HOW TO BE TAX SAVVY
When you’re trying to save money, you can pinch pennies, cut coupons, and stick to a budget, but you won’t be able to get back the money you are paying on taxes other than a one-time tax return each year that you might get.
Cutting down your tax obligations is going to save you far more money than cutting coupons ever could. How can you reduce your taxes? If you want to lower your tax rate to as low as zero, you need to move both your personal life and your business overseas.
As you continue to read, we’ll discuss the US tax net and how Americans can lower their tax rate by going overseas. We are going to talk specifically to driven tax-savvy freelancers and tax-savvy entrepreneurs who are looking for new opportunities to save money by becoming a citizen of the world.
In this article, we’ll discuss:
- How do US taxes work for expats and nomads
- Offshore tax misconceptions
- How can Americans save money on taxes by going overseas?
- Preparing to go offshore
- The first step offshore
- Advice for freelancers going offshore
- Do I have a location independent business?
- Advice for entrepreneurs going offshore
- Knowing who to trust
HOW DO US TAXES WORK FOR EXPATS AND NOMADS?
Taxes in the United States are complicated. The US has citizenship-based taxation. This means that if you are a citizen of the US, you are subject to US taxes, whether you are currently residing in the United States or not.
Even if you are living overseas or spending all your time traveling the world outside of the United States, as long as you are a US citizen, you are required to file your taxes to the IRS each year.
OFFSHORE TAX MISCONCEPTIONS
Because of the United States’ unique and complicated tax structure, many people believe that you can’t save money by going offshore. Luckily, that isn’t true.
As an American, you can lower your tax obligations to as low as zero if you are able to create the correct tax structure. A proper offshore structure can give you a tax-free life.
HOW CAN AMERICANS SAVE ON TAXES BY GOING OVERSEAS?
You can be tax-savvy by going overseas. The United States offers multiple exemptions that allow Americans living abroad to reduce their US tax obligation.
The Foreign Earned Income Exclusion (FEIE) is a tax exemption in the United States that allows US expats and nomads to exempt the first $100,000 or so of their foreign earned income from US federal income tax.
The specific amount changes each year to account for inflation. In 2020, the amount was $107,600. In 2021, the amount is $108,700.
If you are living overseas and making less than 100 grand a year, you can become exempt from US federal income tax. The FEIE does not exempt you from self-employment taxes such as Social Security.
To qualify for this exclusion, you need to pass either the bona fide residence test or the physical presence test. In simple terms, the bona fide residence test requires that you establish another country outside of the US as your tax home. The physical presence test requires that you spend at least 330 days each year outside of the US.
Another exemption is the Foreign Housing Exclusion or Deduction. This can be added on top of your Foreign Earned Income Exclusion. Any amount that you paid for housing in excess of 16% of the Foreign Earned Income Exclusion can be excluded. 16% of the Foreign Earned Income Exclusion in 2020 was $17,216.
The third tax exemption US persons can use to save money on tax by going offshore is the Foreign Tax Credit. If you leave the US and become a tax resident in another jurisdiction, you can get a tax credit for that amount.
If the amount of tax you are paying to the country in which you are residing is equal to or more than the US tax amount, you won’t have to pay US tax. If the amount is lower than the tax obligation in the US, you can get a credit for what you paid to your tax residence and then only have to pay the excess in US tax. If you use this option, you will still be paying taxes, but you won’t be double-taxed by both your country of residence and the United States.
PREPARING TO GO OFFSHORE
If you’re reading this article, you might be considering moving your life and your business overseas. What is the best thing you can do before making the move overseas?
Fix your mindset.
This might not sound like the advice you were expecting, but it truly is the most important part of going offshore. Before you make this change, you need to be prepared mentally for what’s to come.
Before you jump in, you need to come up with a plan. This means thinking through your plan and considering all the angles and only then deciding if this is really what you want to do.
As you create your offshore plan, you need to be realistic about your goals. Is your business really going to be successful? What is a realistic amount that you will be able to make? How will going offshore help your business?
THE FIRST STEP OFFSHORE
Of course, there is a difference between theory and practice. You can talk about ideas and plans all day long, but nothing is going to happen unless you take that first step.
Once you are in the right mindset and have decided to go offshore, jump in.
Every day that you wait, you are losing money. All the income that you are earning while waiting to go offshore is going to be taxed. By going offshore, you are saving money on taxes and the sooner you start, the more you will save. This is one way you can be tax savvy.
ADVICE FOR TAX SAVVY FREELANCERS GOING OFFSHORE
Freelancing gives you the freedom to decide where and when you work. This is a great option for nomads who want to travel the world. At the same time, if you are a freelancer or are working with multiple clients rather than having a regular salaried job, your tax structure is going to be a little bit more complicated.
If you are freelancing overseas, you’re going to need to create a legal structure under which you will operate. You can incorporate your sole proprietorship or form a Limited Liability Company (LLC). Doing this will help you to separate your personal assets from your business assets, which can often become confusing when you’re freelancing.
Not only will this help sort out any confusion, but it will also protect your personal assets if anything should happen to your business.
If you are self-employed, the Foreign Earned Income Exclusion will help you reduce your federal income tax, but it won’t cover self-employment taxes such as Social Security and Medicare. However, if you are to set up your business as a company, you can then become your own employee. By using this structure, you will no longer be considered self-employed and can reduce your Social Security and Medicare tax obligations.
DO I HAVE A LOCATION INDEPENDENT BUSINESS?
A location-independent business will allow you to do business from anywhere in the world without having to be tied down to a specific location. How can you tell if your business is location-independent or could become location-independent?
This is best discussed in the planning stage. As you are looking at creating an offshore tax strategy, consider creating a location-independent business. Preparing your mindset is going to be important.
If you are a freelancer, you may already have a location-independent business. Having a location independent business means you can incorporate anywhere in the world. Nothing is making it so that you have to be in a specific geographic area.
What could stop you from being location independent? If your client base is located in a specific place and you cannot do business with them if you were to move your business somewhere else, then your business is not location independent.
But if you can help your clients from anywhere, you can move your location independent business offshore to a jurisdiction where you can save money by lowering your tax rate.
Some great examples for location-independent businesses include affiliate marketing, ad-based internet publishing businesses, digital agencies, e-commerce businesses, niche websites, traffic arbitrage, SaaS (Software as a Service) and SwaS (Software with a Service) businesses, and web hosting. You can also establish a location-independent business if you are freelancing by writing or editing blogs or designing websites. Basically, if it’s something you can do from anywhere in the world, it’s a location-independent business.
ADVICE FOR TAX SAVVY ENTREPRENEURS GOING OFFSHORE
Going offshore is a great solution for the tax savvy entrepreneur.
Let’s say you have a pre-revenue business. You have the idea for the perfect business but you don’t have any money coming in yet. It’s easier to start a business overseas than it is to migrate an already existing corporation to an offshore jurisdiction (although migrating your business is still possible).
While your business is still in the idea and pre-revenue stage, you need to come up with a plan for your offshore tax structure. This includes deciding what legal structure you’ll use, where you’ll incorporate, where you’ll hire, and even where you’ll bank.
One tax savvy option is to incorporate your location-independent business under a legal structure. You can create an International Business Company (IBC) to register your business offshore.
You want to incorporate your business in a low tax or zero tax jurisdiction.
Belize and Nevis both offer great options for incorporating. The process to incorporate in either country is fairly simple and easy. You can structure your business in these countries under an LLC. In both of these countries, you won’t have to pay taxes on your corporation, only an annual fee. Both countries have privacy policies that will protect your assets if you choose to bank there.
Keep in mind that to make an offshore business structure work for your tax plan, you can’t stay in the United States. You can’t continue to live in California or Florida and expect to pay zero tax on the business you incorporated in Nevis. If you continue to live in the US, you and your business will become liable for US tax.
Likewise, if you were to live and establish tax residence in a territorial tax country like Malaysia, you don’t want to incorporate and keep your business there. Territorial tax countries won’t tax you on income that is made outside of the country but any money made within that country is liable to be taxed.
WARNING: KNOW WHO TO TRUST
When you decide to go offshore, you’ll find there are a lot of resources on the internet. There are plenty of people who are willing to help you get a second residence or passport or create an offshore structure.
While there are reliable sources that you can use, there are also plenty of hidden fees and less trustworthy salesmen. Here is something you need to watch out for — beware of anyone who tries to sell you a residence or passport without asking you why you want it.
Some people in the offshore industry are working off of commission. They have a deal with a specific country where they’ll get some of the money if they get people to use their specific program. What program are they going to recommend to you if this is the case? Theirs of course, the one that is going to make them money.
This may not be the best option.
Where you get your citizenship or residence is going to depend on your unique situation. If they aren’t asking you about your reasoning or needs, then they don’t care. They are just trying to make a sale. They aren’t trying to help you out.
If you want more independence, it’s time to take charge of your life. Creating a tax-savvy life will give you more personal and financial freedom.
There’s no reason you should have to stay in a high tax jurisdiction when there are so many places in the world where you can go to incorporate your location independent business that will work better for your financial situation.
You don’t have to wait until you are well established and wealthy to begin making changes to your tax plan. For young freelancers and entrepreneurs, the time to go offshore and save is now. It’s the savvy thing you could do.