“Global tax” is a term commonly used to refer to someone’s total tax liability across multiple countries and jurisdictions.
We’re about to go through the most important information about the international tax system including
· How it works
· Strategies for tax reduction
· Who to trust with your tax planning and tax preparation
… plus a lot more.
International Tax In A Nutshell
Let’s cover some basics about the international tax system to help you better understand your global tax obligations.
International tax rules must be accounted for when someone:
· Moves abroad
· Engages in cross-border transactions
· Holds assets in foreign countries
One of the most important considerations in determining your global tax liability is your physical location.
Most countries have a territorial tax system – meaning, you are taxed based on where you live.
At times, things can get tricky as some countries have different rules based on your tax residence (where you live) compared to your tax domicile (where you consider “home”). The two are not necessarily the same.
For most people, it’s possible to move to a no-tax jurisdiction and all earnings will be tax-free.
Unfortunately, the same is not true for US citizens because America has a citizenship-based tax system – meaning, US citizens are taxed on their worldwide income regardless of where they live…including so-called “tax haven” jurisdictions with no personal income tax!
With careful planning, Americans can reduce their tax bill when living abroad.
But America’s citizenship-based tax system leads many US citizens to expatriate to achieve their global tax goals – this is discussed in greater detail in a separate section below.
Regardless of your citizenship(s), setting up an entity like a corporation, LLC, etc. in a no tax jurisdiction is often a necessary step in reducing your global tax liability.
But caution must be exercised as not all “tax haven” jurisdictions are created equal.
Don’t be misled by movies and media. Initiatives launched by institutions like the European Union (EU) and the Organisation for Economic Co-operation and Development (OECD) are reducing the usefulness of popular so-called “tax havens” and preventing other jurisdictions from rising to prominence.
In short, these initiatives limit your ability to legally book profits in the low tax jurisdictions. As a result, profits must then be booked in jurisdictions with higher tax rates.
Selecting the appropriate jurisdiction to incorporate is critical – not only to achieve your tax goals but also in terms of ease of use. EU and OECD initiatives have made it extremely difficult to bank and transact from entities from many “tax haven” jurisdictions.
Trusts and foundations are powerful tools that can help reduce your global tax liability while also providing asset protection.
With all things international, tax treaties are critically important to proper planning and tax compliance.
In short, tax treaties govern how transactions between two countries are to be handled.
Frequently, tax treaties offer incentives like reduced tax rates on qualifying transactions.
Engaging in transactions between two countries without a tax treaty is perfectly legal but is generally undesirable.
Often, both countries will attempt to tax the profit that results from the transaction.
Tax treaties often provide a system of “tax credits” where one country agrees to reduce your tax liability due to the taxes paid in the other country.
But if no tax treaty exists, you could be “double taxed” – meaning, you owe full tax in each country.
Obviously, this is rather inefficient and will increase your global tax bill.
International tax consultant
Now that we’ve covered the basics, it’s time to discuss international tax consultants – the people who can help you achieve your global tax goals.
An International tax consultant should not merely record your financial affairs for a given year. Rather, they are proactive and can help you strategically plan ahead.
It’s a consultant’s job to analyze how the tax systems of the relevant jurisdictions interact.
They figure out ways to optimize for tax reduction and possibly reduce financial reporting requirements and compliance costs if desired by the client.
After strategizing and implementing a plan, many international tax consultants also prepare returns on an ongoing basis.
In general, an international tax consultant has some formal training in tax and/or international tax laws. They often have certain academic achievements like earning a JD, LLM, or CPA.
Given the complexity of international tax rules, it’s extremely beneficial to hire an international tax consultant with many years of experience.
Buyer Beware!
Unfortunately, many tax preparation firms do not set their consultants and clients up for long-term success.
First, many firms do not actually connect the clients with the tax preparer.
The clients only speak with a customer service representative who then relays information to the preparer.
Second, many firms hire tax consultants on a seasonal or part time basis.
Increasingly, tax consultants are free-lancers who often have gigs with multiple firms.
This makes it rather difficult to speak with an actual tax expert rather than a customer service representative throughout the year.
Plus, clients often end up with a different tax preparer every year.
This impersonal business model can lead to big mistakes.
A Better Way
It’s beneficial to choose a firm with full-time tax consultants making it easier for you to get in touch should an issue arise at any point during the year – not just tax season.
Ideally, your consultant will be assigned to you – meaning, they will be preparing your return year after year.
There is another way international tax consultants distinguish themselves from the rest – they look out for their clients year round. Especially, for clients that need to file a US tax return with the IRS.
Unfortunately, the IRS makes lots of mistakes when calculating someone’s tax liability. This leads the agency to wrongfully assess penalties and interest.
Your international tax consultant should have you sign a power of attorney that gets submitted to the IRS.
This allows your consultant to be included on all communications from the IRS. This is especially beneficial to people who regularly travel as the IRS uses regular old snail-mail to communicate. You don’t want to be travelling while an important notice is sitting in your mailbox.
Your consultant should catch any errors before they grow into costly and large problems.
Global Tax Management
Yes, Fortune 500 companies have teams of lawyers and accountants strategizing and tracking every move to help with global tax management.
But as we discussed above, multinational individuals and small business owners often need help with global tax management as well.
Making sure you get the help you need before making a major life change is important.
It’s a common mistake for people to take actions and deal with the consequences later.
Unfortunately, this approach is backwards.
It’s best to plan first and take action second.
Here are some questions to consider before making a big decision:
- What is the tax impact of leaving my home country?
- Will I be subject to an “exit tax”?
- What is the tax impact of moving to a certain country?
- How will that country tax my foreign income and assets?
- What is the tax impact of purchasing assets located in a certain jurisdiction?
With taxes, actions can rarely be undone.
Failing to plan for these issues and many others will often lead to an increased overall global tax liability.
Many people understand that they need help with their taxes.
But they often take an approach that leads to global tax inefficiency.
Typically, someone has a domestic tax advisor in their home country.
After moving themselves or assets to another jurisdiction, they seek out another domestic tax advisor.
Frequently, these two tax advisors never speak with one another.
They are often unaware of the international tax rules governing transactions between the two countries. It’s common for domestic tax advisors to recommend a strategy that achieves a goal in one country but has a negative impact in another.
A more effective approach for global tax management is to hire a single advisor or institution to design and help implement a centralized plan or “blueprint.”
Naturally, this requires an international tax consultant with years of experience and considerable knowledge of how the laws of every relevant jurisdiction interact.
They will take a broad perspective and see how a particular move will impact your global tax liability on the whole – not just in one particular jurisdiction.
“Blueprints” and plans can become rather complex. Their designer will often need to hire other professionals located in the relevant jurisdictions to help with implementation. The designer will provide these other professionals with a defined and specific role and should oversee their work.
A centralized plan created by a single advisor or institution is the preferred strategy for global tax management as it is the most efficient way to reduce your global tax liability.
Above, we mentioned how your international tax consultant should monitor your status with tax agencies.
But they should also monitor tax rules and regulations as they change on a daily basis.
Your tax consultant should ensure that your global tax plan complies with all relevant rules. They should come to you with proposals for changes if needed.
Expatriation Taxes: Basics & Strategy
As mentioned above, Americans are taxed based on their citizenship.
This leaves them at a disadvantage compared to citizens of virtually every other country.
Expatriation is the act of renouncing US citizenship – this is the only way to formally and legally cut ties with the US tax system.
For some, expatriation is the only way to achieve their global tax goals.
What Are Expatriation Taxes?
The IRS has two classifications for expatriates: “covered” and “non-covered.”
“Covered” expatriates are subject to the so-called “exit tax” or “expatriation tax”
What’s The Difference Between Covered and Non-Covered Expatriates?
Covered expatriates include anyone who:
· fails to certify that they have been in tax compliance for the five years prior to the expatriation
· Has a net-worth of $2 million USD or more
· Had an average net annual income tax liability of $172,000 for the five years prior to the expatriation
Uncovered expatriates include everyone not meeting one of the categories above.
How Are Expatriation Taxes Calculated?
The exit tax / expatriation tax is a mark-to-market tax on the value of unrealized gains and deferred compensation items (like IRAs and other retirement plans).
Essentially, you are treated if you sold your assets on the day before expatriation and you are responsible for tax on the hypothetical gains.
This gain is taxed at “ordinary income” tax rates.
Is Anything Excluded From Expatriation Taxes?
Yes, there is a $744,000 gain exclusion amount for 2021.
Are There Any Tax Breaks On Deferred Compensation Items?
Yes, you are not subject to the 10% early distribution penalty if you are not yet 59 ½ years of age on the day you expatriate.
Can You Reduce Or Avoid Expatriation Taxes?
Yes, in most circumstances it’s possible to reduce expatriation taxes.
At times, it is possible to expatriate tax-free.
There are two primary strategies to reduce or eliminate expatriation taxes.
The first strategy involves making gifts. It’s often advisable to make strategic use of the lifetime gift and estate tax exemption – $11.58 million per person or $23.16 per married couple.
By giving away some of your wealth, less will be included in the net worth and “exit tax” calculations.
The second strategy involves placing assets inside privately held companies.
In short, it’s often difficult to place a value on shares of a private company.
There’s not always a pool of buyers willing and ready to buy, for example, a minority interest in a family run business.
If these shares have no voting rights and limited rights to distributions, they become even less attractive.
The value of your shares will be “discounted” for lack of “marketability.”
Some private companies prohibit the sale of company stock without permission from the board or other shareholders – this could lead to a discount for a lack of “transferability.”
You can find an example and more information on expatriation strategies by clicking here.
When Is Tax Season Over
A critical part of achieving your global tax goals is filing your returns and reporting requirements on time.
So, when is tax season over?
The best answer is: it depends.
When it comes to America, there are some very important dates.
Individuals must file a variety of documents by April 15 (with an available extension till October 15).
This includes
- FATCA Reports (Form 8966)
This is an informational return required for certain US accounts, specified US persons that own certain debt or equity interests in “owner documented foreign financial institutions (ODFFIs), and certain other accounts based on filer’s chapter 4 status.
- Individual Tax Returns (Form 1040)
This is the annual income tax return.
- FBAR (Form 114)
This is an informational return that does not go to the IRS. Form 114 is filed with the US Treasury Department’s Financial Crimes and Enforcement Network (FinCEN). Form 114 is required of people owning one or more foreign accounts with an aggregate value of more than $10,000 at any point during the year.
- Gift Tax Returns (Form 709)
This form is used by US citizens to report gifts made in excess of $15,000. Its also used to report generation-skipping transfer taxes.
Interestingly, both US citizens living abroad and non-resident aliens have unique extension opportunities. There is an automatic 2 month extension for your individual return making your deadline June 15th. You can file for an extension to push the deadline to October 15. Finally, there is a discretionary that may or may not be granted that pushes the deadline to December 15.
Here are the important dates for entity owners and US owners of a foreign (non-US trust).
Deadline: March 15 (extension available till September 15)
- S Corp (Form 1120-S)
This form is used to report the income, gains, losses, deductions, credits of a domestic corporation (or those electing to be treated as an S corporation).
- Partnership Tax Returns (Form 1065)
This form is used to help report the gain or loss in a partnership business. It must appear on each partners’ Schedule K-1.
- Foreign Trust with U.S. Owner Tax Return (Form 3520-A)
This is an informational return for foreign trusts with at least one US owner.
Deadline: April 15 (extension available till October 15)
- Corporation Tax Returns (Forms 1120 & 1120-F)
All domestic corporations (except those exempted under Section 501) must file form 1120 even if they do not have taxable income.
Form 1120-F is the form that must be filed by foreign corporations to report their income, gains, losses, deductions, credits and to calculate US tax liability (such as GILTI).
You can find other important dates by clicking here.
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