Owning a business in a foreign country means careful planning and execution. H&R Block's Expat Tax Advisors can help you navigate your unique business challenges associated with foreign small business taxes.
You face several unique business challenges, including knowing:
- Local culture
- Local business laws
One of those challenges is the extra tax filing requirements to report your foreign business.
The most basic form of business is a sole proprietorship.
As a sole proprietor working abroad, you file a Schedule C to report the income and expenses of your business. Usually, if you’re operating in the United States, you’re subject to self-employment tax on your net income. Self-employment tax is a version of Social Security and Medicare taxes owed by employees. As an expat, you are generally subject to U.S. self-employment tax for the income you earned abroad through your sole proprietorship. Also, you might even be subject to a similar tax from your host country unless a totalization agreement between your host country and the United States has been reached.
You might know about the foreign earned income exclusion. As a sole proprietor, you can take advantage of this exclusion to the full extent allowed. Any income you exclude requires an equal exclusion of business expenses. Ex: If you can exclude 75% of your gross business income, you can’t deduct 75% of the expenses related to such income.
Even though you must report your income and expenses on your personal return, you might also need to file a separate return reporting your ownership of the foreign business. You must file Form 8858 for any ownership, if you’ve formed a foreign business entity. This is true even though you aren’t taxed at the entity level in the United States or the foreign country where the entity was formed. Contact an H&R Block expat tax advisor for more information on this filing requirement.
You might also operate your business as a foreign partnership. This is a business that you’ve formed with one or multiple other persons outside of the United States that is not classified as a corporation.
Some foreign partnerships must file a separate U.S. return. As a U.S. partner in a foreign partnership, you might need to ensure the partnership files Form 8865. This form helps the IRS to assure your compliance with U.S. income tax laws. The return is informational since the partnership itself doesn’t owe tax. The individual partners must report their shares of the partnership’s income on their tax return.
If you’re an expat in a foreign partnership, you still must report your share of the partnership income on your personal U.S. return, even if the partnership doesn’t need to file a U.S. informational return on Form 8865. It’s crucial for you as a partner to retain significant documentation from the partnership in order to report your share of the income and expenses.
You can also form a corporation in your host country. Your corporation is a separate legal and taxable entity. Under U.S. tax law, the corporation itself doesn’t owe U.S. tax for the foreign income. It also doesn’t file any U.S. returns unless it has U.S. income or is engaged in a U.S. business.
As a shareholder, you usually don’t owe U.S. tax on the corporation’s net income until you repatriate the income to the United States. Using a foreign corporation might help you defer U.S. tax on your business income. There are a number of restrictions on this deferral. For example, many U.S. shareholders in foreign corporations will be subject to U.S. taxes on any passive income generated by the corporation, such as interest or dividends. This is true even though the corporation retains all the earnings. The types of corporate income subject to U.S. tax vary and can be complicated.
You also might be required to file Form 5471 to report your ownership in the foreign corporation, even though you might not owe additional U.S. income tax. This informational return is lengthy and complicated. Contact your H&R Block expat tax advisor for assistance. Your advisor will help you determine whether your corporation is subject to these rules.
Both of these might also apply:
- You owned and operated a business when you lived in the United States.
- You continued to use your U.S.- based business entity to operate in your new host country.
The U.S. domestic entity filing requirements remain the same. This is true even though you live and conduct business in the foreign country.
FBAR and FATCA
You and / or your business entity might have a foreign bank account report (FBAR) and foreign financial account reporting requirements under the Foreign Account Tax Compliance Act (FATCA).