Dateline: Belgrade, Serbia
In the past few months, I’ve taken on more former US citizens, soon-to-be-former US citizens, and overpaying US citizens than usual.
These experiences have been very fulfilling for me as I’ve been able to help these folks create legal strategies to maximize their benefits.
However, I have also come across more US expat tax myths than usual – some saying that you can’t save on tax when you’re offshore and others saying just how easy it is.
Both of those simply aren’t true.
The people seeking my help are busy entrepreneurs who may have read blogs or seen news articles about expat tax issues and renunciation, but might have never actually sat down with someone to go over all their questions.
So, in this article, I want to address some of the most popular expat tax myths surrounding citizenship-based taxation, digital nomads, and renunciants from the United States that just won’t die.
And if you’re going to take away just one thing from this article, it should be this: offshore tax is more complicated than just domestic tax and it’s definitely more work, but if you’re a seven- or eight-figure entrepreneur, that extra work is well worth it.[embedded content] [embedded content]
MYTH #1: YOU CAN’T REDUCE TAXES IF YOU GO OFFSHORE
New laws come into effect all the time and that’s what this myth builds upon.
Some ‘advisors’ say that because of the way American taxation law works now, there is no benefit to going offshore.
“Sure,” they say. “You could save yourself as much as the Foreign Earned Income Exclusion (FEIE) allows that year, but if you’re making any kind of serious money, you won’t be able to save much or anything at all.”
I’m here to tell you that’s false.
Now, let’s talk about what is true: with proper planning, you can reduce your taxes legally if you go offshore.
Sure, the US tax system is unique as it’s one of the very few in the world that uses citizenship-based taxation.
No matter where you are in the world, no matter where you reside, you’re subject to US tax laws.
That doesn’t mean that you will always have to pay a full load of taxes. Most of the seven and eight-figure entrepreneurs that we consult are paying something, but not necessarily the full boat.
There is still an opportunity for substantial savings for Americans, even with the current tax laws that aren’t always that favorable to people offshore.
MYTH #2: YOU’LL HAVE TO RENOUNCE YOUR US CITIZENSHIP
Most people seem to think that Americans can no longer save money on taxes by going offshore unless they renounce their US citizenship.
I recently spoke with an entrepreneur who had been living outside of the United States for the last four years but was still paying a decent chunk in US income taxes every year.
He seemed astonished that people are able to retain US citizenship and yet still reduce their tax. Basically, he wanted to know how to do the same.
This entrepreneur, who was also entitled to Canadian citizenship through his mother, was weighing the idea of renouncing US citizenship in order to save on taxes.
However, as is so often the case, his US tax advisor was totally clueless as to the many expat tax strategies available to Americans living overseas and had not advised his client.
Instead, this entrepreneur had overpaid on tax by an amount well into the six figures.
Let this sink in: if you’re a US citizen entrepreneur living overseas (or willing to live overseas), chances are you can substantially reduce your US tax bill to much lower than it is now.
There’s even a good chance you could pay zero.
For a few years in a row, I gladly paid zero dollars and zero cents in US taxes; that’s $0 in federal income tax, $0 in state income tax, and $0 to Social Security and Medicare.
The main challenge with basing your offshore strategy on what you read in the media is that you’ll probably make mistakes.
While the news has indeed been buzzing with record numbers of Americans renouncing their citizenship, allegedly for tax reasons, the truth is that 90% of entrepreneurs I’ve met do NOT need to renounce US citizenship to enjoy lower tax rates.
And they can do it legally.
The biggest issue I see with entrepreneurs who think they need to renounce: their company is still based in the United States.
By using a US legal entity, even a small business with most of its workforce offshore will leave the owner with tens of thousands of dollars in Social Security and Medicare taxes, in addition to corporate tax if the business is a C Corporation.
I’ve saved more than one person from giving up their US citizenship merely by moving their company to an offshore jurisdiction and structuring their pay properly.
MYTH #3: YOU’LL NEED A COMPLICATED OFFSHORE STRUCTURE
Once you decide to move your business offshore, an endless array of options await.
Should you form a Hong Kong company, or a BVI company, or a Belize company, or a Marshall Islands company?
Should you be like the “cool kid” digital nomads who are raving about Estonia right now?
Just figuring out which country to be based in is a challenge. Moreover, the wrong decision could lead to unforeseen consequences.
For example, while Estonia companies are often touted as “tax-free”, they are only tax-free until you take money out… And then it’s 20% that you must pay.
So, if you buy into the hype from people promoting Estonia, you could cost yourself tens if not hundreds of thousands of dollars.
Be cautious: choosing an overly simple structure could be a mistake. After all, the easiest things to get into are sometimes the hardest to get out of.
However, creating an overly complicated structure can also be a big mistake.
Chances are you don’t need two Nevis IBCs, each owned by a Belize IBC, in turn, owned by a Panama foundation in order to minimize tax.
In fact, these types of complicated structures can often cause problems for US citizen taxpayers. Scour the offshore blogosphere and you’ll no doubt find plenty of promoters offering these “stacked structures”.
In most cases, these stacked structures do nothing but incur a lot of annual maintenance costs as the “beast” that is this mass of companies needs to be fed, from statutory agent fees to registry renewal fees.
Some of these promoters are US citizens themselves and should know better, yet hide behind fake names and stock photos. Many others are simply ignorant and don’t understand US tax law.
This is why it’s so important to create the simplest structure possible that would get the job of lowering your tax done. Extra layers of complication could cause problems with the IRS.
That’s because some of the holding company structures involving stuff like billing and intellectual property could be classified as Subpart F income under US tax law.
For example, a Belgian friend of mine recently told me how he sold his domains to an offshore company that collected “rent” for his low-tax onshore company. In addition to inviting an audit in the onshore jurisdiction, his offshore company would be required to pay tax if owned by a US citizen.
Sadly, US citizens must follow their own set of rules that most offshore company formation services don’t understand.
MYTH #4: YOU CAN’T HOLD US ASSETS IF YOU CLAIM AN EXPAT TAX EXEMPTION
While Americans are often well-aware of their never-ending filing requirements based on citizenship and not residency, US citizens do have a few privileges that others do not.
As there is technically no process for becoming a “tax non-resident” of the United States, anyone can hold US bank accounts without creating a US tax nexus… even US citizens.
While Australians, Canadians, and Brits, in particular, are usually well-advised to move their banking offshore, Americans can continue to bank in their home country.
US citizens can also own US real estate, including homes for their own use.
In general, the US tax system for expats is based less on “intent” and more on “physical presence” compared to other developed countries.
This means that as long as your physical presence is mostly outside of the United States, and in some cases inside another country, you can continue to hold US assets like bank accounts and property.
The same principle is true for those renouncing US citizenship.
I was recently engaged by a gentleman who intends to renounce US citizenship because he is an investor and cannot enjoy the same tax breaks that entrepreneurs do.
He told me that he wanted to renounce as quickly as possible, but that he was afraid it would take too long to sell his US real estate. I informed him that there was no need to sell his US property because doing so was not a requirement for renunciation.
In fact, every single former US citizen I’ve worked with still maintains US bank accounts and credit cards, and several still own property there.
While US citizens enjoy special tax breaks when selling real estate, there is absolutely nothing prohibiting non-citizens from doing business in the United States. Quite the contrary, actually.
The US is home to plenty of foreign investment and you can continue to invest there even if you give up your stateside nationality.
After all, the United States is the world’s largest tax haven and it certainly wouldn’t be if every Chinese guy with a bank account in New York had to pay US taxes.
MYTH #5: US PERSONS CANNOT OPEN OFFSHORE BANK ACCOUNTS
In the FATCA era, some people believe that US persons cannot open bank accounts offshore.
And, of course, I’m here to tell you that this is not true.
It’s a myth that is often used by people in this business who want to make offshore sound super scary and difficult.
It’s also used by the people who love to diss the US government. And I agree with parts of it – citizenship-based taxation and FATCA are certainly unfair, but it is what it is.
Instead, I recommend going where you’re treated best, which means that you need to find the best way to legally make your own path.
And rest assured that there are plenty of banks that will accept US citizens.
Banks in Switzerland and Liechtenstein and a number of other places (mostly in the EU) won’t take US citizens, but there are plenty of banks that will, especially banks in emerging countries.
Even banks in places like Singapore will take on new American clients.
Sometimes, they will limit the activities you can do. For example, you won’t be able to open a full-throttle investment account or you won’t be able to hold certain insurance products.
You might just be able to open a generic savings account or run-of-the-mill transactional account. But you’ll still have plenty of options in many different countries.
Here at Nomad Capitalist, we can help as we keep a list of over a thousand banks that will take American clients, which we update regularly.
After all, going where you’re treated best does not mean crying over the ones that won’t take you.
It simply means finding the ones that will.
MYTH #6: YOU DON’T NEED TO FILE TAXES IF YOU LIVE OVERSEAS
I’ve often spoken about the “Nomad Tax Trap”, which references how many digital nomads have simply left their home countries without so much as filing a departure form and expect to never be taxed as they roam the globe.
For citizens of many countries, this could lead to an audit and possible tax due.
US citizens are required to file a tax return annually, no matter where they live.
This includes all of their worldwide income, all of their assets, and things like bank accounts overseas. You’ll have to report all that and will be liable for any tax that might be due.
This is the single biggest downside of being an American – citizenship-based taxation.
For example, if you are from the United States but live in tax-free Monaco and have an investment property in Dubai that generates rental income, Dubai and Monaco may not tax you but the United States certainly will.
This myth is also a major point of confusion when it comes to renouncing US citizenship. Just getting up and leaving isn’t enough to sever your ties with the system. You will need to officially renounce, which includes reporting all of your assets (worldwide) on Form 8854 – the expatriation return.
Basically, the IRS wants to get all up in your business before you get out of their ‘system.’
But back to filing the annual tax.
You’re definitely going to want a tax preparer to help you, especially if you want to claim the Foreign Earned Income Exclusion (FEIE).
It’s important to note that some people believe that they don’t need to file a tax return if they claim the FEIE and don’t owe any tax. But really, you need to specifically claim the FEIE on your tax return.
If you don’t and then come back a few years later saying that you meant to claim it, that may not work. The IRS certainly won’t always entertain such requests.
So, let me repeat, even if you don’t owe anything, you will still have to file.
MYTH #7: YOU HAVE TO LIVE IN ONE PLACE OVERSEAS
This is yet another expat tax myth that is also untrue.
Here’s how it really works: the easiest way for a US citizen to claim a tax exemption on his or her income is to spend the vast majority of their time outside of the United States.
It doesn’t matter where, as long as it is outside of the US.
Even though I do have homes in foreign countries and bona fide connections to another country or countries, my total absence from the United States for three years led me to claim the easiest exemption possible: the Physical Presence Test.
By merely being out of the United States, I qualified for a healthy exemption on earned income, and by structuring my businesses properly, I could legally pay zero in tax.
While it’s possible to get a few extra perks by having a single “bona fide residence” in a foreign country and live there most of the time, I’ve found that most US expats don’t want or need those extra perks.
In fact, the United States is one of the friendlier developed countries for digital nomads.
As draconian as US tax law is, you don’t need to prove your intent to leave the country or pass a tax domicile test as in other developed countries.
All you need to do is be physically located somewhere else.
MYTH #8: YOU CAN’T FIX EXPAT TAX ERRORS
You may understand that, as a US citizen, you may qualify for tax breaks such as the Foreign Earned Income Exemption.
But, for the reasons listed above and many others too, expats and nomads often assume that they don’t qualify for the tax exemptions available.
Recently, someone who had spent the vast majority of their time living in Europe came to me seeking help reducing his taxes. In 2018 alone, he paid nearly $80,000 in US taxes even though he lived overseas.
The worst part was that he didn’t owe anything; he paid $80,000 more than was legally required.
And, as you might know, the IRS does not police tax returns for taxpayer overpayments. You will have to proactively seek to fix your own tax errors not to leave any of your money on the table.
This is why I always recommend working with an expat-focused US tax preparer. Not only do you need someone knowledgeable in US tax law to create your offshore structure but also someone knowledgeable in international tax to file your annual returns.
We have a whole network of expat-focused tax preparers available to Nomad Capitalist clients.
And in case you’re still not convinced, I’ve mentioned before how my US accountant fought me for the first year when I tried to claim the Foreign Earned Income Exemption.
Even though my accountant was from a highly reputable firm, he had no experience with expat tax and wrongly believed that I didn’t qualify for the exemption, even though I spent very little time in the United States that year.
Had I not literally read him the law, I would have paid a lot of unnecessary taxes.
The good news is that if you’ve made this mistake, there is still hope. It is possible to amend past tax returns, especially if you have overpaid.
A good accountant can review your past returns and find any errors or overpayments that can be corrected. Depending on how you filed and paid, the IRS may have to issue you a paper check in the mail, but you will get any overpayments refunded eventually.
Myth #9: THE IRS IS OUT TO GET YOU
The IRS is an organization that’s often feared, especially when it comes to ‘non-standard’ situations such as offshoring and expat tax.
If you’re doing things properly to begin with – if you have the right structure in place and have set up your affairs properly – you have nothing to worry about.
What should you do if they contact you? Freak out and run for the hills?
Certainly not. It’s not the end of the world if you get asked any questions.
Most often, it’s just a matter of explaining some part of your business or personal affairs.
I recommend getting a memorandum explaining the structure that you’ve set up or the way you’ve structured your offshore affairs.
Get some help with it and get it all in writing, then keep it safe in your files if it’s ever called upon.
Sure, it’s going to cost you a little more to have the proper tax professionals to get everything done right for you, but it’s definitely worth it.
Imagine getting that knock on the door and then simply having to say: “Here is what I’m doing and why I’m doing it.”
It will sometimes take additional paperwork, but the issue may just resolve itself without much fanfare.
And whatever you do, don’t just set up your business structure via cheapoffshorecompanies.ru or some other non-legitimate looking website and expect that everything will be OK.
The IRS, for one, certainly won’t love that if any issues arise.
Ready to Legally Optimize Your US Expat Taxes?
The offshore world isn’t as scary as it seems once you learn how to navigate it.
Our team has the experience to help you figure all of this out and go where you’re treated best. If you want our help, feel free to reach out.
Have you encountered any of these US tax myths? What was your experience?
Leave a comment below.