Living abroad can still provide significant U.S. tax relief for citizens who meet the proper requirements. By qualifying for the Foreign Earned Income Exclusion (FEIE) and structuring earnings through an offshore corporation, a U.S. professional can effectively eliminate federal income tax on a sizable portion of income while minimizing other tax liabilities.
Foreign Earned Income Exclusion
- Amount – In 2019 the exclusion covered $105,900 of earned income (adjusted annually).
- Eligibility tests
- Physical‑Presence Test – You must be physically present outside the United States for at least 330 days in any 365‑day period.
- Bona Fide Residence Test – You must establish a genuine residence in a foreign country for an entire tax year; this test involves more detailed planning and documentation.
- Qualified income – Only earned income (e.g., wages, consulting fees, freelance work) qualifies. Passive income such as dividends or interest does not qualify for the exclusion.
- Interaction with state tax – Most states mirror the federal treatment, but a few (e.g., California) may still impose state income tax unless you establish domicile outside the state before leaving.
Remaining U.S. Tax Obligations
- Social Security and Medicare (FICA) – Under the scenario described, wages paid by a foreign corporation to its U.S. employee are not subject to U.S. Social Security or Medicare taxes.
- Health‑care mandate – The individual mandate of the Affordable Care Act is no longer enforced, removing that concern for expatriates.
Using an Offshore Corporation
- Form the entity in a low‑tax jurisdiction (e.g., British Virgin Islands, Cayman Islands). Corporate tax rates can be 0 %, 2 %, or 5 % depending on the jurisdiction.
- Pay yourself a salary from the offshore corporation. The salary can be set at or below the FEIE limit, meaning the amount is excluded from U.S. federal income tax.
- Corporate earnings that remain in the offshore company are taxed at the jurisdiction’s corporate rate (often 0 %).
- Above the FEIE limit – Recent U.S. tax reforms require that retained earnings exceeding the exclusion be subject to a minimum tax, often cited around 10 %, though the exact rate depends on the specific provisions that apply. Proper planning is needed for income in the low six‑figure range and above.
Comparison with a U.S. Corporation
- U.S. corporate tax – A domestic corporation pays a flat 21 % corporate tax on profits.
- Personal tax – After corporate tax, any salary or distribution to the owner is subject to ordinary federal (and possibly state) income tax, plus FICA.
- Potential savings – By moving profits to an offshore corporation and paying a salary within the FEIE, many entrepreneurs report 40 %–70 % overall tax reduction compared with a U.S. corporate structure.
Practical Steps for U.S. Citizens
- Determine eligibility for the FEIE using the physical‑presence or bona‑fide‑residence test. Keep travel logs, passport stamps, and residency documentation.
- Choose a jurisdiction with favorable corporate tax rates and stable legal environment.
- Incorporate the offshore entity and open appropriate banking facilities.
- Set a salary that stays within the FEIE limit to maximize exclusion.
- File IRS Form 2555 (Foreign Earned Income) with your U.S. tax return to claim the exclusion.
- Monitor earnings above the exclusion and engage a tax professional to navigate the post‑exclusion corporate tax rules introduced by recent legislation.
- Consider state residency implications; if you are a resident of a high‑tax state, establish domicile abroad before the year ends to avoid state tax.
Caveats
- The FEIE applies only to earned (active) income; passive income remains fully taxable in the U.S.
- State tax treatment varies; some states may still tax worldwide income regardless of foreign residency.
- The “10 %” minimum tax on retained earnings above the exclusion is a simplification; actual rates depend on the specific provisions of the Tax Cuts and Jobs Act and subsequent regulations.
- Proper documentation and compliance are essential; failure to meet the physical‑presence or bona‑fide‑residence criteria can disqualify the exclusion and trigger penalties.
By meeting the FEIE requirements and structuring earnings through an offshore corporation, a U.S. citizen can legally eliminate federal income tax on a substantial portion of a low‑to‑mid‑six‑figure income while reducing corporate tax exposure. Income above the exclusion threshold requires additional planning, but the overall framework remains viable for many expatriate professionals and entrepreneurs.
