Starting a business in the U.S. can be complex, but if you’re a U.S. citizen living abroad and running your own solo business, choosing the best business entity for your company might be enough to make your head spin.
If you want to establish a company while living in another country, here’s a look at what often makes the most sense and the requirements to maintain your business while abroad.
Income reporting requirements when living internationally
When living overseas as a U.S. citizen, you’re required to pay taxes to the IRS and generally follow the same filing dates as if you lived domestically. This holds true even if you are a permanent resident in another country. Taxes apply whether you’re filing for yourself as an individual or with a business entity.
Americans living outside of the U.S. (including Puerto Rico) are automatically granted a two-month extension to June 15th to file an annual tax return. However, this only applies to filing your return. If you owe taxes, they are still due on the regular due date. Paying your taxes after the traditional April deadline may lead to interest and penalties.
Foreign entities for digital nomads and foreign residents
A foreign entity is a term for a business entity that operates in another jurisdiction from its home base. Even though it has “foreign” in the name, that could mean operating in a different state or a different country.
For example, a business established in Colorado with operations in California may have to register in California as a foreign entity. The same may be true of a company registered in Mexico, Thailand or any other foreign country with operations in the U.S. If you’re living and working outside of the U.S., particularly for a long period of time, you may have to register your business in the country where you’ve set up shop. Check local laws where you’re living, even if temporarily, to make sure you stay on the right side of the law.
Tips for digital nomads running a business abroad
For digital nomads living internationally, creating an S Corp based in the United States has several potential advantages. In addition to the tax savings of forming an LLC taxed as an S Corp, you may find additional tax savings.
For example, if none of your income is generated from the United States, the Foreign Earned Income Exclusion (FEIE) may be a source of tax savings. Be mindful of the potential for double taxation when you’re looking to register in the U.S. as a foreign entity. If you’re not careful, you may find yourself paying taxes on your profits in your host country as well as to the IRS.
As an LLC or an LLC taxed as an S Corp, filing as a foreign entity is easy if you live overseas and haven’t renounced your U.S. citizenship. You choose a state for registration and file your paperwork according to the Secretary of State or another department that handles entity paperwork.
You could form your S Corp before moving overseas, start it and have it pay U.S. taxes at the federal and state levels. That said, you should consider your destination country’s business and tax laws and how they apply to an existing business.
Also, be aware that only U.S. citizens can form an S Corp. If you renounce your citizenship, you won’t be eligible.
Steps to create a business entity and stay compliant
If you are a digital nomad or permanently living outside of the U.S., here’s how to make sure your business is in compliance.
1. Decide if you need a legal entity
When you have a business that generates income, it must be reported to the IRS, even if you are a U.S. citizen who lives overseas or are a permanent resident in another country. Unless you renounce your U.S. citizenship, you’re still responsible for filing and paying your U.S. taxes.
New businesses start out as a sole proprietorship by default. As your business grows, it could be smart to upgrade to an LLC or an S Corp, or a combination of the two as an LLC taxed as an S Corp. Additionally, if you are starting a business where it is likely you could be sued, creating a business entity is likely a good option. When managed appropriately, a business entity can shield your personal assets from legal liability.
2. Choose an entity
Aside from deciding to start a business, one of the most significant decisions a business owner makes is the business structure. From a tax preparation perspective, the simplest option is to remain a sole proprietor, as your taxes are submitted as a Schedule C on your individual tax return. However, upgrading your business to its own legal entity can offer tax and legal advantages.
Many solo business owners opt to form an LLC. While an LLC offers liability protection, it doesn’t save you on taxes by default. With a standard LLC, all business income is taxed at your personal income tax rate, and you may be subject to self-employment tax. Check out the advanced strategies here to learn how that works.
To solve this issue, savvy business owners elect to be taxed as an S Corp. Doing so can lower your total tax liability in several ways. Depending on your business income, opting for S Corp taxation can save you thousands of dollars per year.
3. Maintain and file tax reports
Whatever type of business you run, it’s critical to maintain accurate accounting records so you or a trusted accountant can file an accurate tax return. With an LLC or an LLC taxed as an S Corp, you may also have to submit annual filings to your state to keep your business in good standing.
Income reporting requirements for foreign entities
Filing your taxes as an LLC is as simple as completing Schedule C on your individual tax return. You will list your income and expenses, then pay taxes on your profits. There are no additional forms to complete, making it easy for most to file.
For an S Corp, you must file Form 1120S. When completing your 1120S form, you’ll receive a form called Schedule K-1, which is used to complete your personal tax return.
If you have employees, including yourself, you will need to withhold, report and pay employer payroll taxes on a quarterly basis. In most cases, you must file a state tax return in the state your business is incorporated.
Since you will be operating as a foreign entity, you’ll need to file the Report of Foreign Bank & Financial Accounts (FBAR). The U.S. Treasury requires the FBAR to report financial transactions from foreign bank accounts. FBAR’s purpose is to ensure the payment of taxes on income earned in a foreign country by a U.S. resident or business.
Enjoy life abroad as a business owner
Choosing your business structure has a significant impact when you live internationally, not only for tax purposes but also for legal protections for your personal property. As a result, you must take the time to understand the advantages and drawbacks of each entity type so that you can make the right decision for your situation.
Getting the right help, ideally from a tax professional, can save you time and potential headaches, especially if you run into trouble regarding filing the correct forms and staying in compliance with tax authorities. Doing this will also allow you to focus on making your business successful.
