Nowadays, more people consider living abroad, whether for education, adventure, love, or work. According to InterNations’ Expat Insider 2021 survey, 36% of U.S. Americans relocate to another country for career-related reasons.
Running a business in a foreign country is exciting. You get to discover new opportunities while enjoying different cultures and environments. However, these perks come with challenges.
In terms of tax, there are differences between preparing and filing for business tax returns as a local and foreign entrepreneur. You must be aware of local and international tax laws to avoid stumbling upon unexpected penalties and issues.
Complying with foreign tax laws as an entrepreneur can be overwhelming since there are a lot of details you need to review. To help you out, we’ve rounded up some tax preparation tips for foreign entrepreneurs.
Essential Tax Preparation Tips for Foreign Entrepreneurs
With these tips, you can effectively run your business abroad as you would if you were in the U.S.
Tax Preparation Tip #1: Keep separate accounts for business and personal matters
You may think that having one bank account for your personal and business matters is fine since you don’t have many expenses yet. Whether you’re handling a small or big operation, your own money must be in a separate bank account from your business expenditures for tax purposes.
Make sure that all your business income and expenses are made using your business account. By doing this, you can organize and balance your business finances accurately without getting confused.
Foreign bank accounts
Suppose you opened foreign bank accounts that reached an aggregate total balance of $10,000 at any point during the tax year. In that case, you’ll need to report it to the Internal Revenue Services (IRS) by April 15. If you miss the deadline, there’s an automatic extension until October 15.
You must file a Foreign Bank Account Report (FBAR) or FinCEN Form 114. FBARs are required not only on accounts under your name (or business name) but also on those you have signatory authority over, like a foreign bank account for your small business. For this, you need to report it separately as it’s not part of your tax return.
Tax Preparation Tip #2: Claim a tax deduction on start-up costs
The money you shelled out to start your business can be tax-deductible. You can pay less on taxes with various credits and deductions.
Remember that you should claim deductions only on expenses that have something to do with your business. For example, don’t report expenses on your new blender if you’re working as a marketer. Use your best judgment as to what is considered a business expense.
Some examples of expenses you can deduct are:
- Vehicle use
- Rent (business equipment and space)
- Internet and phone bills
For a start-up business, you can claim research and development deductions. When you’re still feeling out if your business is feasible, you can deduct expenses on training employees and ordering supplies.
Tax Preparation Tip #3: Know the difference between employees and subcontractors
Subcontractors or freelancers are hired on a project basis and use their resources when working. By distinguishing the two, you can determine which tax form you should file.
If you’ve hired employees, you should file Form W-2 for each of them if they are working in the U.S. or a U.S. taxpayer (i.e. U.S. citizen, resident or green card holder). This document will state their wage and tax statement. If you’ve hired freelancers, you should file Form 1099-NEC. This will report the payments made in exchange for the services provided.
If you get these two confused with each other and file the wrong form, you can get in trouble. It can result in costly penalties, which will lead to a large tax bill and unpaid Medicare and Social Security taxes.
What if my employees or subcontractors are non-U.S. persons?
For foreign subcontractors, you don’t have to file a Form 1099. Instead, it would be best if you ask them to complete a Form W-8 BEN, a document that certifies your subcontractors are not U.S. taxpayers. You don’t have to submit this form to the IRS. It’s just a supporting document in case of an audit, and they ask you why you didn’t file for a Form 1099.
Non-U.S. taxpayers aren’t subject to any U.S. tax reporting, so you don’t have to submit a Form W-2.
Tax Preparation Tip #4: Have a solid payroll system
When you own a business, tax preparations go hand-in-hand with the payroll, so you must know the ins and outs of the system. In this part of the business, you have a lot of responsibility in keeping your documents updated and filed on time.
Make sure you ask your employees to complete Form W-4 so that you can withhold the correct federal income tax from their pay. Employee deposits to Medicare and Social Security payments should also be up to date and accurate. If you miss a date or deposit the wrong amount, you’ll face hefty penalties.
All of these may sound overwhelming for a novice entrepreneur. You’re not alone. Most entrepreneurs hire accountants or get help from tax preparation services to ensure that everything runs smoothly for at least the first year of their business.
Tax Preparation Tip #5: Choose a corporate structure wisely
When you start a business, you must determine the corporate structure you belong to under the IRS. It will decide your tax requirements and the form you should file for an income tax return.
The different types of U.S. business structures are:
- Sole proprietorship
- S Corporations
- Limited Liability Company (LLC)
LLC is one of the most popular business structures for expat entrepreneurs. It allows you to form your company in any country.
There are various kinds of LLCs, such as domestic and foreign. Domestic LLCs are businesses that are organized and registered in your home state. The IRS disregards domestic LLCs and treats them as a corporation, partnership, or part of the owner’s individual tax return.
Foreign LLCs do business in countries other than their home state. For these, you must file Form 8832 and elect your business as a foreign LLC so that the IRS can give you a disregarded status. You only have to do this once. However, you must file Form 8858 yearly to maintain your disregarded status and prevent the IRS from classifying your business as a corporation for tax purposes.
Tax Preparation Tip #6: Keep a detailed travel calendar
If your business requires you to travel back and forth between the U.S. and other foreign countries, you should keep an accurate travel calendar. It would help if you noted all the expenses you’ve made during this time and where you made it.
Expenses made in the U.S.will affect your calculations for Foreign Earned Income Exclusion and Foreign Housing Exclusion or Deduction. This is crucial for your tax return preparations. Your deductions and income should be divided by transactions made in and out of the U.S.
Tax Preparation Tip #7: Ensure your business is tax compliant
The IRS can better view your global transactions through the Foreign Account Tax Compliance Act (FATCA). It means that your non-U.S. transactions can undergo U.S. taxation. With this, you must report your foreign assets on Form 8938 if you have more than $200,000 of specified foreign financial assets at the end of the tax year.
Suppose at least 75% of your business’ income is passive (e.g., royalties, dividends, capital gains) or at least 50% of your company’s assets are passive (e.g., investments that produce capital gain, interests, or dividends). In that case, your business becomes a Passive Foreign Investment Company (PFIC).
With PFIC, you need to follow a different set of reporting requirements. You must keep an accurate record of your dividends, shares, and other undistributed income earned by the company. The IRS is strict when it comes to tax guidelines under this category.
Tax Preparation Tip #8: Consider foreign tax rates
The country where you start the business matters, as each has different tax policies. For example, in Japan, the tax rate for corporations can run up to over 20%, and individual marginal tax rates can go as high as 45%. Meanwhile, in the United Arab Emirates, there are no individual and corporate taxes.
Where you move or start your business will greatly influence your financial success, so make sure you research before establishing your foreign company.
Don’t Overlook Tax Planning
Starting a business overseas is no joke. Since it’s in a foreign land, some concepts and business aspects may be unfamiliar to you. By getting to know your taxes as a foreign entrepreneur, you’ll be able to prepare for tax season well. You won’t have any unpleasant surprises if you’re informed.
Tax compliance is crucial if you want to run a successful business as an entrepreneur abroad. You don’t want your business to crumble for easily avoidable mistakes. If you need help sorting out your expat taxes, reach out to Tax Samaritan. With over 25 years of experience in U.S. tax preparation and representation, we can surely lend you a hand in dealing with taxes in a hassle-free way.
Contact us today to get personal service with realistic and effective tax solutions.