We received a lot of calls from small business owners who live and conduct their business outside of the United States. More often than not they are in compliance with the tax and business laws of their country of location, but have not stopped to think about the rules and regulations they must comply with to keep the IRS happy. We are now going to discuss those US tax requirements that any US citizen or permanent resident must comply with in order not to get into trouble with the US Internal Revenue Service.
Sole Proprietor: If you are a sole proprietor you can file for your offshore business using schedule C. But there are other forms such as the Form 1116 which can be used to take credit against your US taxes for any foreign income taxes paid by your business and form 2555 that should be filed (if you qualify as a bonafide resident or under the physical presence test) to exclude up to $87,300 (of your foreign earned income) from US taxes.
Foreign Bank, Financial and Other Monetary Accounts: If at any time during the year you had over $10,000 US (when combining the highest balances in all such accounts) in foreign bank accounts, stock brokerage accounts or financial accounts you must file form TDF 90-22.1 by 6/30 of the year following the tax year with the US Treasury. You must also indicate you had this much in foreign accounts on schedule B of form 1040. Failure to file this form or filing it late (no extensions are permitted beyond 6/30 can result in a penalty of $10,000 per year or more and possible criminal penalties). This form is required of US taxpayers even if they sign on an account belonging to a business entity or somebody else.
This form includes for each account the financial institutions name, account number, country of location and the highest balance in the account for the calendar year.
Foreign Corporation You must file form 5471 if you own more than 10% of a foreign corporation. That form includes information about the foreign entity and its annual income statement and balance sheet. It also includes names, etc. of all other US owners of the entity. If the foreign corporation has defined types of income known as Subpart F income, you must pay US income tax on your share on your personal tax return. Not all income is Subpart F income. You therefore need to consult an international tax expert to determine if the type of business you are operating produces Subpart F income or not. Failure to file this form or filing it late can result in a penalty being imposed of $10,000.
Foreign Partnership or LLC: If you own more than ???? percent of a foreign partnership or Limited Liability Company you must file Form 8865 with your tax return each year. This form reports information on the entity, and includes its balance sheet and income statement as well as you share of the taxable income. Failure to file this form can result in severe penalties.
Foreign Trusts: Some countries such as Mexico require you, as a foreigner, own any real estate in a foreign trust (Called Fideicomisos in Mexico). Failure to file that form or forms with the US can result in a penalty equal to 15% of the value of the real estate in the trust. Forms 3520A which is suppose to be filed by the trustee is due 3/15 following each calendar year end. Form 3520 if required is due as an attachment to your personal tax returns. Some individuals have ignored this requirement and run the risk of being assessed penalties for each year that the form has not been filed. Remember, that the statue of limitations does not run out for assessing taxes and penalties if a form is not filed. Also, you should keep in mind that the IRS is in business of collecting taxes and will do if you have not complied with the laws. It is not in their nature to ignore assessments if the law states you owe taxes or penalties. Currently, if you have not filed this form, it can be filed late and the penalties can be abated. There is not guarantee that the IRS will maintain this position into the future.
Check the Box Election (Form ) The IRS states that certain types of legal entities located in foreign countries (the type and designation varies by country) can make an election to be treated as a “flow thru entity." This means that if you as the US owner of all or part of the entity along with your other US owners can elect to have all of the entities current taxable income or loss immediately taxable on your personal tax return (form 1040). When this election is made it also allows any foreign income taxes paid by the entity to flow thru to your personal return so you can offset the income from that entity on your return with a foreign tax credit for the foreign income taxes paid abroad on that taxable income. It often avoids double taxation on the foreign earning.
You will find that most of the forms previously mentioned are intimidating and complex. They were originally designed for large international businesses which all have large and expensive accounting firms to help them fill the forms out and understand the often unclear and cryptic instructions that go with them. However, for a small business the part of the forms that must be filled out are often not as big as it seems.