It sounds tempting. Move your business to another country and avoid US taxes. But, is it legal?
Like so many other instances in tax planning, the real answer is “it depends.” You may have heard that US citizens are taxed on worldwide income. Most of the time that is true. The default answer for “Is it subject to US tax?” is usually “yes.” There are two main exceptions that may be applicable for you if you have an online business.
First, if you live outside the US for most of the year, you can exclude a big part of your income. This is known as the foreign income exclusion.
Second, if you have income from a business that is owned by a foreign entity and the income is not brought back to the US, you may be able to avoid US taxes on that foreign income.
Let’s start with the foreign income exclusion. In order for this to apply you need a couple of things:
(1) You must be a qualified foreign income recipient. That means one of the following three is true:
- A US citizen who is a bona fide resident of a foreign country or countries that includes an entire tax year,
- A US resident alien who is a citizen or national of a country with which the US has a tax treaty and is a bona fide resident of a foreign country or countries that includes an entire tax year, or
- A US citizen or US resident alien who is physically present in a foreign country or countries for at least 330 full days during 12 consecutive months.
(2) You must have foreign earned income. You can qualify with this either as an employee of a foreign company or by being self-employed.
If you’ve got an online business, it’s pretty easy to qualify for this as long as you are out of the country for the required number of days.
The foreign income exclusion amount for 2013 is $97,600 per person. If you’re married, both working and file jointly, you can exclude up to a total of $195,200.
Plus, you can get a qualified housing exemption for up to 30% of the foreign income exclusion. That is $29,280! The actual amount varies based on where your foreign home is and the number of qualifying days you actually have.
One of the biggest advantages for online business owners is that you can make money anywhere. And if you set up shop in another country, you may slash your taxes at the same time.
There are also some strategies you can use to maximize the deduction if you qualify as a foreign income recipient under the 3rd definition. Using this definition, you select any consecutive 12 month period for the requisite 330 days. So, you may have multiple calendar, tax years may be involved. If you have just a few qualifying periods, you may need to pro-rate the amount of the exclusion. Make sure your tax preparer is up to date on the special advantages for the foreign income exclusion. You could save big-time on taxes!
In the next article, we’ll look at how to strategically use the second income tax exclusion, foreign entity exclusion, to pay little to no taxes.
It’s your money. Keep more of it. You can find more real-life tax busting strategies by Diane Kennedy, CPA/Tax Strategist at her website http://www.USTaxAid.com. Diane and her husband lived outside the US for five years and, to this day, continue to run foreign businesses. When it comes to taxes, the more you know, the less you’ll pay.