How do capital gains taxes work?
Capital gains taxes are another one to add to your long list of taxes to try to avoid. These taxes take a chunk of your profit and give it back to the government.
Imagine what you could do with that money if it didn’t all go away. The money could be reinvested into your business or maybe invested into a nice vacation.
Whatever your desires may be, it’s possible to figure out a way to structure your company and investments so that you won’t have to pay a high capital gains tax, if any at all.
We’re going to go over how capital gains taxes work, and specifically how capital gains tax works for offshore companies.
In this article, we’ll discuss:
- What Are Capital Gains?
- Do Offshore Companies Pay Capital Gains Tax?
- Do US Expats Have to Pay Capital Gains?
- How to Avoid US Capital Gains Tax
- Countries with No Capital Gains Tax
- Places to Avoid
What Are Capital Gains?
Capital gains are the profits you make when you sell a capital asset. If a capital asset has increased in value from the time you bought it to the time you sell it, you’ve made a capital gain.
Basically, if you make a profit on something, the government is going to take a chunk.
Capital gains tax can be charged when you make a profit on the sale of your company, real estate, or even cryptocurrency like bitcoin. For example, if your house sells for more than when you first bought you’ll have to pay a capital gains tax on your house.
Capital gains are taxed at different rates depending on where you are being taxed and how long you have held an asset. Capital gains are usually divided into short-term capital gains and long-term capital gains.
Of course, different countries have different capital gains tax rules. You can use this to your advantage and include a country that has a tax system that will benefit you and your company in your global tax plan.
Do Offshore Companies Pay Capital Gains Tax?
You may have heard stories of people doing secret business overseas and avoiding tax completely. This may work in the movies, but it’s not very likely that anyone will get away with that today.
Tax avoidance using an offshore company while remaining in the United States isn’t going to work.
Trying to have a secret offshore company is illegal and it’s likely you’ll be caught. US persons are required to report offshore assets, income, bank accounts, and corporations on their tax returns to the IRS each year. Failure to report can lead to serious consequences.
This means that if you are a US person, even if you aren’t living in the US, and have an offshore company, you’ll have to report that to the IRS.
As a US person, you’ll then have to pay capital gains tax on the profits you make according to capital gains tax law.
Do US Expats Have to Pay Capital Gains?
Do US persons living abroad have to pay capital gains tax?
To answer this, first, we’ll briefly break down how taxes work for US persons living abroad.
The United States is the only country in the world that actively taxes US persons (which includes citizens and green card holders) no matter where they live. You can spend years offshore without returning to the US and you’ll still be obligated to file and pay US taxes if you have US citizenship.
This means US persons will be obligated to pay capital gains tax, even if they reside overseas.
Thankfully there are some exemptions designed for US persons living abroad that can help you to reduce the amount of taxes you pay. The Foreign Earned Income Exclusion (FEIE) allows US expats to exclude the first about $108,000 of their salaried income from US income tax. This value is adjusted annually to account for inflation, and in 2021 stood at $108, 700.
Sadly, the FEIE does not extend to capital gains tax. US persons who live and run their business offshore are still required to pay US tax on their capital gains.
However, you may be able to avoid US capital gains tax if you are incorporated in a jurisdiction that is taxing you an amount equal to or more than the US capital gains tax rate.
The US has tax agreements with other countries that prevent double taxation. Foreign Tax Credits allow you to take the amount of tax you have to pay in your offshore jurisdiction and apply it as a credit towards what you owe in the US.
If you are paying a lower tax total in your offshore jurisdiction, you can subtract that from the US tax amount and pay the difference to the IRS. If you live in a high tax jurisdiction, you’ll only pay tax in that jurisdiction.
While this can help you to avoid double taxation, it won’t really lower your overall tax burden. As long as you are a US person, you are going to have to pay capital gains tax to the US on any profits you earn. However, there are a couple of ways that you can avoid US capital gains tax.
How to Avoid US Capital Gains Tax
How can you avoid capital gains tax? The process is going to be a bit different depending on your connection with the United States.
There are two main ways that US persons can avoid paying US capital gains tax.
Move to Puerto Rico
Your first option is to move to Puerto Rico.
Puerto Rico is a territory of the United States and this allows US persons to more easily move to Puerto Rico and take advantage of the island’s tax benefits.
Act 22 in Puerto Rico (Now Act 60) allows high-net-worth individuals to come into Puerto Rico and pay 0% tax on their dividends, interest, and capital gains that they obtain while they are a bona fide resident living in Puerto Rico.
But be aware that you won’t be able to claim the zero percent tax on capital gains in Puerto Rico as soon as you move there. To qualify, you’ll need to be a tax resident of Puerto Rico for at least a full year.
This act also allows you to enjoy Puerto Rico’s low corporate taxes by starting or moving your business to Puerto Rico.
Remember that only certain types of businesses qualify for this tax program. You also cannot have more connections to any other country, as Puerto Rico needs to be your main tax home in order to qualify for these benefits.
Note too that any capital gains earned before moving to Puerto Rico are not exempt from taxation.
Leave the US and Renounce Citizenship
The next option for avoiding US taxes on your capital gains is to leave the US and cut off all ties — including your citizenship.
If you don’t want to spend your time in Puerto Rico, your only other option for legally avoiding capital gains tax in the US is to renounce your US citizenship and move your business and investments offshore.
Your first step in this process is going to be getting your second citizenship from another country. There are different ways to go about this and they all have their benefits and drawbacks. What citizenship you get will depend on how much time you have and how much you’re willing to spend. You can find information about getting your second citizenship here.
You’ll need another citizenship before you can renounce, otherwise, you’ll be stateless.
After that, you can renounce your US citizenship. When you do this, you may have to pay an exit tax on unrealized capital gains. This exit tax is going to be higher the longer you wait, assuming that your assets are going to increase in value. Because of this, you’ll want to try and renounce and leave as soon as you can.
Before you renounce, you’ll want to come up with a plan for where you want to move your business and keep your other assets. You’ll want to find jurisdictions that have low capital gains tax rates and offer you and your company more freedom.
You can’t renounce your US citizenship and then keep your business and assets in the United States. Anything you leave in the US is going to be subject to US tax if left behind and will drag your right back into the US tax net.
Capital Gains Tax Outside of the US
The process is a little bit different if you aren’t a US person but are wanting to avoid capital gains tax. Most other countries are not going to require you to renounce your citizenship to avoid their taxes, but they will require you to become a tax non-resident.
This means you’ll still need to leave the country and establish stronger ties somewhere else. Different countries have different rules.
Countries with No Capital Gains Tax
After you leave your high-tax country, you’re going to want to find a place where you won’t have to pay a high capital gains tax ever again. This is something you definitely want to consider when deciding where to incorporate next.
Many countries throughout the world offer tax exemptions and benefits to foreigners. Some countries are tax havens and have no tax at all.
Hong Kong does not charge any capital gains tax, and has been a great place to incorporate. In addition to no capital gains tax, Hong Kong has a lower than average corporate tax rate of up to 16.5%.
Not far from Hong Kong, both Singapore and Malaysia do not have a capital gains tax. Malaysia is a territorial tax country, which means it won’t tax you on income earned outside of the country.
The Cayman Islands and Belize are two Caribbean nations that do not impose any capital gains tax. Both of these countries are considered tax havens and are friendly to expats.
If you are interested in incorporating in Europe, you can consider Switzerland, Belgium, or Monaco. These aren’t the cheapest places to live, but none of them have capital gains tax.
New Zealand has been a popular expat destination for a while. New Zealand has no capital gains tax and is ranked as the second freest economy in the world by the Heritage Foundation.
Places to Avoid
If you are looking to start a business, invest in real estate, or do anything where you plan on making a profit, you’ll want to avoid high capital gains tax rates. Here are some of the highest capital gains tax rates in the world.
Some of the highest capital gains taxes are found in Europe. Denmark has the highest capital gains tax in the world, ranging from 27% to 59%. The first $9,000 in profits is taxed at 27%. Over $9,000 in capital gains are taxed at 42%. Interest on income from bank deposits and real estate income is taxed at 59%.
The next most expensive capital gains tax are found in France and Finland. France charges a capital gains tax of around 32.5%. Short-term capital gains can be taxed at rates as high as 45% to 60%. Finland’s capital gains taxes range from 30% to 32%.
Another place to avoid is the United States. Even within the United States, there are certain areas that are going to charge you more capital gains tax than others.
New York and California charge the highest rate for capital gains tax. New York state taxes capital gains at 31.4%. These taxes are even higher in New York City.
California has some of the highest tax rates in the world — a large contributing factor to why everyone seems to be leaving. Capital gains in California are taxed 33%.
Capital gains taxes are placed on profits you make on your assets, but it’s possible to come up with a plan that will allow you to keep more.
Starting an offshore company and moving overseas will give you more financial freedom and lead you toward becoming a tax-free citizen.
Incorporate your business and invest in places that charge low or no capital gains tax and avoid high tax countries and states.