US Tax and the Location Independent Entrepreneur


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There is a lot to like about being an independent entrepreneur. The main thing is freedom. Freedom to choose who you work with. Freedom to choose when you work. Freedom to choose how much money you make. And, if you have an online business, you can also choose where you work.

In my business, I’m seeing more and more online business owners. These are successful businesses that are run completely online. You don’t need an office. You don’t need a bricks and mortar location. You just need a laptop and good Internet!

Your costs for the business are much lower and the income is pretty much however much you wanted to be, once you get your particular business model dialed in. My clients’ net income typically is running from $100K all the way up to $1 million per year. And that’s just the individual entrepreneurs I meet in my tax practice.

The one thing that’s confusing, though, is what happens when you owe taxes.

In today’s blog, I want to talk about location independent entrepreneurs. You may also know them by the term “digital nomads.”

Usually, the description digital nomad refers to someone who has a backpack and a laptop and is traveling all over the world, working where they stay, maybe a week, maybe a month at a time. A location independent entrepreneur may have the same kind of lifestyle, or may actually live in one location and work in another. It could be they still live in the US or it could be they live outside the US.

Let’s start with the self-employed, virtual worker who still lives in the US. For purposes of this blog, we are assuming they are entrepreneurs or self-employed. In other words, they are not W-2 wage earners.  The biggest questions for them all have to do with state nexus. Nexus means connection. What states do they have connection with?

There’s probably no question that they will owe US federal income tax. But, do they owe in their “home” state income tax or sales tax on sales made other states or income tax to other states? The answer is, “It depends.” Let’s start there.

Sales tax nexus is a very hot topic right now. Nexus means connection. You can have sales tax nexus, income tax nexus or “other tax” nexus. If you have nexus with another state or even another county or city, you may be required to collect and pay sales tax on sales made in that location and, if you have income tax nexus, you may be required to file a non-resident tax return.

Your main question should be determining where you have state nexus. This is a question to ask your CPA. I have a home study course that talks about nexus. In fact, we went through this in a coaching class in September 2019. To find out more about coaching, please go to https://www.ustaxaid.com/coaching-program/. If are you are reading this prior to December 2019, the September Home Study Course on Nexus and the recording of the coaching session are still available when you join today. We keep the past 3 months of coaching sessions live for coaching students.

What if you live outside the US?

You may still have sales tax issues, depending on where your US sales are made. Again, that is determined by your sales tax nexus. The creating your own nexus strategy home study course is almost 100 pages, so obviously we can’t cover it in this blog. That’s because each state gets to determine its own nexus policy and it gets complicated.

Income tax nexus, however becomes clearer. States are required to have physical presence nexus in order to assess state income tax. If you’re living in another state or country, you don’t have physical presence solely due to your own actions. As long as you don’t have employees or physical items, such as inventory or real estate, inside the state, there is probably no state income tax nexus.  That’s especially true for federal income tax purposes.

There are a number of strategies that you can use to reduce or even completely eliminate income tax. Here are a few very simple examples.

David is a digital nomad. He travels throughout Europe and Asia, seeing the world and running his online sites. Since most of his income comes from affiliate marketing, advertising spots on his YouTube channel and website and drop shipping products, his work is done completely online from wherever he is. His only requirement is that he has fast Internet that is reliable.

David decides that for him, the best strategy is to take advantage of foreign corporations that are in countries that have no income tax. However, because he does collect income in the US, it is best to use a merchant service provider in the US. The fees are much cheaper if you use a US company for that and there isn’t nearly as much retention required by the credit card company. So, he decides, after consultation with an offshore expert and a consultation with me, to set up a Wyoming LLC. The Wyoming LLC is wholly-owned by an international business corporation (IBC) in a country that doesn’t have income tax. There are a number of countries that work for this. Typically, I work with just a handful because this is where the people I work with have connections.

The LLC is owned by the IBC and is a disregarded entity for tax purposes. Because David is a US citizen, he needs to report that he has ownership in a foreign entity. The foreign entity income would be taxable to him if the income stayed in the company. However, David’s business has income is about $100,000 per year. The IBC pays him salary for that amount and so the IBC has no taxable income. (Income – salary = zero) There is no payroll tax in that country and there is no US intangible tax on foreign income because there is no net income.

David however does have salary income.  But, he qualifies as having a tax home outside the US. Although I’m skipping the details here, this is an important and sometimes complicated step. Make sure you have an expert in US tax law for location independent business owners advising you, designing and implementing the strategy.

In this example, David does qualify as having a tax home outside the US. Therefore, the income he earns is foreign earned income. And he qualifies for the foreign earned income exclusion.

The amount he earns is under the FEIE for 2019 and thus it’s not taxable.

In other circumstances, he may have wanted to draw a salary from the Wyoming LLC. He still could qualify for the FEIE with a salary from the WY LLC. However, he would have to pay payroll tax on that salary.

Although David doesn’t need it, because of the income amount into his IBC, he could have also received a housing allowance and living allowance. This would mean tax free income to him.

There are many steps to the strategy, and I can’t stress enough the need for an individual strategy based on your own circumstances. There are more reporting requirements when you use a strategy like this, so factor in the cost to set up and maintain two structures and the additional tax filing costs. These are forms that you are not going to want to self-prepare and you’ll find there are a lot of tax professionals who really understand these tax returns. That means you’ll pay more to get them prepared. Factor all of those costs and before you decide whether it’s really worth.

In David’s case, he saved almost $30,000 in payroll taxes and income tax by using the strategy. His ongoing costs, for bookkeeping, business structure maintenance, foreign bank account costs, and tax preparation is less than $5,000 per year.

And, he can rely on others to do a lot of that. In other words, not a lot more work for him.

Is the cost worth it? Spend $5,000 to save $30,000? Only you can decide if that is worth it.

Tomorrow, I’m going to look at expat taxes. There are differences, and it’s important to understand these before you file your tax return.



3 Comments

  1. Nathan says:

    I continue hearing the tax war drums beating that indicate states may require persons or corporations to file income taxes in their state on apportioned income, even if they are not physically located in the state. This may or may not be related to the Wayfair ruling, but it’s a scary though having to not only pay sales tax in 42 states, but also file income tax returns in multiple states as well. Thoughts?

  2. Diane Kennedy says:

    Thanks for your comment!

    There is a possible solution, but I have to stress POSSIBLE. It has not been tested in the courts yet.

    The issue is the GILTI tax. If you set up a foreign company that you as an American living in the US own and control, you have that intangible tax.

    So the possible solution, which personally I don’t like, is that you set up a company that a foreign national owns and controls. A similar situation is to use a trust, again, owned and controlled by someone else.

    Like I said, it’s untested and I’m concerned about turning over a company to someone else, especially if there are assets in it. If you take the money out immediately, there wouldn’t be as much risk, but once it is paid to you it would be taxed anyway.

    I guess that’s the long way around, there is no safe, secure way to do it. Is it time to move out of the US?

  3. Michael Coody says:

    Diane,
    I’m about to embark on this scenario; do you see any way to avoid US taxes on this? I’m a US citizen, living in Texas. I’m going to start selling Panamanian RE for a commission. I won’t receive customer payment, only a commission for the sale after the fact. I will not be a W-2 classification, just an independent rep.

    Do you see any doable structure set up to avoid uncle sam’s big bite?

    Best regards,

    Michael

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