u.s. expat tax guide – india
Splitting Company Shares with a Spouse for US Citizens in India
Let’s say you married an Indian citizen and decided to set up a private company to help reduce your tax liability. Could splitting shares help you save even more on taxes?
The idea of giving shares to your spouse sounds appealing. After all, if you both own equal parts of the company, you might think this could help split the income and reduce your overall tax burden. However, the IRS sees things a bit differently.
The IRS uses something called constructive ownership rules. These rules mean that even if you give 99% of the company to your spouse and keep just 1% for yourself, the IRS still considers you as owning your spouse’s shares.
Why?
Because you’re married, and the IRS assumes that, together, you effectively control the company.
So, if you own even 1% of the company, and your spouse owns the other 99%, the IRS will say that you “constructively” own 100% of the company.
This is because, from the IRS’s perspective, married couples work together to control their finances, and this extends to owning a business.
What is a Controlled Foreign Corporation (CFC)?
Since the IRS views both spouses as controlling the company, it may fall under the classification of a Controlled Foreign Corporation (CFC). A CFC is a foreign corporation in which US shareholders, either directly, indirectly, or constructively, own more than 50% of the shares.
In this case, even if you directly own only a small portion of the company, the fact that your spouse owns the rest means that the entire company is controlled by you as a US citizen.
Being classified as a CFC means there are additional tax filing requirements, such as Form 5471. You may need to file detailed reports about the company, including its income, expenses, and ownership structure.
While you might not always owe taxes on the company’s income, the filing requirements remain in place regardless of whether there is any tax liability.
Does splitting shares reduce filing obligations?
Unfortunately, splitting shares between you and your spouse does not reduce your filing obligations.
You will still need to file Form 5471 for the company, as well as Form 8858 if applicable. These forms provide detailed information about your foreign business to the IRS.
Even if your spouse owns a significant portion of the company, the IRS still requires that you report the entire company’s information.
That said, splitting shares can sometimes be beneficial when it comes to distributing income. For example, if the company earns US$100,000 in profit, you could choose to take US$50,000 as a distribution and give the remaining US$50,000 to your spouse.
This means that instead of being taxed on the entire US$100,000, you would only be taxed on the US$50,000 that you personally received. Your spouse would be taxed on the other half, depending on their tax situation.
Why professional tax help is essential
These tax rules can be quite complicated, and there are a lot of forms involved. Many people think they can use free tax software to handle their filings, but these programs often don’t cover the specific forms needed for foreign corporations.
For instance, while the software might inform you about Form 5471, it might not mention Form 8858, which is often required as well. Additionally, if your company has foreign bank accounts, you might also need to file an FBAR (Foreign Bank Account Report) or Form 8938 if the account balance exceeds certain thresholds.
Each of these forms carries significant penalties if not filed correctly. For example, missing just one of these forms can lead to a US$10,000 penalty.
If you miss three forms, you could be looking at US$30,000 in penalties, even if you filed Form 5471 correctly. This is why working with a tax professional who understands international tax laws is so important.
How can splitting income benefit you?
Let’s say the company has retained earnings of US$100,000. If you are the sole owner, you would be responsible for paying tax on the entire amount. However, if you split the ownership with your spouse, you could each take US$50,000, which may result in lower individual tax rates depending on your circumstances.
By distributing income between you and your spouse, you may be able to take advantage of lower tax brackets or other tax benefits available to your spouse.
This can be especially helpful if your spouse is not a US citizen and has a lower tax rate. However, it’s important to remember that the filing requirements remain the same, regardless of how the income is split.
Should you consider becoming an employee instead of self-employed?
If you’re self-employed, you might also want to consider setting up a company and becoming an employee of that company.
This approach can offer some tax benefits, such as reducing self-employment taxes and allowing you to take advantage of the Foreign Earned Income Exclusion (FEIE). By setting up a private limited company, you can pay yourself a salary, which can then qualify for FEIE, allowing you to exclude up to US$126,500 of foreign-earned income from US taxes in 2024.
This is something that tax software won’t tell you—you need a proper tax strategy to maximize your savings. A professional tax advisor can guide you through this process, helping you set up the company and understand the tax advantages of becoming an employee rather than remaining self-employed.
By distributing income between you and your spouse, you may be able to take advantage of lower tax brackets or other tax benefits available to your spouse.
This can be especially helpful if your spouse is not a US citizen and has a lower tax rate. However, it’s important to remember that the filing requirements remain the same, regardless of how the income is split.
