Many websites advertise the tax savings of going offshore. An offshore business structure is not just for the Apples and Googles of the world. Even small business owners and solo entrepreneurs can benefit.
$20,000 tax savings with the right business structure
Let’s look at an example of an entrepreneur with an online business to illustrate the potential tax savings with an offshore structure.
Mike, a US citizen living abroad, owns a web development business, which he operates as a Wyoming LLC. He makes $180,000 in earnings and has $40,000 expenses, so a net profit of $140,000.
No tax savings with a standard LLC
Since an LLC is a pass-through entity (and he didn’t elect to be taxed as an S corporation), the profit passes through to Mike’s personal income. He meets the requirements for claiming the Foreign Earned Income Exclusion, so he doesn’t have to pay income tax on the first about $110k (with the standard deduction).
Because he is in the 28% tax bracket, he pays about $8.4k income tax for the non-excluded $30k income.
In addition, since he is considered self-employed, he also has to pay 15.3% self-employment tax (Social Security and Medicare) on his entire earned income of $140k, so about $21.4k. So in total he pays almost $30k tax to the US.
While the LLC structure provides Mike with liability protection, it does not optimize his tax situation.
Some savings with a S corporation
He could avoid the self-employment tax if his LLC elects to be taxed as an S corporation. Mike could then pay himself a (reasonable) salary below the FEIE limit, let’s say $60k, which would be subject to Social Security and Medicare tax, about $9k.
The remaining $80k earnings are considered a profit distribution and hence not subject to paying 15.3% tax for Medicare and Social Security. It is however subject to income tax on the amount above the $110k FEIE due to the fact he is the sole shareholder and primary employee of the company. At the 28% tax bracket, this is $8.4k, as in the previous example, bringing his total tax burden to about $17.4k.
This simple election to be taxed as corporation could save him roughly $12k per year.
Significant savings with a tax-optimized offshore business structure
Mike could optimize his tax burden even further with the right offshore business structure.
If he had an offshore structure in a low or no tax jurisdiction that is owned by his US C corp, he could benefit from the new GILTI tax rate of only 10.5%, if his business meets certain requirements.
He would also not pay any Social Security or Medicare taxes as he is being paid from a foreign company. He can take a $100k salary which is not taxable under the foreign earned income exclusion, given that he qualifies. The remaining $40k profit of the company would be subject to the 10.5% effective tax rate of the corporation under GILTI, $4.2k.
He can receive this money in the form of dividends. Those would be taxed at a rate of 0%, 15% or 20%, depending on his tax rate. Assuming he takes out the entire $40k profit as dividend and is in the 15% tax bracket, Mike pays another $6k in tax. His tax total would be just over $10k, compared to almost $30k without a good structure in place.
Mike would benefit from significant tax savings, even when you take into account the cost of setting up and maintaining the offshore business.
Furthermore, the right foreign structure not only gives huge tax savings but also asset protection.
How solo-entrepreneurs should structure their business
Of course every situation is unique. Depending on your income, type of business, your needs, and other factors, your outcome could be quite different.
A structuring expert can help you evaluate different onshore and offshore scenarios and advice on a full plan that includes tax optimization, asset protection, retirement planning, and more.
If you’d like to learn more and get help structuring your business, please schedule a consultation.
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