If you’re planning on living and working abroad, here’s how to use the FEIE in your offshore business. Remember that the US taxes its citizens on our worldwide income… no matter where you live, Uncle Sam wants his cut. Your first and best line of defense for business and wage income is the FEIE.
The Foreign Earned Income Exclusion (FEIE) allows an American to exclude up to $102,100 in salary from their income for tax year 2017. The FEIE doesn’t apply to passive income, dividends, rental profits, capital gains or any type of income other than salary.
That salary can come from a US corporation or an offshore corporation. If you get paid by a US corporation, you’re still liable for Social Security, Medicare, FICA, etc. Bottom line, using a domestic entity cost you (the employee) 7.5% and your employer 7.5%, for a total of 15%.
Here’s how to use the FEIE to reduce your worldwide taxes.
Above I say the FEIE covers business and wage income. Wage income is simple enough… it’s the salary you earn from your employer while working outside of the United States. That employer can be offshore or in the US. So long as you perform the work abroad, and qualify for the FEIE, you get the full exclusion.
Business income can be converted into wage income in order to qualify for the Exclusion. Run your business through an offshore corporation, draw a salary from the entity using the FEIE and reporting it on Form 2555, and pay zero tax on your first $102,100 in salary.
If a husband and wife both work in the business, they can take out over $200,000 a year tax free. For most small businesses, that’s a great deal.
How to Qualify for the FEIE
There are two ways to qualify for the FEIE. You can use the physical presence test (often referred to as the 330 day test) or the residency test.
With the physical presence test, you must be out of the US for 330 out of any 365 day period. Stay out of the country and you qualify for the exclusion, period. If you can fulfill the terms, this is the easiest way to qualify for the FEIE… it’s difficult for many to stay away that long, but easy for your tax preparer.
Two comments on the 330 day test:
The 330 day test can be used over any 365 day period. If you’re out of the U.S. from October 2017 to November 2018, you can exclude any wage income earned over that period. You’ll take a prorated FEIE on your 2017 and 2018 returns.
The 330 day test is all or nothing. If you miss 330 by even one day, you lose the entire FEIE! This test is high risk option for those who spend time in the US and push the envelope.
I’ve seen the entire exclusion lost because a flight was canceled, ill health costing you a day, returning for a death in the family, and many other reasons.
The residency test is more secure… it’s more complex to use for, but offers a level of security for your FEIE.
Basically, if you’re a resident of a foreign country for a full calendar year, you can spend 3 to 4 months in the United States a year, but never more than 183 days in any one year.
The first step in qualifying for the FEIE under the residency test is to become a legal resident of a foreign country. Residency comes with all kinds of tax and legal responsibilities, so you need to spend time to find the best residency program.
I suggest you secure residency in a country that won’t tax your foreign sourced profits and doesn’t require you spend a certain number of days in the country. A country that will tax local profits but not foreign profits.
The best countries in this category with low cost residency options are Panama and Nicaragua. For a complete list of countries with territorial tax systems, click here.
- Foreign sourced profits are those earned selling to people and companies outside of your country of residence. Local source profits are earned selling in your country (such as operating a retail store, bar, restaurant, etc). Most online businesses have only foreign sourced profits.
Panama will give you permanent residency with an investment of only $20,000 in their teak reforestation program. Nicaragua has a similar offer with an investment of $35,000. For details, please contact me at email@example.com.
Securing residency in a country that doesn’t tax your foreign sourced income (one with a territorial tax system) is the key to minimizing your worldwide taxes. There’s not much point in going offshore to escape the IRS if you end up paying about the same in taxes in your new country.
I hope you’ve found this article on how to use the FEIE in your offshore business to be helpful. For more information on this, or how to obtain residency in a country with a territorial tax system, please contact me at firstname.lastname@example.org or call us at (619) 550-2743. All consultations are free and confidential.