Get to know the authorLiving and running a business abroad offers exciting opportunities, but it also brings unique challenges – especially when it comes to taxes. Understanding potential tax savings for business owners can be a game-changer, allowing American expats to reduce their U.S. tax burden by making smart financial decisions. Optimizing your salary is one of the most effective ways to maximize tax savings, ensuring that you keep more of your hard-earned income while staying compliant with both U.S. and foreign tax laws.
In this article, we’ll explore key strategies to help you minimize taxes, including leveraging the Foreign Earned Income Exclusion (FEIE), understanding GILTI tax, and structuring your salary to maximize benefits. Whether you’re a seasoned expat business owner or new to navigating international tax rules, these insights can help you optimize your earnings and boost your bottom line.
Understanding the tax benefits of optimizing your salary
As an American business owner living abroad, optimizing your salary can significantly impact your tax burden. By making strategic decisions about how you pay yourself, you can reduce — or even eliminate — your U.S. tax liability. This strategy is essential for expats because U.S. citizens are taxed on their worldwide income, regardless of where they live or work.
Running a foreign business adds layers of complexity to your financial situation, especially in terms of taxes. For instance, as a U.S. citizen or green card holder living abroad, you must still file a U.S. tax return. The good news is that several tools, including the Foreign Earned Income Exclusion (FEIE), the standard deduction, and strategies like salary optimization, can help you minimize your U.S. tax bill while running your foreign business.
Salary optimization doesn’t only inform how much you pay yourself; it’s also about how you pay yourself. Strategic salary structuring, combined with other key tax strategies, can ensure you maximize benefits like the FEIE, minimize exposure to taxes like the Global Intangible Low-Taxed Income (GILTI), and even make the most of spousal salary options if your spouse is actively involved in the business.
The power of the Foreign Earned Income Exclusion (FEIE)
The Foreign Earned Income Exclusion is one of the most powerful tools in your arsenal as an American expat business owner. It allows you to exclude up to $126,500 (as of 2024) of your foreign-earned income from U.S. taxes. Essentially, if you meet the qualifications, a portion of your income is sheltered from U.S. taxes altogether.
To qualify, you must meet one of two tests: the Physical Presence Test or the Bona Fide Residence Test. The Physical Presence Test requires that you spend at least 330 full days outside of the U.S. in a 365-day period, while the Bona Fide Residence Test requires you to prove that you have a long-term home in a foreign country for at least one calendar year.
Who qualifies for the FEIE?
Many expats assume they qualify for the FEIE automatically, but that isn’t always the case. Eligibility requires careful attention to detail. You must have foreign-earned income (which excludes investment or passive income) and satisfy the time-based residency requirements. Business owners who spend considerable time traveling between countries or returning to the U.S. for extended periods may need to carefully track their time abroad to ensure compliance.
The 330-day rule under the Physical Presence Test is often the easiest way to qualify, especially for expats with flexible schedules or digital nomads. The Bona Fide Residence Test, while potentially more subjective, requires a permanent home in the foreign country — and that’s crucial for high-earning expats planning to make a long-term commitment to living abroad.
How to maximize tax savings with the FEIE
By strategically setting your salary right around the FEIE threshold, you can avoid paying U.S. income taxes on up to $126,500 of those earnings. This strategy becomes particularly effective when combined with other exclusions and deductions, such as the standard deduction. By paying yourself a salary that qualifies for the FEIE and stays within its limits, you can ensure that a significant portion of your income remains untaxed by the U.S.
Example: If you run a business in Spain and pay yourself an annual salary of $120,000, and you qualify for the FEIE, you may not owe any U.S. federal income tax on that income, dramatically reducing your overall tax liability.
How the standard deduction complements the FEIE for maximum savings
The standard deduction is another valuable tool for reducing your U.S. tax burden as a business owner abroad. For 2024, the standard deduction is set at $29,200 for married couples filing jointly, and $14,600 for single filers. This deduction is applied and directly offsets your taxable income, further lowering the amount subject to U.S. tax.
Combining the FEIE and standard deduction
The real magic happens when you combine the Foreign Earned Income Exclusion with the standard deduction. By strategically setting your salary at the right level, you can optimize these tax-saving mechanisms. For example, if you’re married and both you and your spouse work in the business, you can each claim the FEIE and combine it with the standard deduction to maximize your tax-free income.
For instance, if you pay yourself the FEIE threshold amount of $126,500 and take advantage of the standard deduction, you could effectively shelter up to $155,700 ($126,500 + $29,200) from U.S. income taxes.
Example calculation
Consider a married couple living in Singapore. Both spouses actively participate in the business and pay themselves salaries of $126,000 each. By claiming the FEIE for both, they exclude up to $253,000 of their income from U.S. taxes (2 x $126,500). Additionally, by combining the standard deduction, they can reduce their taxable income even further, potentially avoiding U.S. taxes on all or nearly all of their income.
Reducing GILTI tax through salary optimization
The Global Intangible Low-Taxed Income (GILTI) tax was introduced as part of the 2017 U.S. tax reforms and primarily affects business owners with Controlled Foreign Corporations (CFCs). If your business qualifies as a CFC — meaning that you own at least 50% of it and it’s incorporated outside the U.S. — you might face taxes on its profits even if they haven’t been repatriated to the U.S.
Essentially, GILTI applies a minimum tax on the profits of foreign corporations controlled by U.S. shareholders, aiming to discourage profit-shifting to low-tax jurisdictions.
How salary optimization reduces GILTI exposure
One key strategy to reduce your GILTI exposure is by paying yourself a higher salary. GILTI is calculated based on a CFC’s retained earnings — the profits the corporation doesn’t distribute. By paying yourself a reasonable salary, you reduce the amount of profits the company retains, thereby lowering your GILTI exposure.
It’s important to strike a balance between maximizing your salary (to reduce GILTI) and ensuring that your salary doesn’t exceed the FEIE limit, which would expose you to unnecessary U.S. taxes. The goal is to optimize your salary in a way that minimizes both U.S. income tax and GILTI tax.
Balancing salary and GILTI for optimal savings
For many business owners, the optimal strategy is to pay themselves a salary that qualifies for the FEIE while minimizing retained earnings to reduce GILTI. This requires careful planning, especially if your foreign business is highly profitable. A qualified expat tax advisor can help you structure your compensation in a way that reduces your overall tax liability while complying with both U.S. and foreign tax laws.
Paying your spouse a salary for additional tax benefits
One often-overlooked strategy for maximizing expat tax savings is paying your spouse a salary. If your spouse actively participates in the business, paying them a salary not only compensates them for their work but also doubles your household’s tax benefits.
By paying your spouse a salary, you can take advantage of double FEIE benefits — allowing you to exclude up to $253,000 of foreign-earned income from U.S. taxes in 2024. This strategy is especially useful for married couples running a business together.
Example of joint savings
Let’s say you and your spouse live in the UAE, where there is no personal income tax. Both of you are active in the business and pay yourselves $126,000 each. By leveraging the FEIE for both of you, you could exclude a combined $252,000 of your income from U.S. taxes. If you combine this with the standard deduction, you could completely eliminate your U.S. tax liability on all of your business earnings.
Consider local payroll taxes
Before you implement this strategy, it’s essential to factor in any local payroll tax obligations. Some countries have payroll taxes that apply even to business owners, so while paying your spouse a salary can reduce your U.S. tax liability, it’s important to ensure that it won’t trigger high local taxes that offset those savings.
Country-specific considerations: local taxation and salary strategies
While U.S. tax law offers many opportunities for expat business owners to reduce their tax burden, it’s important not to overlook local tax laws in the country where your business operates. Each country has its own rules for taxing income, payroll, and businesses, and these rules can significantly impact how much tax you owe locally.
Some countries have tax treaties with the U.S. that can help reduce or eliminate double taxation, while others have no treaties in place, meaning you might be taxed both locally and by the U.S. Understanding these local tax implications is critical when deciding how to structure your salary and business.
Avoiding double taxation
One of the primary concerns for expat business owners is avoiding double taxation — paying tax on the same income in both your host country and the U.S. While tools like the Foreign Tax Credit (FTC) can help reduce or eliminate U.S. taxes on income that has already been taxed abroad, it’s important to carefully plan your salary structure to ensure you aren’t paying more in taxes than necessary.
Examples by country
Let’s look at some country-specific considerations:
- United Kingdom: The UK has a high-income tax rate but a tax treaty with the U.S. that can help mitigate double taxation. Optimizing your salary to take advantage of the FEIE and Foreign Tax Credit is crucial.
- United Arab Emirates: The UAE has no income tax, making it an ideal location for expat business owners. Paying yourself a salary under the FEIE threshold can allow you to run your business tax-free.
- Singapore: Singapore’s tax rates are relatively low, and the country has a tax treaty with the U.S., but expat business owners still need to carefully plan their salary to avoid triggering GILTI or excessive U.S. taxes.
Key points for effective salary structuring
One of the most important decisions expat business owners need to make is whether to pay themselves a salary or dividends. Salaries may be subject to payroll taxes and can qualify for the FEIE, but dividends might be taxed differently depending on local laws and U.S. tax rules.
In many cases, paying yourself a salary up to the FEIE limit is the most tax-efficient strategy, while dividends can be used to distribute additional profits. It’s important to work with a tax advisor to determine the best combination of salary and dividends based on your business structure, income level, and local tax laws.
Keep detailed records
To ensure you remain compliant with both U.S. and foreign tax laws, it’s essential to keep detailed records of your salary payments, business expenses, and tax filings. Many countries require businesses to maintain payroll records, and these records can also help you demonstrate compliance with U.S. tax rules, including the FEIE and GILTI regulations.
Avoid pitfalls
One common mistake that expat business owners make is overpaying themselves and exceeding the FEIE limit. This can result in a higher U.S. tax bill, as income above the FEIE threshold is subject to U.S. tax. Similarly, failing to account for local tax laws or underpaying yourself can trigger penalties and increase your overall tax burden.
How to maximize the tax strategy
Given the complexities of U.S. tax law for expats, it’s essential to work with a tax professional who specializes in expat taxes. A CPA with expertise in international tax planning can help you navigate the FEIE, GILTI, and other expat tax strategies to minimize your U.S. tax liability. They can also ensure that you remain compliant with both U.S. and foreign tax laws, avoiding costly penalties.
Annual review of your salary structure
Your salary structure should be reviewed annually to account for changes in tax laws, thresholds, and your business’s financial situation. Each year, the FEIE threshold, standard deduction, and other tax rules are updated, and it’s important to adjust your salary accordingly to maximize your tax savings.
Combining adventure with smart tax planning
Living abroad as a business owner can be a rewarding adventure, and with the right tax strategy, it can also be incredibly cost-effective. By optimizing your salary, leveraging the Foreign Earned Income Exclusion, and combining it with the standard deduction, you can significantly reduce or even eliminate your U.S. tax liability. Add strategies like paying your spouse a salary and minimizing GILTI exposure, and you’ll be well on your way to maximizing your tax savings.
