u.s. expat tax guide – india
How US citizens in India report self-employment income to the IRS.
If you’re self-employed in India and hold US citizenship or a Green Card, you must file Schedule C along with your 1040 to the IRS. Schedule C is a form where you report all your business income and expenses.
However, if your self-employment income is earned when you’re located outside the US, you also need to file an extra form: Form 8858. This form provides the IRS with details about any businesses you have outside the US, such as income, assets, expenses, and even the value of the business.
This is just an informational form, meaning it doesn’t directly increase your taxes. But it’s very important to file it correctly, as failing to file can lead to significant penalties: starting at US$10,000 and going up to US$50,000.
Once you get hit with these penalties, it’s extremely difficult to get them reduced or removed.
If you’re not sure how to do all this, it’s a good idea to work with a tax professional who knows these forms well. That way, you can avoid any costly mistakes or penalties and ensure everything is done correctly from the start.
Can US citizens reduce their tax burden while living in India?
Yes, there is a way to lower your tax burden as a US expat in India. Instead of being self-employed, you could set up a private limited company in India.
This means that your income and expenses would be reported through the company’s tax return, not as personal self-employment income. Setting up a company changes your tax situation quite a bit, which can make it more favorable.
Why do US Green Card holders consider setting up an Indian corporation (Form 5471)?
The Tax Cuts and Jobs Act brought some major changes. The US corporate tax rate was reduced from 35% to 21%, and this change also affected how foreign corporations owned by US citizens were taxed.
If you own an Indian company, the IRS could tax you on the company’s profits, even if you didn’t actually take any money out of the company.
Before the TCJA changes, if your company made, for example, US$100,000 in profit, but you only took out US$20,000 as salary or dividends, you only paid tax on that US$20,000.
Now, however, the IRS wants to tax the entire profit if you control the company. This caught many business owners by surprise because nobody wants to pay taxes twice on the same income—once in India and again in the US.
What is the high tax exemption and how can it help US citizenship holders avoid double taxation?
The “high tax exemption” is a helpful rule that can protect you from being taxed twice on the same income.
The high tax exemption means that if you are already paying a high rate of tax in a foreign country—more than 90% of the US corporate tax rate—then you don’t need to pay additional US taxes on that income. Since the US corporate tax rate is 21%, the threshold for the exemption is 18.9%.
Most companies in India pay a corporate tax rate of 30%, which is well above the 18.9% requirement. This means that if you set up a company in India and pay Indian taxes, you usually won’t owe anything more to the IRS—as long as you leave the profits in the company and don’t take any distributions. You only need to pay US taxes when you decide to take the profits out of the company.
How can setting up an Indian company help US expats save on taxes?
Let’s break this down with an example. Say you’re in India and your company earns US$100,000 in profit. You would pay 30% tax in India on that profit, which is US$30,000.
Since you paid more than the 18.9% threshold, the IRS will not require you to pay additional US tax on that income until you take it out of the company. This means you avoid paying taxes twice, which could otherwise add up to over 45% of your income.
Instead of being self-employed, you can set up an Indian company and become an employee of your own business. This allows you to pay yourself a salary and take advantage of the Foreign Earned Income Exclusion (FEIE), which lets you exclude a certain amount of your foreign income from US taxes.
You can also use Foreign Tax Credits (FTC) to lower your US taxes even further. If you leave the money in the company, you’re only paying Indian taxes at 30%, with no additional US taxes. This strategy can help you save a lot of money every year.
What are the costs and complexities involved in filing Form 5471?
If you decide to set up a company in India, you will need to file Form 5471 with the IRS. This form provides details about your foreign corporation and can be quite complicated, as it requires a lot of supporting information and schedules.
The cost of hiring a tax professional to handle Form 5471 can be quite high, but in many cases, it is worth the investment. The long-term savings from avoiding double taxation can far exceed the initial costs of setting up and maintaining a company.
