16 November 2020
How to Live Tax Free as an American
One of the most common questions we receive from our customers is ¨how can I reduce my taxes?¨ We understand this perfectly well; no one likes to give away their hard-earned money and for U.S. citizens, the tax rates are very high. As we already explained in “Pay Zero Income Tax: The Legal Way” , every citizen is obligated to pay two types of tax: the personal tax and the business tax, these are strictly defined by the country’s tax system.
Does this mean that huge taxes will consume part of your money during your entire life? Well, it depends. If one is ready to give up the American citizenship, one can reduce the taxes to zero.
However, we know that most people won’t make this move as they still want to enjoy the benefits of having an American passport. This group can use several offshore strategies to reduce their taxes, which are usually based on the FEIE.
Foreign Earned Income Exclusion (FEIE)
The Foreign Earned Income Exclusion is the cornerstone of all legal tax reductions for US citizens and green card holders living overseas. In 2020, FEIE allows up to $107,600 of earned income to be tax-free.
This amount increases each year to account for inflation.
To qualify for the FEIE one must meet a couple of requirements. Firstly, you need to spend at least 330 days outside of the US. You can spend all this time in one country or in a few places, however you must be in a foreign country. What exactly does this mean? Any time spent in a sailing boat or in the air won’t be considered towards the required 330 days. Therefore, if you go for a cruise which takes about two weeks you won’t be able to qualify for the FEIE, even if you were sailing far away from US territory.
Secondly, you must earn the money while living and working in a foreign country. The more economic and financial ties to a foreign country you can demonstrate, the better for you.
Every applicant who fulfills the previous conditions must complete Form 2555 or Form 2555-EZ along with the personal tax return. Form 2555 is the standard form, while Form 2555-EZ is for expats who are not planning to use the foreign housing deduction in conjunction with the FEIE.
Does FEIE reduce all types of tax?
Unfortunately, no. Income coming from passive activities such as forex or cryptocurrency trading, stock trading, capital gains, buying and selling of real estate, pension income, rental income, social security benefits, etc, will be taxed without exception.
Some people erroneously believe that if the FEIE reduces their tax obligations to zero, they do not have to file a US tax return. That is not true – Foreign Earned Income Exclusion does not exempt you from the obligation to complete this form.
Puerto Rico ACT 60 (formerly act 20 and 22)
The Puerto Rico Act 60 – Export Services Tax Incentive established in 2012, can provide a good solution for everyone who wishes to lower their taxes but stay in the American community. This program offers corporate tax rates for a mere 4%, 100% tax exemption on distributions from earnings and profits, 50% tax exemption on municipal taxes and 75% tax exemption on municipal and state property taxes (small and medium businesses can receive a 100% exemption during their first five years of operation). Simply speaking – you can save about 90% on your tax burden!
How to qualify?
The Puerto Rican government introduces two possibilities. The first option, decreed in Act 20, involves setting up a company and establishing an office in Puerto Rico.
The second possibility, subject to Act 22, consists in purchasing a property, making a donation to charity and setting up a Bona Fide Residence.
To enjoy the benefits of Act 20, several requirements must be met. The first step is to establish a company in Puerto Rico. If you already have a business in the US, you can sell your assets to your new Puerto Rican company for the transfer of shares or perform a tax-free reorganization of the company into a Puerto Rican LLC or a partnership.
The challenge does not end after opening the company. Each entrepreneur must be aware that only exportable service-based businesses qualify towards act 60. The Puerto Rican authorities presented a list of activities that may qualify for tax exemption, which include Computer software development, Consulting services, Advertising and public relations, Educational and training services, Trading companies, etc.
Once you make sure that your business meets the criteria listed above, we can move on to the next step: to establish an office in Puerto Rico.
The office may be registered in your place of residence or in a separate building, but it must be located in Puerto Rico. If the company makes a profit of $3 million or more, you are obligated to hire at least one full-time employee and provide social security, health care and other employee related benefits.
The government has the right to interview your employees in order to monitor their activities.
The final step in achieving your tax reduction is to apply for a tax concession and obtain a tax exemption decree. You can submit the form here: https://ogpe.pr.gov/freedom/?lang=en or use professional assistance.
Act 22 is dedicated to entrepreneurs whose activities are not on the list of companies that may benefit from tax exemptions. If that is your case, you can choose a second solution and establish a bona fide residence, invest in real estate and make a qualifying donation to a local Puerto Rican charity.
The government has not determined the minimum value of the property that you must purchase. However, it must be your primary residence and cannot be rented.
The charity donation must be at least $10,000, of which a minimum of $5,000 must be donated to a government-approved charity. The other half can be donated to any Puerto Rican charity of your choice.
The last step is to establish the Bona Fide Residence. To qualify, one must spend at least 183 days per year in Puerto Rico, move or open an office there and prove that most of his/her financial and economic ties are connected to the country.
As an evidence you can include having a permanent residence in Puerto Rico and local driving license. We also recommend moving your family and personal belongings to the country.
Written by Magdalena Wczesna
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