An Expatriate Small Business Owner’s Letter to the IRS
Dear IRS,
My name is Jenny, and I’m one of millions of American citizens living abroad*. I met my Canadian-born husband Frank while in college in the U.S., and I returned with him to Canada so he could work in his family business.
As you well know, as a U.S. citizen, I am required to continue to comply with U.S. tax law – and of course Frank and I also need to be compliant with Canada tax law. I should add here that I am a proud small business owner. Several years ago, I became an on-line exercise coach. For $19.99 per month, you can join the Wi-Fi workouts I run from our house.
Frank suggested that I incorporate to reduce my personal liability, so I set up a Canadian company. It pays me a bit of a salary, but I leave some of the income in the company every year to build up a nest egg (like for when I need new equipment). I get a beneficial small business tax rate of around 12% in Canada, and I have, until lately, been able to avoid paying U.S. tax on earnings I kept in the company – so I felt that things were working out OK from a tax standpoint.
I guess I don’t need to tell you that the new tax reform was a game changer. On my 2017 tax return, I was required to include in my taxable income all of the historic earnings of my company (called a transition tax). Fortunately, that inclusion came with an incentive tax rate – and I can now take cash out of the company equal to the included earnings without further U.S. tax. However, due to the complexity of the calculations (even after you put out those handy worksheets), I ended up using a tax preparation firm.
I was hopeful of taking the return “in house” again for my 2018 return, but when I got into the nitty gritty, I realized it wasn’t going to be possible as a result of the following:
- A new regime called GILTI that requires me to report my annual company earnings on my U.S. tax return (converting the income to U.S. tax rules!);
- An election under Internal Revenue Code (IRC) §962 that allows me to use my Canadian tax to offset U.S. tax on the GILTI income – with the result that I can defer most of the U.S. tax until the earnings are distributed (which was what I was doing before the tax law changes);
- A substantially expanded Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations, that includes numerous new schedules – and if I don’t get it right, I can be fined $10,000.
To complete my 2018 return, I paid $600 for the Form 5471, $800 for the IRC §962 election, $200 for the GILTI form, and $200 for some new forms related to my 2017 transition tax inclusion (you got those out a little late – but I get we are all busy). Plus, I had the normal Form 1040 and bank account reporting. So because of my company, I had to pay an additional $1,800 of tax preparation fees – and I ended up owing almost nothing in U.S. tax. That’s a lot of $19.99’s.
So here are my “asks” on behalf of all expatriate small business owners:
- Create a simplified Form 5471 for individuals (and particularly small business owners) – something more aligned to the pre-2018 form. I know we will still need to do all the math, but it would be a relief not to need to show all our work in Fortune 500 detail.
- Provide a simple form for the IRC §962 election (or a workbook like you provided for the transition tax) that can bring the compliance cost down. The instructions to the Form 1040 suggest I can attach a mere statement, but I ended up with several corporate forms in my personal tax return that were well beyond my comprehension – and seem like overkill.
- Update helpful Publication 54 to include guidance for me and the many thousands of other U.S. citizens abroad who own foreign corporations – include sample completed forms so we can try to work through it ourselves (and get it right).
We expatriates have a much longer wish list (including adopting residence-based taxation), but for now I could really use some relief from the complexity and paperwork these new international laws have created.
Thanks for your consideration – and keep me in mind for your fitness needs.
Jenny
*Jenny is a composite example of thousands of American small-business owners residing abroad. This article illustrates the cost and complexity of filing requirements for small businesses overseas and the type of reliefs that are available.
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