John Lund | Marc Romanelli | Getty Images
Tax planning for Americans abroad – especially small business owners – is about to get a little more complicated.
This is because they now face a new tax that only came into effect at the end of 2017, known as the transition tax.
This new levy – a tax of 15.5% on foreign income held in cash and cash equivalents and 8% on other income – applies to U.S. shareholders of foreign companies, including U.S. owners of small companies based abroad.
The tax “repatriates” the money these companies keep abroad. It applies to cumulative profits and profits of businesses dating back to 1986 and determined at the end of 2017.
Large companies must also pay taxes on cash held abroad, but there are certain good news for them: in the future, they will be able to take advantage of dividends received deductionsaid Richard Tannenbaum, CPA and Head of Global Mobility Practice at Mazars USA.
This means that they can repatriate their dividends without paying taxes.
The development is less than positive for expats with small businesses abroad: their cash flow could be limited by the transition tax, and they are grappling with increased complexity.
“Getting customers to understand the law is the first battle, making them believe you are the second battle,” Tannenbaum said.
Indeed, one of his clients, an American entrepreneur residing in Belgium, pays 35% tax on his income each year. Although he has repatriated some of his earnings, most of the money tied to his business is offshore.
“Many European countries have high tax rates, and their idea is that they have always paid 35% tax, why pay another US tax on top of that? Said Tannenbaum.
Here’s what the new tax means for expatriate entrepreneurs.
Photo by Vadym Petrochenko via Getty Images
Small businesses can keep cash on hand to cover their day-to-day needs, so a 15.5% tax on this pot of assets could put owners in a bind.
“For small businesses, especially businesses started by expatriates, this could put people out of business and be a life-changing negative event,” said David McKeegan, co-founder of Greenback Expat Tax Services.
“If you knew you had to keep $ 100,000 on hand for working capital, it wasn’t taxed by the US, but now the US government is taxing that $ 100,000 at 15.5%,” did he declare.
In addition, the 8% tax on non-monetary profits would affect illiquid assets.
The transition tax is different from the requirement that Americans report their foreign financial assets and accounts, known as Foreign Accounts Tax Compliance Act (FATCA) and the Foreign bank and financial accounts report (FBAR).
“While the FBAR can apply to any individual who has a foreign account, the transition tax applies to controlled foreign companies,” Tannenbaum said.
There is a risk of overlap between the two tax requirements for small business owners: an American who owns at least 50% of a foreign company must already report the company’s offshore bank accounts on FBAR , did he declare.
This same company could also be subject to the transition tax.
Internal Revenue Services offices in Washington, DC
Adam Jeffery | CNBC
To help business owners adjust to the new tax, the IRS allows them to make installment payments during eight years to discharge the responsibility.
During the first five years, a taxpayer would pay 8% of the bill due. Payments would then increase in subsequent years: 15% in the sixth year, 20% in the seventh year and 25% in the eighth year.
“You definitely want to start putting money aside now, assuming you can do it,” McKeegan said.
Individual taxpayers had until April 18 of this year to make the first of eight annual installments of the new tax, but the IRS granted a stay: the agency will waive the late payment penalty if filers make their installment before April 15, 2019.
Meanwhile, business owners who filed a 2017 return without electing to pay the transition tax by installments can do so by filing an amended return by October 15, 2018.
“It will be a push in September to figure that out and put the math in place,” Tannenbaum said.
More personal finance
What expats don’t know about this tax requirement will cost them