Establishing a Business Abroad, Guatemala

Many U.S. expats operate their own business while living abroad. In this article, we discuss the advantages and disadvantages of establishing a foreign corporation from the standpoint of U.S. taxes.

The Tax Corner

by John Ohe (IRS Enrolled Agent).

This is a dense topic. Therefore, we will be highlighting only the main points.

Expat businesses generally fall into two categories:
• A local business primarily serving residents of the host country;
• A business primarily serving U.S. customers or international customers (outside of the host country)

Expats with local businesses often set up a foreign corporation. For example, a Sociedad Anonima (S.A.) is a common business entity in Guatemala. The business pays taxes to the local government and is not subject to U.S. tax laws. However, U.S. persons are individually subject to U.S. taxes on their wages and any dividends received.

Generally speaking, U.S. expats with a local business should take a salary rather than dividends in low tax rate jurisdictions, such as Guatemala. The principal reason is that the foreign earned income exclusion can eliminate up to approximately $100K in wages from taxable income.

Dividends, however, are 100 percent taxable by the IRS (although the U.S. tax liability can be offset by foreign taxes paid). If earnings from the business exceed $100K, then it may be beneficial to take $100K in salary first, and pay the remainder in dividends or retain the earnings within the company (a great option). Retained earnings are not taxable by the IRS until distributed as dividends to U.S. persons.

Expats with businesses that primarily serve U.S. customers or international customers often operate without establishing a foreign corporation. Depending on the size and nature of the business, one may be operating as a sole proprietorship or through a U.S. entity (e.g., LLC, S-Corp).

There are two critical issues for operating a business without the use of a foreign corporation. The first is that U.S. expats continue to be subject to FICA (Social Security and Medicare tax). The second issue has to do with the foreign earned income exclusion (FEIE).

The IRS does not allow self-employed individuals (i.e., sole proprietorships and single-member LLCs) to exercise the foreign earned income exclusion on net income. Rather, the FEIE is based on gross income. The calculation is somewhat complex and beyond the scope of this article.

Given the issues mentioned above, an increasing number of U.S. expats are setting up foreign corporations in favorable tax jurisdictions. In the Western Hemisphere, Belize and Panama are popular destinations because they do not tax non-residents.

Therefore, one can establish a corporation in Belize and pay zero taxes to the Belize government (provided the person does not reside or generate income in the country). The U.S. expat can pay him/herself a salary up to the FEIE without owing U.S. income tax. Lastly, there are no FICA taxes owed.

The main disadvantage of a foreign corporation (whether one has a local or international business) is the increased reporting requirements demanded by the U.S. government. For more information, google “Form 5471.” There is a plethora of information online.

This article was written by John Ohe (IRS enrolled agent and chartered financial analyst). John is a partner at Hola Expat, which specializes in preparing tax returns for U.S. expats. If you would like to submit a tax-related question, email: info@holaexpat.com

Disclaimer: The answers provided in this article are for general information, and should not be construed as personal tax advice.
Tax laws and regulations change frequently, and their application can vary widely based on specific facts and circumstances.