Every entrepreneur has a different goal when starting a business. More than anything, the type of business you start as a U.S. expat can make or break your entrepreneurship venture. While some people want a company, others are happy with a sole proprietorship. Often, a sole proprietorship is the simplest option because it costs less to start and requires less paperwork.
Sole proprietorship vs starting a company
A great example of a sole proprietorship is a part-time consulting business. This means you only report your business information to the IRS through a Schedule C. Business information includes:
- Your gross income
- Expenses linked to the income
- The net profit or loss
If your business is at a net loss, you can apply that net loss against other income. If you have a net income, you then pay regular income tax. You also have to consider whether there may be a self-employment tax applicable to that net income. This will depend on your country of residence and whether that country has a self-employment tax exemption treaty with the U.S.
For legal purposes, people often want a more formal business structure. If this is your goal, then you need to set up a company. This may be a very simple straightforward entity where you and or family members own 100% of the shares. Complete ownership of a company also means you control everything concerning the running of the business. This will involve accounting for all your business income and expenses, reporting that income, and paying taxes accordingly.
How you can avoid filing Form 5471
The IRS requires that certain U.S. citizens and residents who are “officers, directors, or shareholders in certain foreign corporations file Form 5471 and schedules to satisfy the reporting requirements of sections 6038 and 6046, and related regulations.”
You can avoid filing Form 5471 if you do not acquire a shareholding of 10% or greater in a non-US company. If you acquire 10% or more of the shareholding of a non-US company, then you will need to report that on Form 5471 for the first year of the acquisition.
I want to know more about US taxes abroad
Can it help if your spouse is not a U.S. citizen?
Having a spouse who is not a U.S. citizen can be of tax benefit when it comes to company ownership. In many cases, we see clients who set up a non-U.S. company and own 100% of the shares so they can run a business outside the country. But that creates a problem because the company is then considered a controlled foreign corporation.
Because a U.S. person controls more than 50% of the company shareholding, the net income of the company is subject to U.S. tax, whether or not that income is distributed to the U.S. person. To avoid this, you and your non-U.S. spouse could each own 50% of the shares. Then, your company will not be considered a controlled foreign corporation.
This will mean that the net income of your company is not subjected to US tax. Rather, the tax is deferred until the income is distributed to the U.S. person. That advantage gives you more control of your company. You can choose the amount and timing of that income distribution and match that with your existing tax requirements to have a more efficient overall tax picture.
Tax filing as a self-employed U.S. expat
Self-employed U.S. expats often show concern when they hear of Form 8858, but they have no reason to worry. Form 8858 is an information return for U.S. citizens with a disregarded business entity or a foreign branch. This form does not mean you will pay any additional taxes. It only gives the IRS more information regarding the business income of a U.S. citizen outside the country.
Think of someone who runs a sole proprietorship outside the U.S. and has a Schedule C. In those cases, we want to file Form 8858 to report that income and the deductions to show the net position. Foreign rental property is also considered running a business outside the U.S. Therefore, it’s appropriate to report it on Form 8858 to give the IRS more information. We file these forms to protect our clients so that they don’t get a penalty from the IRS for non-filing.
We provide tailored tax services for U.S. expats across different regions of the globe. You can book a consultation with us right here for world-class service. Our team of highly experienced expatriate accountants will be happy to help you.