Today's comment is from Mark Nestmann, LL.M., President of The Nestmann Group, Ltd., an international wealth protection consultancy, and the Wealth Preservation and Tax Consultant for The Sovereign Society.
Dear A-Letter Reader:
Around this time of year, you might be a little depressed when you think about the big check you just sent to the IRS. So, do something about it! And while you're at it, why not add an offshore flavor to your tax savings?
Consider the following ideas, which can help you cut next year's tax bill a minimum of 10% and, if you're willing to live outside the U.S., by 90% or more:
* Begin by doing all those things you know you "should" do, like loading up your IRA, pension plan or 401(k) to whatever contribution limits apply. If you contribute only $10,000 for 2006, you could easily save $4,000 or more next April 15. (Incidentally, your IRA is a great way to fund foreign investments, and is one of the only ways U.S. taxpayers can safely invest in offshore mutual funds.)
* Or, consider life insurance, variable annuities and other tax-deferred investments. You won't get a tax deduction when you buy them, but the income from them grows free of U.S. tax. Once again, insurance contracts, if you buy them from a foreign insurance company, offer convenient and potentially tax-deferred access to foreign investments.
These are the easy savings. While you won't save additional taxes using these techniques than you would if you invested only in the U.S., you'll have access to a world of investments that are difficult or impossible to buy in the U.S.
If you want to save even more in taxes, think about starting an offshore business.
Let's say you form a U.S. company that owns and operates a website that sells handmade rugs in Guatemala. Your marketing is successful, and within two years, you're making US$500,000/year after all costs. From those profits, you're paying yourself a US$250,000 annual salary.
The most tax-efficient way to operate a small business like this in the U.S. is probably with an LLC or an S-corporation where all income is attributed to the business owners, and none to the business itself. But even then, assuming this business is your only source of income, you'll pay over $172,000 in federal taxes.
Let's say that instead of forming this business in the U.S., you form it in low-tax Panama and operate it through a Panama international business company (IBC). But to save taxes in the U.S., it must be a genuine Panamanian business. So, you pay someone in Panama—perhaps a secretary or accountant—a salary of $25,000 annually to operate the business. You pay yourself a $250,000 dividend (upon which you'll pay tax). The remaining $225,000 in profits, you keep offshore as retained earnings. If the business meets some stringent requirements, the most important of which is that you don't manage the enterprise yourself, the entire $225,000 can be tax-deferred. Assuming it does, your total savings in federal tax: $79,281.
Of course, most start-up businesses need hands-on management. So if you really want to make this strategy pay off, you'll need to move offshore to a country like Panama that doesn't impose income tax on foreign income. In that case, you can manage the business and legally defer U.S. taxation on the profits, provided that your company:
- Is engaged in an active trade or business
- Operates entirely outside the U.S.
- Doesn't buy products or services from U.S. persons or companies related to you
- Doesn't generate U.S. source income, or, if it does, that income is not "effectively connected" to a U.S. trade or business.
These requirements aren't difficult to meet if you're living offshore and the business income is mostly from non-U.S. sources. The tax picture gets even more favorable when you consider U.S. citizens living offshore can receive a salary of up to $80,000 free of U.S. tax, plus an additional $80,000 for their spouse.
For such an offshore business generating $500,000 in annual profits, living and managing it offshore gives you a total tax savings of more than $160,000! (That's if instead of paying yourself a $250,000 salary, you pay yourself $125,000 annually and your spouse another $125,000. The balance of $250,000 remains tax-deferred in the corporation.)
Naturally, the IRS knows these strategies, both for tax savings in offshore investments and offshore businesses. To begin with, there are complex reporting requirements with which you must comply, and hiring offshore tax experts to do the required accounting can be expensive. And over the years, the IRS has persuaded Congress to erect a series of roadblocks to these offshore tax savings. For instance, as deferred income accumulates within your IBC, you'll need to invest those profits in the business or pay yourself dividends taxable at ordinary U.S. rates. If you don't pay dividends, you may lose the opportunity to defer tax on the IBC's earnings.
So, be careful! Go offshore, but get professional advice before you do.
MARK NESTMANN, Wealth Preservation and Tax Consultant
on behalf of The Sovereign Society
assetpro@nestmann.com
http://www.nestmann.com