Following is an abbreviated question that was received at the USTaxAid site. In today’s online ecommerce world with global multi-national companies available to all of us, this is very timely.
It all comes down to one big question: “When can a US citizen avoid US tax with a foreign corporation?”
Paraphrased, the question was this:
“I am a US citizen and US resident. I have e-residency with another country and am considering setting up a company based in that country for lower tax rates. My business is 100% online. Would my home state (US) and the US federal government collect federal and state tax on the income I make?”
The USTaxAid community member goes on to explain:
“The income is earned from various sources like Netflix, Amazon, etc. There is no physical location for the company and independent contractors and employees work from their homes.”
Let’s deal with a couple of issues from this question, one at a time.
The easy answer for a US citizen to escape foreign tax is with a foreign corporation where the customers are not in the US, the company does not operate in the US and the cash doesn’t come back to the US. I call it the 3 Cs – customers, company and cash. If any one of them is violated, there is a US tax of some amount.
In this case, the customers sound like they are all over and there is no effort made to track them. That’s a problem. If you’re a US taxpayer and you have customers in the US, you have US tax. Period. If all of the customers are outside the US, you’ve pass the first huddle.
Next, we need to look where the company operates. Since the business is online, the physical presence is a little harder to prove, at least at the surface. In this case, the states have laws that have stepped in. States want to prove “nexus” or connection so that they can collect state income tax, state sales tax on sales and any miscellaneous tax like gross margin taxes or franchise taxes.
The states each have their own definition, but one thing they agree on. If an employee is working for a company, their presence is a triggering event for nexus. That means you’ve got federal tax as well, because you had US employees.
If you have US independent contractors, you need to look at what their function is. It is generally an issue if they are part of the sales process or fulfillment. In that case, the state in which they reside is due some tax, or at least a tax return. And, of course, the IRS wants their share.
If you work in your company, and it sounds like you do, then you have pulled this company into your home state. In this case, it’s not a pro-rata amount due to the quantity of work you do, but as an owner it means that it definitely going to be taxed for the federal and state.
In some cases, just being an owner and living in a state can trigger it. That will depend on the state law where you reside.
And finally, cash. If you’re planning to keep the money all offshore, and nothing else is a problem, then you have a shot at paying no US tax. Otherwise, you’ll pay something.
Of course, that’s all the simple version of how it works. There a lot of other plans that may work as ways to bring some cash in to cover expenses, for example. But if you live in the US, have employees in the US, make sales to people in the US, the simple foreign corporation isn’t going to work.
It bears a separate mention on the fact that you have dual citizenship, with one of those being as a US citizen. The way dual citizenship works is that you are a citizen of your home country when you’re in that country. So, if you were an Australian, for example, as well as a US citizen, you’d be Australian in Australia and American in the US.
There is a lot of complexity with foreign accounts. Make sure you’re following the best strategy with proper implementation and impeccable compliance so you don’t end up in trouble.