When planning an international structure, deciding between an offshore corporation or an offshore LLC can make a world of difference. There are significant tax differences between an offshore LLC and an offshore corporation. Here’s how to select the best offshore structure.
Note that this article is focused on foreign corporations and foreign LLCs… company structures outside of the United States. The treatment of US structures is different.
This distinction is most important if you’re thinking of setting up an “offshore” business in the US territory of Puerto Rico. For tax purposes, Puerto Rico is an offshore jurisdiction where corporate taxes are 4% for approved businesses and US Federal tax laws don’t apply to residents and Puerto Rico sourced income.
However, US corporate laws apply in Puerto Rico. Thus, a Puerto Rican LLC can elect to be treated as a corporation for US tax purposes by filing IRS Form 8832. A single member LLC in Puerto Rico is a disregarded entity and a multi-member LLC is treated as a partnership. At the same time, a corporation in Puerto Rico can’t elect to be treated as a disregarded entity.
To compare Puerto Rico to the tax benefits described below for offshore corporations, see: Panama vs. Puerto Rico.
Offshore Corporation vs Offshore LLC
In 99% of the cases, an offshore LLC will be best for the following:
- To hold an IRA account outside of the United States,
- To hold your personal investments,
- To hold real estate abroad,
- To manage advanced asset protection structures such as foreign trusts,
- To maximize privacy when forming structures in countries with public registries,
- As the most basic form of asset protection, and
- Small businesses expected to earn less than $100,000 or $200,000 a year.
Thus, an offshore corporation is best for:
- An active business operated outside of the United States with net income of more than $100,000 or $200,000,
- An foreign division of a US company or one owned by a US person living in the United States,
- A joint venture with a non-US partner operated offshore,
- As a UBIT blocker for an offshore IRA LLC, and
- To hold investment and property in countries that don’t have an LLC statute (such as Panama).
- To hold investments for the purpose of obtaining residency in Panama.
I’ll review each of these, beginning with IRA accounts in offshore LLCs.
Offshore IRA LLCs and UBIT Blockers
An offshore LLC is required if you want to take your IRA offshore. Specifically, you need a jurisdiction that allows for single member LLCs. This is because the LLC is owned by your retirement account. You’re the manager of the LLC, but the owner is your account or accounts.
Because of the complexity of forming an offshore IRA LLC, and their specific requirements, your country options are limited. I suggest you focus on Cook Islands, Belize, Nevis, and Seychelles. All of these have solid asset protection structures, single member LLC regulations, and are experienced in IRA LLC setups. For more, here’s how to take your IRA offshore in 6 steps.
If you were to incorporate an offshore corporation rather than an offshore LLC for your IRA, you would be creating a UBIT blocker corporation rather than an IRA limited liability company.
UBIT stands for Unrelated Business Income Tax. UBIT the 35% tax that you pay on income earned from leverage in your IRA account. If you buy real estate with a mortgage, you pay 35% tax on the gain attributable to that loan. If you buy stocks on margin, the same UBIT applies.
If you invest with leverage in the United States, there’s no way to avoid UBIT. If you invest abroad, you can combine an offshore IRA LLC and an offshore corporation as a UBIT blocker and pay zero in US taxes.
A UBIT blocker is an advanced tax planning tool that supports your offshore IRA LLC… but the offshore LLC is the primary holding company. You must have an LLC before integrating a UBIT blocker.
For more on offshore IRA LLCs, here’s why your IRA should be the first flag you plant offshore.
Personal Investments and Real Estate
Personal bank accounts and real estate abroad should always be held in an offshore LLC. The LLC provides anonymity and a level of protection. If you were to hold these investments in an offshore corporation rather than an offshore LLC, you might incur additional taxes in the United States.
An offshore LLC generally provides flow-through tax treatment. So your capital gains and investment returns flow out of the offshore LLC and onto your personal return with no tax at the company level. Because offshore investments are tax neutral for US persons, it’s most efficient to hold them in an offshore LLC.
That is to say, there’s no tax savings for a US resident or citizen on capital gains earned abroad. A US person pays US tax on their worldwide income no matter where earned and no matter where they live. If you’re operating a business, there are some tax benefits to being abroad. There are no tax benefits to passive investments abroad.
Note that foreign real estate held in your name might not need to be reported to the IRS. If you own property outside of the United States, don’t rent it out, and it’s titled in your name, you have no annual reporting requirements. For this reason real estate can provide privacy to Americans investing abroad.
However, if foreign real estate is held inside an offshore LLC or an offshore corporation, you need to report the entity. Both an LLC and corporation have annual filing requirements. You need to weigh the need for protection with an offshore LLC against the desire to minimize your annual tax reporting.
Manage Advanced Structures
We often use offshore LLCs to manage advanced asset protection structures. For example, a Cook Island Trust managed by a Belize Limited Liability Company.
The Cook Island trust gives you maximum protection and the offshore LLC gives you control.
The Settlor of the trust (you) sets up and funds the trust for the benefit of your heirs. You also want to control the assets of the trust, so we incorporate an LLC as the manager of the trust. You’re the owner of this management LLC.
This allows you to hold assets in a trust offshore and manage those assets for the benefit of the beneficiaries.
Offshore LLCs to Maximize Privacy
Let’s say you form a Panama Foundation and a Panama corporation. You might have a Foundation as the owner of your active business whereby the Foundation acts as both a trust and a holding company.
The owners, founders, directors and shareholders of Panama structures are public record. Panama maintains a searchable database of its structures which greatly reduces your privacy.
The founder of a Foundation and the officer(s) of a corporation can be persons or structures. So, we can use a Belize LLC as the Founder and the officer. You are the owner of the Belize LLC and the Belize LLC is the owner of the structure.
When a creditor searches the Panama database, all they see is the name of a Belize LLC. You will not appear in any public record. The only ones who know you own the structure are your lawyers and your bankers.
For more on this topic, see The Bearer Share Company Hack
Offshore LLCs for Basic Asset Protection
An offshore LLC is the most basic form of asset protection. It puts your assets behind a barrier, removes your name from the account, and provides protection from creditors.
An offshore LLC can protect your IRA, defined benefit plan, personal savings, real estate, gold held in a vault, and any assets outside of the United States. An offshore LLC is the first of defense… and often the only layer you need.
You might choose an LLC to open an international bank or brokerage account. The LLC is often the first, lowest cost, and easiest step offshore. An LLC allows you to plant a small flag offshore and get the lay of the land.
Offshore Corporation or Offshore LLC for Your Business
If you’re going to operate a business outside of the United States, you need an offshore company. You can use an offshore LLC or an offshore corporation, but you must have one or the other. To maximize the tax benefits available to foreign businesses you must operate through one of these structures.
If you’re living and working abroad, and your business will net less than $100,000 or $200,000, you can operate through an offshore LLC. An LLC is easier to report to the IRS, thus your compliance costs will be lower. See below for details.
If you’re living in the United States and operating a foreign division, or living abroad and netting more than $200,000, you need an offshore corporation and not an offshore LLC. Here’s why:
When you’re a US person operating a foreign division, your objective is to hold your foreign sourced income outside of the United States. That is, you want to hold retained earnings offshore tax deferred… paying US tax on those profits only when you distribute them to the parent company or shareholders in the US.
Only a corporation (and not an offshore LLC) is eligible to retain earnings tax deferred. In certain cases, you can file an election with the US IRS to change the status of your foreign entity. However, making the election can be complicated and many foreign structures don’t qualify for this treatment. For a list, see: Entity Classifications.
If you, the business owner, are living outside of the United States, and qualify for the Foreign Earned Income Exclusion, then you want to match your structure to the FEIE amount.
First, here’s a quick review of the FEIE. If you’re out of the United States for 330 out of 365 days, or a resident of a foreign country, you can exclude up to $102,100 in salary from your Federal income tax. That is to say, you get $100,000 tax free. If you earn more than this you’ll pay US tax on the amount over the FEIE (subject to the Foreign Tax Credit).
If a husband and wife are both living abroad, both qualify for the FEIE, and both work in the business, they can take out a combined $200,000 free of Federal income tax.
For more on how to plan your offshore business, see: Pay Zero Income Tax the Legal Way.
If your business won’t net more than the Foreign Earned Income Exclusion, you can operate through an offshore LLC. You might choose an LLC because IRS Form 8858 is much less detailed than IRS Form 5471 used for foreign corporations.
For more on reporting an offshore LLC, see: US Filing Requirements for Offshore LLCs
If your business will net more than the FEIE, or might net more than the FEIE in the next few years, you should form a corporation. You will want to retain the amount in excess of the FEIE in the corporation tax deferred.
As I said above, with an offshore corporation, if your salary exceeds the FEIE amount, you’ll pay tax in the US on the excess. You can elect to hold this excess in the corporation tax deferred and only pay tax in the United States when you take it out as a dividend.
For example, you net $300,000 in 2017. You and your spouse each take out $100,000 in salary tax free. You leave the remaining $100,000 in the corporation to be taxed only when you receive it or it’s otherwise distributed to you by the corporation.
Note that you never want to take out less than the Foreign Earned Income Exclusion. If you have the income, you always want to take out the full FEIE amount. Remember that the FEIE gets you tax free income. Retained earnings are tax deferred, which means you’ll pay Uncle Sam what he’s owed some day.
If you need to keep some cash in the business, take out up to $100,000 in salary and then lend the money to the corporation. This gets the money to you tax free and allows you to take back as a repayment of loan, also tax free.
Joint Venture in an Offshore Corporation
An offshore corporation owned by a US person or US persons is referred to as a Controlled Foreign Corporation. A US person is any US citizen, green card holder or resident. A resident is typically someone who spends 183 days a year in the United States regardless of their legal status.
A foreign joint venture is an offshore corporation that’s half owned by US persons and half by non-US persons. That is, an offshore company where a US person owns 50% or less and non-US persons own 50% or more. An offshore company where US persons own 50% or less is not a CFC for US tax purposes.
A CFC can retain some income but must pay US tax on several forms of income as earned (such as capital gains and foreign base company income). A CFC has a lot of limitations and must file US forms every year just like a US corporation. For more, see How to Eliminate Subpart F Foreign Base Company Service Income.
A joint venture avoids the most complex sections of the US tax code as applied to offshore corporations. This section, generally referred to as Subpart F, makes is difficult to retain income, other than active foreign source business income outside of the United States.
This is all to say, a joint venture in an offshore corporation has many tax benefits over a controlled foreign corporation. As the focus is the retention of income in the low tax jurisdiction, a corporation is required and not an LLC.
Offshore Corporation to Gain Residency in Panama
If you want to open a bank account or do business in Panama, you need residency. The same goes for those making multiple trips to Panama within a year. You must get residency or risk being refused entry.
You can get residency by purchasing a condo for $350,000+ or by investing $20,000 in Panama’s green initiative, the reforestation visa program.
With the reforestation visa, you form a Panama corporation, buy the teak as a business investment, and open personal and business bank accounts in the country. This gives you sufficient contacts with Panama to get residency.
If you want to invest your retirement money to buy the teak, you can form an offshore IRA LLC in Belize (or wherever) and then an offshore corporation in Panama to hold the teak. For more see: How to get Residency in Panama Using Your IRA
An offshore corporation is the best structure for large businesses, joint ventures, residency in Panama, and advanced IRA tax planning. An offshore LLC is easier to report and more efficient as a pass-through entity to hold your IRA, personal assets, or a small business earning less than the FEIE amount.
If you would like to discuss which structure is best for your situation, please contact us at firstname.lastname@example.org or call (619) 550-2743 for more information. All consultations are free and confidential. We’ll be happy to help you structure your affairs offshore.