Introduction

In today's international business environment, tax requirements and legislation are becoming increasingly complex and demanding. Tax and international business planning must be a focal point when starting, funding, and operating an international business.

The Law Office of Chris Rusch can assist by incorporating your international business, opening business, investment and/or brokerage accounts, and developing a complete international business strategy to include risk mitigation and tax savings or deferral. Our services include:
  • Plan and incorporate your international corporation and open offshore bank accounts.
  • Advise on structuring the acquisition and financing of US businesses for overseas investors.
  • Determine the most tax-efficient way to structure your foreign offices.
  • Structure the funding of your overseas business.
  • Advise on Medicare, FICA, and corporate contributions for employees of a foreign subsidiary where all of the work of the employee is done outside of the US.
  • Advise on issues affecting independent contractors working outside of the US.
  • Manage the impact of Controlled Foreign Corporations and Passive Foreign Investment regulations.
  • Support your transfer pricing policy.
  • Help you manage your effective rate of tax and assist you with timing of transactions.
  • Determine the best methods of profit extraction, including dividend policy.
  • Prepare and file all US Federal, US Treasury, and State tax and returns / forms.

Planning Issues

There are may planning options available (see Offshore Business Options and Country Guide in the right column of this page) and they depend upon your business strategy, country, and many other factors. The most common question I get is, "How can I retain earnings in my international company while remaining compliant with US law?" Yes, it is possible, but it requires a lot of upfront work to set up the business and entity correctly. I attempt to summarize the rules below.

The following applies only to those actively engaged in international business. For personal asset protection, click here. There are no legitimate tax deferral options for personal asset protection companies or trusts.

There are two major groups of US tax regulations that must be managed: 1) Controlled Foreign Corporation status and 2) Passive Foreign Investment Company rules under Sub Chapter F. The planning options below are available in countries which have a tax treaty with the US...generally not Caribbean islands.

PFIC: A foreign corporation with one or more U.S. shareholders (regardless of the % owned) is a PFIC if 75% or more of its income is passive income or if at least 50% of its assets would be invested in instruments which produce interest, dividends and/or capital gains.

The consequences to a U.S. resident or citizen of owning stock in a PFIC can be severe. Certain "excess distributions" characterized as ordinary income even if they would otherwise qualify for capital gains treatment. Moreover, tax due with respect to excess distributions or gain from the sale of PFIC stock is subject to an interest charge to reflect the deferral since the income was earned by the PFIC. In addition, shares of PFIC stock are not entitled to a Section 1014 step-up in basis at death.

Fyi…PFIC regulations were enacted by US Congress at the request of the US Mutual Fund industry who was losing business to foreign investments.

CFC: A foreign corporation is a CFC if at least 50% of either the total voting power or total value of the stock of the foreign corporation is owned by U.S. persons, each of whom owns at least 10%. Stock held by family members is grouped together for the 10% test.

The consequences to a US resident or citizen of owning stock in a CFC is that they are taxed on their share of the corporation's "Subpart F Income" whether or not this income was distributed. This includes interest, dividends, rents, royalties, and business income derived from transactions with related parties. In other words, the CFC is treated as a pass-through (like an LLC or S-Corp in the US) for passive income to limit retained earnings and a US shareholder must report these income items on their US tax return each year.

Therefore, a company must engage in investments and businesses so as to avoid being categorized as a PFIC and must be constructed to avoid CFC status if it is to retain passive income in a low tax jurisdiction.

Again, the above is a summary of the rules and an attempt to illustrate the complex nature of international planning. Please contact me for a free consultation on how your international operation can be structured to comply with the various tax treaties and the US tax code.

Compliance

Any US company, citizen or resident that has an interest in a bank account outside of the US is required to disclose the account each year to the United States Treasury on form TD F 90-22.1, Report of Foreign Bank and Financial Accounts. Failure to file this form can result in extremely severe penalties, but this is just the beginning of the compliance requirements. For more information on the risks, see my Offshore Defense page.

Some of the other basic requirements are: to file Form 5471, Information Return of US Persons with Respect to Certain Foreign Corporations, Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation Engaged in a U.S. Trade or Business, Form 5471, Information Return of U.S. Persons with Respect to Foreign Corporations, Form 8858, Information Report with respect to Foreign Disregarded Entities, Form 926 for US persons transferring property to a foreign corporation, Form 8865 for US persons transferring property to foreign trusts, and Form 3520/3520-A reports of foreign trust with US owner.

Making matters more challenging, there are a number of State and Federal laws regarding Fraudulent Conveyance that limit the transfer of money and assets out of the US. These apply when you transfer assets for less than fair market value and/or to defeat current or reasonably anticipated creditors.

With that said, the complexity of international planning is when and how much of the international businesses income is taxable in the US. Even if you choose to have your entity disregarded for US tax purposes (ie. pay tax as if the business was in the US), there are elections to make, forms to file and what would usually be taxed as capital gains might be converted to ordinary income.

Two of the major rule categories are described below. Please contact me by 619-557-0587 or by email at chris@ruschlaw.com to file your returns and keep your business in compliance with US law. Click here for the fees for preparing some of these returns.

Employees and Independent Contractors

Special tax rules apply to US employees of a foreign affiliate (a corporation owned 10% or more by a US person or corporation).

In summary, Medicare and FICA taxes only apply to work performed in the US when done on behalf of a foreign corporation. This means that the employee and the foreign corporation are not responsible these taxes for work performed outside of the US.

If your corporation and your employees wish to pay in to the US system, you can enter in to an agreement with the IRS to cover US citizens and residents of a foreign affiliate.

Independent Contractors: The tax relief above does not apply to independent contractors. A US citizen who is self employed outside of the US must pay self employment tax on his foreign earned income and self employment tax is not reduced by the foreign earned income exclusion. Click here for more information on personal returns.

I also note that, if the independent contractor has business expenses (deducted on his Schedule C), these proportionately reduce his foreign earned income exclusion. For example, if he earned $100,000 with 25% in expenses, he will pay SE tax on $75,000, his 2006 foreign exclusion was $82,500 less 25%, and he pays Federal tax on $13,125 at the tax rate applicable to $75,000 (according to the rate change that took effect in 2006...in 2005 he would have paid Federal tax at the rate applicable to someone earning $13,125). I note that the current, 2008, exclusion, is $85,700.

Benefit Plans: If you offer defined benefit plans or other employee benefit programs to your US employees, you may be required to offer the same plan to employees of the foreign affiliate that is in the same "industry or line of business" as the US entity.

 Click here to schedule a confidential appointment by email or call my direct line at (619) 557-0587. I will personally answer your call and determine what steps are needed to resolve your tax problems.

Note: Chris Rusch is the author of The Expat Tax Bible 2010, published by International Living. For additional information click here to be taken to IL's website.