years away from being retirement age qualified, my wife 35+ years away. So it seems like it might make sense. Comments? What am I missing in this quick run down?
I think there is a risk and FUD that our SS earnings would dip and our projected SS payouts would drop and it is not guaranteed by the government to be there, etc…

What happens to your SS if you stop contributing 25+ years before being able to pull benefits?

Does it just get forfeited or do you still get something, just minimal?

Are there US citizens doing something like this in Europe?
Instead of paying into the US SS system, but setting up their own system, to complement the standard 401k/IRA retirement savings plans?

You did say to ask you anything. :wink: TIA

EDIT: Sorry - my calculations of SS payouts were wrong. I wrote ~$1300/mo but the SSA.gov site shows me ~$2200/mo at age 67.
I changed annuity value required from 350,000 to 600,000 and ROI from 8 years to 12 years for me, and 24 years for me and my spouse to save the value required for that annuity versus paying into the SS system.
Other logic errors or shortsightedness?

@mule5: My clients based in Europe don’t move that much and contribute into the social security system of their country. As such, they use the totalization agreement to avoid paying self-employment tax.
I am actually in a similar situation (albeit that I am currently in Thailand, and as such not covered by a totalization agreement). I came to the conclusion that if I was to sign out of the US system for 5-10 years, I would not get much benefits and the remaining contributions would be essentially lost. To make matters worse, provided legislation remains unchanged, I would be entitled to 50% of my future ex-wife’s benefits. And my compliance cost would be less (I would do my 5471 myself). If you don’t pay tax, you don’t need a 401k/IRA since you wouldn’t have to deduct it against.

I wrote a general post on self-employment tax (but you seem to have it covered): http://www.taxsamurai.com/index.php/2015/09/03/do-us-citizens-living-outside-the-us-have-to-pay-ss-tax/
This one covers this situation http://www.taxsamurai.com/index.php/2015/09/04/should-a-digital-nomad-or-other-self-employed-us-citizen-working-abroad-pay-social-security-taxes/

Also, I apologize, it seems that you did more computations, looking into the Social Security side of it. I wouldn’t get too much into it since there is so much time to go - legislation will get passed (probably reducing Social Security benefits), financial situation will change (interest rates on which annuities are based…)

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Hi, @opwagner thanks for the AMA!

I am a solo-preneur with a Minnesota based S-Corp. I don’t have a spouse, dependents, or employees. I have been travelling outside the US since Jan 1, 2015 and will qualify for the FEIE based on the physical presence test.

I am wondering about state taxes for 2015. Basically, do I pay them? I won’t have a physical residence in the state apart from ~20 days this year, but my S-Corp has been registered in MN since 2010. I also own a condo (with mortgage) that is being rented out and is not homesteaded.

If I am required to file/pay taxes, would you recommend setting up an entity (LLC, S-Corp, etc.) in an income tax-free state? Any states in particular ideal for digital nomads? I am 100% location independent at this point and will probably be nomadic without a permanent home-base for the foreseeable future (1 to 5 years) so it would be good to avoid the $1,000s of state taxes since I’m not getting much for them being out the country! Thanks in advance.

@Chuck_Anderson : While it is best to be a resident of a no income tax state (and I would recommend Florida), states have exclusions so that you would not have to pay taxes there. In the case of MN, it is basing that on the Foreign Earned Income Exclusion.


Taxpayers who earn income in a foreign country may qualify for
the federal foreign earned income exclusion. If taxpayers qualify
for the exclusion and do not include the foreign earned income on
their federal return, this income will not be taxed by Minnesota.
Minnesota residents who earn income in a foreign country may
treat that income as nonresident income as long as they meet
both of the following conditions:

  1. Their tax home is in a foreign country and they were
    either:
    a bona fide resident of a foreign country for an
    entire tax year. or
    were physically present in a foreign country for at
    least 330 full days during any 12-month period.
  2. If they owned homesteaded property in Minnesota, they
    notified the county to revoke homestead status within
    three months of moving out of the country and the property
    remained nonhomesteaded during their absence.

Taxpayers who qualify for the federal foreign income exclusion:
Must use the nonresidency rules to determine whether
income received must be assigned to Minnesota. For
example, interest received while the taxpayer was
overseas is not taxed by Minnesota because the person is
considered a nonresident.
Are only required to file a Minnesota return if they have
Minnesota sources of income that exceed the
part-year/nonresident filing requirement level for the tax
year.

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