The United States is one of the few countries that taxes its citizens based on citizenship rather than residence. This “citizenship‑based taxation” means that, regardless of where a U.S. person lives, a federal tax return must be filed each year. For many expatriates and digital nomads, the system includes a foreign‑earned‑income exclusion of roughly $100 000, which can reduce the U.S. tax burden on overseas earnings.
Recent corporate tax reforms
In 2017 the Tax Cuts and Jobs Act (often called the “Trump tax reform”) lowered the federal corporate income tax rate from about 40 % to 21 %. While the headline rate dropped, several deductions and exemptions were eliminated, so the net benefit varies by company. The reform also introduced the Global Intangible Low‑Tax Income (GILTI) regime, which changes how U.S.‑owned foreign corporations are taxed.
How GILTI works
- Scope – GILTI applies to controlled foreign corporations (CFCs) that are at least 10 % owned by U.S. shareholders.
- Taxation basis – Instead of taxing foreign profits only when they are repatriated, GILTI requires U.S. shareholders to include a portion of the CFC’s earnings in their current‑year taxable income.
- Participation exemption – A 100 % dividend received from a CFC that has paid foreign tax can be excluded, but only up to the amount of foreign tax paid. This partial exemption reduces, but does not eliminate, the U.S. tax on foreign earnings.
- Impact on location decisions – Because GILTI is calculated on a per‑shareholder basis, simply registering a company in a low‑tax jurisdiction (e.g., Puerto Rico, the Virgin Islands) does not automatically shield income from U.S. tax unless the company meets specific asset‑and‑income thresholds.
Puerto Rico tax incentives
Puerto Rico offers a distinct tax regime that can be attractive to U.S. citizens who relocate there:
- Act 60 (formerly Acts 20/22) – Qualified businesses can benefit from a reduced corporate tax rate of 4 % on eligible income, and individuals can receive 100 % tax‑exempt dividends.
- Eligibility – To qualify, the business must meet activity, payroll, and investment criteria, and the individual must become a bona‑fide resident of Puerto Rico (generally requiring physical presence for at least 183 days per year).
- Limitations – Not every company can claim the 4 % rate; the incentive applies mainly to service‑based businesses that generate income from outside Puerto Rico.
Trust structures
U.S. taxpayers sometimes use non‑grantor trusts (often referred to as “grantor‑type” trusts) to manage assets and potentially defer or reduce taxes. Key points:
- Non‑grantor trusts are separate tax entities; income retained in the trust is taxed at the trust level, while distributions to beneficiaries may be taxed to the recipient.
- Potential benefits – Properly structured trusts can provide estate‑planning advantages and, in some cases, mitigate the impact of GILTI by isolating foreign earnings.
- Risks – Trusts are subject to complex reporting requirements (e.g., Forms 3520/3520‑A) and may trigger “throw‑back” taxes if foreign income is deemed attributable to U.S. beneficiaries.
Domestic tax‑neutral options
For businesses that operate primarily within the United States, an S corporation can offer a pass‑through tax structure:
- S‑corp election – Income, deductions, and credits flow directly to shareholders, avoiding double taxation at the corporate level.
- Eligibility – Limited to 100 shareholders, all of whom must be U.S. citizens or residents, and only one class of stock is permitted.
- Interaction with GILTI – Because S corporations are not CFCs, they are generally not subject to GILTI, making this structure attractive for domestic‑focused enterprises.
Practical considerations
- Residency determination – To benefit from Puerto Rico incentives, maintain clear documentation of physical presence, domicile intent, and local ties (e.g., property ownership, driver’s license).
- Compliance burden – Citizenship‑based taxation imposes annual filing obligations (Form 1040, Schedule B, FBAR, FATCA) regardless of income level. Failure to comply can result in penalties and loss of expatriate benefits.
- GILTI calculation – Companies must track foreign earnings, assets, and related party transactions to compute the GILTI inclusion accurately; professional advice is often required.
- Tax planning timeline – Changes to tax law (e.g., potential revisions to GILTI or Puerto Rico incentives) can affect long‑term strategies, so periodic review of the structure is advisable.
In summary, the U.S. tax system’s citizenship‑based approach, combined with recent corporate reforms and the GILTI regime, creates a complex environment for both individuals and businesses. Relocating to Puerto Rico can provide significant tax savings for qualifying entities, while trust and S‑corporation structures offer alternative pathways to mitigate U.S. tax exposure. Careful planning and ongoing compliance are essential to realize these benefits without incurring unintended liabilities.
