US Tax Classification and Filing Rules for Expats with a Foreign Business
US expats are required to file US taxes from abroad, reporting their worldwide income, just like Americans living in the US.
Many expats believe that either a tax treaty or their income level may mean that they don’t have to file. Unfortunately though, all American citizens and green card holders who earn over $10,000 (or just $400 of self-employment income) are required to file an annual federal tax return.
To avoid double taxation, expats can claim one or more exemptions that the IRS has made available, such as the Foreign Earned Income Exclusion and the Foreign Tax Credit, depending on their circumstances.
How expats with a foreign business report it, depends on the type of business and the expat’s circumstances. US tax classification of a foreign business can differ from foreign classification, and how a business is classified is important as it affects the way that the business is reported.
US tax classification for expats’ foreign business
Whereas single-owner, US-registered limited liability companies are assumed to be ‘disregarded entities’ (meaning that their profits are reported on their owner’s individual tax return), expats with a foreign limited liability company must file form 8832 to elect to have their business classified as a disregarded entity by the IRS.
Once they have done this, expats who own 100% of a foreign limited liability company also have to file form 8858 every year to report the details of the foreign corporation (although it’s profits will still be reported on the owner’s form 1040).
Expats who don’t file form 8832 to elect to have their foreign limited liability company classified as a disregarded entity have to file the much more onerous form 5471 each year to report their business details and profits.
“The classification of a foreign entity as a corporation, a partnership, or disregarded entity, potentially affects many aspects of U.S. taxation.”
– the IRS
Expats who own more than 10% of a foreign corporation meanwhile, or who are officers of a foreign corporation and acquire stock in it during the year, or who earn any part of a foreign corporation that is a Controlled Foreign Corporation (which generally means that the corporation is in total more than 50% owned by Americans), are also required to file form 5471.
Expats who own over 50% of a foreign partnership are required to file form 8865, along with any expats who own at least 10% of a foreign partnership that no one owns over 50% of.
FBAR for expats with a foreign business
Americans who have a total of over $10,000 in foreign bank and investment accounts at any time during a year are required to report them by filing FinCEN form 114, better known as a Foreign Bank Account Report, or FBAR.
Expats should note that the combined total of foreign account balances also includes any accounts that expats have signatory authority or control over, including business accounts, even if the account isn’t in the expats’ name.
How the Tax Reform affects expats with a foreign business
Trump’s Tax Reform affects expats with foreign registered corporations that have retained earnings (retained earnings are profits that were left in the business rather than extracted, which up until now weren’t considered taxable). Historical retained earnings are now subject to a one off Repatriation Tax of 15.5%, which can be paid over a number of years.
Furthermore, from now on profits from Controlled Foreign Corporations will be taxed as if they were the owners’ income. This could lead to higher rates of tax payable on company profits, so expats with Controlled Foreign Corporations should consult an expat tax specialist as soon as possible to minimize their future corporate tax liability.