How To Choose Between An Offshore Corporation or Offshore LLC For Entity Type
Since the level of protection in an offshore corporation or an offshore LLC are identical the law considers them equals. There is one basic reason to choose one over the other. An active business should be placed in an offshore corporation and passive investments should be placed in a Limited Liability Company (LLC).
The Offshore Corporation
A business operating overseas allows the US taxpayer to maximize the Foreign Earned Income Exclusion. Earnings can be retained over and above the FEIE amounts. This defers or eliminates any US tax payable on offshore earnings.
- The taxpayer draws a salary up to the FEIE and reports it on their personal tax return. A married couple operating a business can each draw the same salary earning about $200,000 free of US federal taxes.
- If the profits from the business are more than the FEIE then those funds are retained by the corporation and the tax is deferred until they are distributed as dividends, or possibly as salaries in the future if the profits decrease.
- The offshore corporation eliminates FICA, Medicare and other social program payments which can be up to 15% on net profit and are not covered by FEIE.
- A detailed offshore IRS Form 5471 corporate tax return must be filed annually. This requires a profit and loss statement, a balance sheet and some sub forms so there will be some cost.
The Offshore LLC
Offshore LLCs are an ideal option for passive investments. There is no tax break on passive investments in corporations within the US because passive income is taxed when it is earned. This rate is reduced only by the Foreign Tax Credit so making reporting simpler makes sense.
- The offshore LLC has a lower cost for compliance. An LLC usually files IRS Form 8858 assuming it is owned by a single person, or a couple and this is is easier and cheaper to prepare than the paperwork for the corporation.
- The Foreign Tax Credit allows the taxpayer to deduct amounts paid in taxes to other governments on foreign investments, eliminating double taxation on offshore transactions.
- There are no retained earnings in an LLC so it is not used for businesses generating income unless that income will always remain less than the FEIE.
- Total net profits are reported on Form 2555 and if they exceed the FEIE the difference will be taxable.
The difference between the LLC and the Offshore Corporation makes the choice clear in most situations. An active business is usually placed in a corporation, unless it is small enough to be served by an LLC. Passive income is placed in an LLC.
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