As more entrepreneurs embrace the digital nomad lifestyle, starting a business abroad has become a popular idea. However, while setting up shop in your favorite vacation destination may seem ideal at first, it's important to understand the tax implications of starting a business abroad--especially since the business structure you choose can have a big impact on your tax bill and filing requirements.
Setting up a foreign business could complicate your taxes
Regardless of where you live, all US citizens are required to pay taxes on their worldwide income. You may also have to report foreign financial accounts and investments in foreign entities. This means that structuring your business as a foreign corporation or partnership won't help you escape US taxes.
In fact, the opposite may be true. US citizens who own a controlling interest of a foreign business must file additional tax forms--such as Form 4571 for foreign corporations and Form 8865 for foreign partnerships. Additionally, while some foreign entities may offer tax advantages in their local country, these benefits may not be recognized in the United States. Each country has unique business structures, so if you're considering opening a foreign-based business, make sure to consult with an accountant first.
Opening a business abroad may help you claim special tax credits
On the other hand, founding a US-based sole proprietorship or partnership abroad may help you qualify for certain tax credits and exclusions available only to expatriates. So long as you report foreign earned income on your personal tax return and meet the IRS's requirements for living abroad, you may be eligible for the Foreign Earned Income Exclusion (FEIE). This exclusion, which is designed to help Americans living abroad avoid double taxation, can result in significant savings on your tax bill. For example, in 2021, the FEIE allows expats to exclude up to $108,700 of their foreign earned income from US taxation.
However, it's important to note that the FEIE and other tax-cutting techniques won't exempt you from paying US self-employment tax of 15.3%. On top of this, you may also have to pay social insurance taxes to your host country. Although, in some locations, totalization agreements protect Americans living abroad from paying social insurance taxes twice.
Other tax considerations
To help prevent tax cheats from hiding money in offshore accounts, the IRS requires foreign banks to report on Americans' accounts. Due to the extra burden of this reporting, some foreign banks have decided not to do business with US citizens (and have even gone so far as to close the accounts of current US customers). This can make it difficult for some expat entrepreneurs to conduct business abroad.
Expat business owners may also face challenges when trying to find an accountant who understands their unique tax situations. Choosing a tax professional who has worked with expats extensively can help ensure that you never miss a requirement or pay more than you have to.
Whether or not starting a business abroad is the right move for you depends entirely on your unique situation. As is often the case when starting a business, speaking to an experienced accountant can help you secure the most advantageous structure for your new venture--while also maintaining the jet-setting lifestyle you desire.