The Transition Tax for US Expat Business Owners
All American citizens and green card holders who had income over $12,200 (in 2019), or just $400 of self-employment income, have to file a US tax return in 2020.
This is due to the fact that the US taxes based on citizenship rather than on residence the way most other countries do.
US expats also may have to file an FBAR to report their foreign bank and investment accounts, and also report their foreign registered businesses.
Tax credit and other provisions are available to reduce expats’ US individual and corporation tax bills, so most expats don’t end up paying any US tax, although they always have to file to claim these measures and report their business interests and their corporate and personal income.
Up until the 2017 Tax Cuts and Jobs Act (often referred to as the Trump Tax Reform), foreign registered businesses were exempted from paying tax on their company profits until these profits were extracted from the business (in the form of a dividend for example).
A number of large US corporations in particular tech firms such as Apple and Microsoft, were taking advantage of this rule though by registering offshore in low corporation tax countries and leaving their profits in the business over many years, forming as huge, un-taxed offshore cash piles. In some cases American owned companies were sitting on hundreds of billions of dollars’ of US profits without paying any US corporation tax.
To remedy this, the 2017 Tax Reform introduced two new taxes. The first was a tax on a new category of corporate income called GILTI (Global Intangible Low Taxed Income). This meant that offshore registered firms owned by US citizens (or entities) would pay a tax on their future profits.
The second new tax is known as the Transition or Repatriation Tax.
The Transition Tax is a one-off 15.5% tax on the retained earnings (i.e. the past profits that haven’t been extracted) of American owned offshore registered corporations.
The new tax has not only affected large American firms like Apple, but also tens of thousands of foreign registered small businesses owned by American expats.
The Transition Tax was unavoidable for these expats, and it has provided a blow to both firms and owners. These expats have incurred a further cost in that they have also had to restructure to become as tax-efficient as possible going forward.
One American expat small business owner is fighting back though. Israel based tax attorney Monte Silver has been taking on the IRS in the US courts on the grounds that they didn’t consider the impact on small businesses when drafting the Tax Cuts and Jobs Act, as they are legally obliged to when creating new laws. So far at least, his case seems to be having more success than anyone anticipated.
