How to Maximize the Value of the Foreign Earned Income Exclusion

In a year that started with more than 4,400 Americans renouncing their citizenship and the nation being more politically divided than ever, great things are ahead for Americans who decided to move themselves and their businesses to another country. In 2018 the Foreign Earned Income Exclusion will increase from $102,100 in 2017 to $104,100.

Here’s how you can take advantage of this increase and maximize the value of the Foreign Earned Income Exclusion .

The first thing you need to do is move to a country that will grant you an easy and fast residency. The most important component in selecting your country of residency is to find one that won’t tax your worldwide income. If you’re going to make the jump, no need to land in a high tax jurisdiction.

There are many options but the one that stands out is Panama. Panama only requires you to make a $20,000 investment in an approved reforestation project and you get immediate residency. This program also covers your wife and your dependent children 18 and under.

If you’ve got the cash, and want to live in the European Union, consider Portugal. You can get residency with a deposit of 1 million euros in a local bank or by purchasing real estate worth more than 500,000 euros. Living tax free in the EU is more complex than Panama, but it can be done if you don’t spend more than 180 days in any one country.

The next thing you need to do is cut most of your ties with the United States. Visit the country for personal reasons and never overstay your welcome, sell your house and every other business with your name on it. Stay in the United States for one more day than the predetermined 183 and you will lose your FEIE and all your money will be taxable by the United States.

If you’re operating a business, close your US corporations and open new ones offshore. These offshore structures should be set up in a tax free zone to minimize worldwide taxation and thus maximize the value of the Foreign Earned Income Exclusion.

Your offshore corporation will be reported to the US IRS on Form 5471 and your salary from this business on Form 2555. Also, you’ll probably need to report your foreign bank account to the US treasury.

As you’re leaving the United States, you should become more and more involved in your new country country of residency. Donate to local charities, hire local workers, and generally become a valued member of the community.

How much time you’re required to spend in each country will depend on your Visa. For example, Panama and Portugal don’t have physical presence requirements. I suggest you spend a few weeks a year in these countries to keep up appearances. On the other hand, Nicaragua requires you spend at least 180 days a year in country.

The Foreign Earned Income Exclusion only covers $104,100 of your income in 2018 – each dollar more will be taxed. For example, if you made $200,000, $95,900 is subject to US taxes. It is highly recommended to set up a salary that nears that amount and invest any other remaining amount into the company.

• The FEIE applies to your salary. It does not apply to capital gains earned while abroad. In most cases, US citizens are taxed by the IRS on their passive income just as if they were living in America.

Remember that you don’t need to pay yourself a salary. You can earn money in your offshore corporation, pay yourself a salary of $100,000, and hold the rest inside the corporation as retained earnings. These profits will only be taxed in the US when you take them out of the corporation as a dividend or other payment not covered by the FEIE.

One way that you can double your Foreign Earned Income Exclusion is by hiring your spouse to work for the company. If both are working in the business, and each can reasonably draw a salary of $100,000, you can take out $200,000 in salary tax free… and retain any excess in the corporation tax deferred.

And he or she doesn’t necessarily need to be your spouse. They can be your partner or significant other. If they’re a US citizen, they must qualify for the FEIE. If they’re not a US person, then the only requirement is that the salary must be reasonable (an ordinary and necessary business expense).  

Such a person needs to have a job and a function in the company and needs to be earning a reasonable salary based on that position. There needs to be concrete evidence that they work for the company (time records, etc.).

As I said above, the key to the Foreign Earned Income Exclusion in 2018 is qualifying for residency in a foreign country. If you select a business friendly and efficient jurisdiction, you will maximize the value of the Exclusion.

Once you have your residency, setup an offshore corporation and draw a salary from that entity. This will allow you retain earnings in excess of the Exclusion. You don’t want an LLC, you need a corporation.

The Foreign Earned Income Exclusion is a complicated topic and this article only covers the basics of how it works for more information, or for assistance with residency in Portugal or Panama, please contact us at [email protected] or call us at (619) 550-2743. We’ll be happy to assist you with your international tax plan and support you through the coming changes.

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