Can Expat exclude "earned" Foreign Company Dividends?

  • Thread starter JamesAndCourtney.bowen
  • Start date

J

JamesAndCourtney.bowen

I am a US citizen starting a business and ran into an
interesting IRS tax question: My company would provide
services to mostly-American businesses, but our work would
be done in Malaysia (as a Malaysian Corporation) - I and my
employees would be living and working there. (Malaysia
doesn't have a tax treaty with the USA.). That company will
take its Malaysian income tax-free (based on Malaysian tax
incentives) and will pay me tax-free income in the form of
dividends. (The payment has to be as dividends or I'll be
taxed heavily in Malaysia.) I would like to immediately
repatriate that money to the USA. Ideally, it would be done
in one of two ways:

1. The income is considered earned income by my wife and I.
(We'll both be working full-time for the firm.) We will pay
Self Employment Tax on the income, but will be exempted for
up to $80,000 of income each (total of $160,000 exempted)
from Federal Income tax. Because we won't have residence in
a state, we'll also be exempt from state tax.

2. The income is considered unearned, unqualified dividend
income from a Controlled Foreign Corporation. ("Controlled"
by me, a US-citizen.) I will thus have to pay Federal Income
Tax at my full personal tax rate. However, as it is not
earned (self-employment) income, I will NOT be subject to
self-employment tax / FICA. Again, we'd have no state
residence, and would therefore be exempt from state tax.

In either case, clearly I'm hoping to avoid all of the
following:
1. Paying state income tax for work done outside of the USA.
2. Paying both Federal Income tax (not shielded by the
Foreign Earned Income Exclusion) and Self-Employment Tax
or FICA.
3. Somehow getting stuck paying corporate income taxes
(double-taxation) in the USA since I am the sole
shareholder and a US citizen, and since my company is
selling to US businesses.

I suppose then, the questions are these:
1. Does it matter if do business as an LLC locally (in
USA;North Carolina) while I'm starting the business here, as
long as later on, when I personally work and hire workers in
Malaysia, I keep clear records showing that the work is then
being done in a foreign country, under a foreign company's
name? Do any other steps need to be taken to make sure the
IRS doesn't consider that income to be locally earned or
subject to US Corporate tax?

2. Would my dividend income (which is a dividend on paper
but really earned by my wife and I as full-time workers in
the company) be considered earned income for purposes of the
foreign earned income exclusion?

3. If it isn't earned income (and therefore taxable), does
that mean Self-Employment Tax and FICA are exempted?

(Note, I'd be there for years and would thus meet the tax
home, bona fide residence, etc. tests.) Am I on the right
track here? Or setting myself up for a nasty tax surprise?

Thanks in advance!

Moderator:
It is a priviledge to live in the Promised Land of
North Carolina!
 
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G

Gene Utterback, EA, RFC, ABA

I am a US citizen starting a business and ran into an
interesting IRS tax question: My company would provide
services to mostly-American businesses, but our work would
be done in Malaysia (as a Malaysian Corporation) - I and my
employees would be living and working there. (Malaysia
doesn't have a tax treaty with the USA.). That company will
take its Malaysian income tax-free (based on Malaysian tax
incentives) and will pay me tax-free income in the form of
dividends. (The payment has to be as dividends or I'll be
taxed heavily in Malaysia.) I would like to immediately
repatriate that money to the USA. Ideally, it would be done
in one of two ways:

1. The income is considered earned income by my wife and I.
(We'll both be working full-time for the firm.) We will pay
Self Employment Tax on the income, but will be exempted for
up to $80,000 of income each (total of $160,000 exempted)
from Federal Income tax. Because we won't have residence in
a state, we'll also be exempt from state tax.

2. The income is considered unearned, unqualified dividend
income from a Controlled Foreign Corporation. ("Controlled"
by me, a US-citizen.) I will thus have to pay Federal Income
Tax at my full personal tax rate. However, as it is not
earned (self-employment) income, I will NOT be subject to
self-employment tax / FICA. Again, we'd have no state
residence, and would therefore be exempt from state tax.

In either case, clearly I'm hoping to avoid all of the
following:
1. Paying state income tax for work done outside of the USA.
2. Paying both Federal Income tax (not shielded by the
Foreign Earned Income Exclusion) and Self-Employment Tax
or FICA.
3. Somehow getting stuck paying corporate income taxes
(double-taxation) in the USA since I am the sole
shareholder and a US citizen, and since my company is
selling to US businesses.

I suppose then, the questions are these:
1. Does it matter if do business as an LLC locally (in
USA;North Carolina) while I'm starting the business here, as
long as later on, when I personally work and hire workers in
Malaysia, I keep clear records showing that the work is then
being done in a foreign country, under a foreign company's
name? Do any other steps need to be taken to make sure the
IRS doesn't consider that income to be locally earned or
subject to US Corporate tax?

2. Would my dividend income (which is a dividend on paper
but really earned by my wife and I as full-time workers in
the company) be considered earned income for purposes of the
foreign earned income exclusion?

3. If it isn't earned income (and therefore taxable), does
that mean Self-Employment Tax and FICA are exempted?

(Note, I'd be there for years and would thus meet the tax
home, bona fide residence, etc. tests.) Am I on the right
track here? Or setting myself up for a nasty tax surprise?
I can't address your entire post since I don't do foreign
corporation work.

But I wanted to mention that just because you are living
overseas doesn't mean you are exempt from state tax. You'd
pay no state tax if your last state of residence had no
state tax.

Some states are confirming states - meaning if you get the
Foreign Earned Income Exclusion on the Federal return you
also get it on the state return (Maryland is one of these
states). But there are also states that do NOT honor the
foreign earned income exclusion - California comes to mind.

You should check with a tax pro familiar with your state of
residence to make sure you get it right.

--
 
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