U.S. Taxes for Worldly Americans: The Traveling Expat's Guide to Living, Working, and Staying Tax Compliant Abroad by Olivier Wagner

Author:Olivier Wagner [Wagner, Olivier]
Language: eng
Format: epub
Publisher: Identity Publications
Published: 2017-02-01T00:00:00+00:00

UNDERSTANDING SUBPART F INCOME

Until 1962, one could create a foreign corporation and defer taxation on its income (especially passive income) until the corporation was sold. Furthermore, it would convert regular income into long-term capital gains (taxed at a lower tax rate). Congress passed provisions to prevent this deferral. The part of this code that does the excluding is called Subpart F. The basic premise is that income earned by the corporation is taxed to the shareholder even if it was not distributed.

Enacted in 1962, Subpart F tightly regulates income earned by Controlled Foreign Corporations. The two broad categories of income classified as Subpart F Income include income earned outside the company’s country of incorporation [“Foreign base company income (FBCI)”] and passive income [“Foreign personal holding company income (FPHC)”]

Whether the income is from rents, royalties, interest, dividends, sales or services, you will end up owing under Subpart F. To the extent that these gains were not distributed, they would have to be listed as part of your individual return. There are a few exceptions to this rule. For instance, if you paid taxes to a foreign country equal to 90% of what you would pay in the U.S., it is not considered Subpart F Income (since the top tax rate is 39.8%, that means a foreign tax rate of 35.82% or greater). Also, regular operating income earned within the country of incorporation is not considered Subpart F Income, but importantly, the work you performed for the corporation (“Personal Services Income”) is.

The Foreign Tax Credit applies to any taxes the CFC may have paid to its host country – the taxpayer can claim his/her share of FTC as if he/she had paid it himself/herself.

Another thing to watch out for is the fact that the sale of real estate is taxable under U.S. tax rules. In many countries, these sales may be tax-free. As such, you wouldn’t be able to offset it with a Foreign Tax Credit. There are some notable exceptions available on the U.S. side, but it should ideally be broken down on a case-by-case basis. If you’re not sure if there are any exceptions which apply specifically to you, contact me through my website and we’ll go over your situation together so nothing is missed.

Digital nomads can avoid having to pay into Social Security by being the employee of their own foreign corporation. The wage would equal what would otherwise be net income, and as such, there wouldn’t be any income to be treated as Subpart F Income. It would otherwise be Subpart F Income – “Personal Services Income” to be specific.

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