Offshore Taxes 101
I write often about opportunities and strategies for the American abroad interested in mitigating his U.S. tax burden. However, if part of your global diversification plan has you relocating to a new country, you may have another tax burden to address, as well—that of the jurisdiction where you’re becoming a resident.
This is the case, by the way, for any foreign resident, not only Americans abroad.
When sizing up your potential local tax obligation overseas, start by identifying how your target country taxes income. The United States is one of two countries (Eritrea is the other) that taxes its citizens on worldwide income no matter where they reside. Most countries tax income based on residency. If you’re living in the country, you’re meant to pay taxes to that country on your income.
Taxes In France
Take France as an example. People generally think that France is a super-high-tax jurisdiction. When you do the math, though, you find that an American living in France wouldn’t likely pay any more in taxes than he would living in the United States.
First, France has a taxation treaty with the United States, effectively eliminating the risk of double taxation. Second, in France you have only the central government tax to worry about, no state taxes. In the United States, you have state taxes in most states, and in some you also have a county or a city income tax to worry about.
Finally, the way that income taxes are calculated in France (it’s a complicated and unique system) means that your tax rates are greatly reduced if you’re a couple or a family.
Taxes In Ecuador
Ecuador is another interesting example. Technically, this country taxes residents on worldwide income. They impose a tax on worldwide income… but they don’t collect it. For practical purposes, therefore, as a foreign resident in Ecuador, you won’t pay taxes on your worldwide income but only on income earned in Ecuador (if you have any). This is the reality, but it’s a risk. Anytime in the future, Ecuador could decide to invest in the infrastructure necessary to collect the tax they’re constitutionally allowed to impose.
Another approach to taxation is jurisdictional. This is when a country taxes you on income earned in that country only, even though you’re a resident. It is this approach to taxation that creates the biggest opportunity. Residing in a country where taxation is based on the jurisdiction, it’s possible to organize your affairs in a way that can reduce or even eliminate your tax burden.
Taxes In Panama
Panama is a good example of this approach. As a resident in Panama, you are taxed in Panama only on income earned in Panama. It is possible, therefore (easy, in fact), to live in Panama and owe no taxes locally. By setting up a non-Panamanian company (for an Internet or a consulting business, for example), meaning your income is considered earned outside Panama, you are not liable for Panama tax on it.
Countries that take this approach to taxation are referred to as “tax havens.” Belize and Uruguay are two other good examples.
Remittance Based System
Another approach a country can take to taxation is referred to as a “remittance based” system. This is when a country taxes you only on income you earn in or bring into the country. Income earned outside the country and not brought into the country (not remitted) is not taxable.
This can be a brilliant situation. Imagine that you live in Country A but are paid by a corporation (in another jurisdiction) for work done outside Country A. That income wouldn’t be taxed as long as you didn’t bring it into Country A. Meaning that, in theory, you could earn millions of dollars but remit, say, US$50,000 a year (enough to live on). That’s all you’d owe tax on.
Ireland took this approach to taxation for many years (including the years we were living there). Unfortunately, this is no longer the case. Today, taxation in this country is based on where the income is earned rather than on where it is paid. When Ireland followed the remittance-based system, many executives of U.S. companies moved to the country, lived and worked there, but were paid in the United States. They were liable for Irish tax only on the money they brought into Ireland to live on.
Note that, the current Irish approach to taxation continues to allow for a remittance approach for income earned outside Ireland. This means that a consultant, for example, or perhaps an oil industry worker, living in Ireland but performing work elsewhere and being paid for that work outside Ireland would owe no tax on that money in Ireland as long as he didn’t bring it into Ireland.
Thailand is a current example of a country with a remittance-based tax system.
Most countries charge tax on income you earn in that country, regardless of your residency status. You’re liable for tax on income earned in France or the United States (or Uruguay or Malaysia, etc.), for example, even if you’re not a resident of those countries. This fundamental point has implications for investment income, from dividends, interest, or rental investment properties, for example.
One additional tax to be aware is what’s termed a “wealth tax.” This is a tax on your net worth or assets. The list of countries charging a wealth tax is getting shorter and changing regularly. For example, France recently changed their wealth tax to just include real estate assets. Italy has a wealth tax only on financial assets held outside of Italy. However, most people won’t fall under the wealth tax thresholds when there is a wealth tax. Using France as the example again, the tax doesn’t kick in until 1.3 million.
Understanding The Tax Ramifications
While taxes shouldn’t drive your choice for where to base yourself physically, once you have identified the countries that interest you most for your overseas adventures, you need to understand the tax ramifications of becoming resident, starting a business, making an investment, or earning income in each of them.
I recommend, therefore, that you outline your potential taxable income in each country on your favorites list relatively early on in your planning. To do this, you need to understand where your money will come from to pay for your new life. For example…
- Social Security: If this will be your only income, then you probably have nothing to worry about. Most countries don’t tax this kind of retirement income.
- Other retirement income (IRA, 401k, pension): This income may or may not be taxable as retirement income in a country (often not).
- Investment income (dividends, interest, capital gains): Generally these are taxable in the country where they are earned. A tax treaty or tax credit should eliminate double taxation.
- Earned income: Income earned from a job or a business is the most complicated to assess. If you have earned income, depending on where the income is earned and where you are resident, you’ll have some tax planning to do.
Keeping these categories of income in mind, take a look at the tax structure for the countries you’re considering for a potential move. Estimate your potential tax bite for each one and then compare that to what you’re paying back home.