Two American Tax Laws That Could Bankrupt U.S. Entrepreneurs or Investors Abroad
By Travis J. Todd, American Entrepreneur and Co-founder of Silicon Allee
Paying taxes in any country is a bit like pulling teeth, but the US tax authority, the IRS, has some opaque policies you may not be aware of which could end up costing you hundreds of thousands of dollars.
Anyone who’s founded a company, or heck, had to pay any kind of tax in Germany knows that the Finanzamt (the German tax authority) is a mess.
I like to picture the German Finanzamt as a room full of monkeys sitting in front of a random number-generator machine. Each monkey gets a tax ID, slams a couple of buttons producing a random positive or negative number, then hits ‘submit’ to get their banana. A couple of days later your bank account is either automatically debited or credited with this amount, no tax advisor I’ve ever hired can explain to a satisfactory level of detail how exactly they arrived at this number. The only light they shed on the matter is: “Yeah, no one knows why. Not even the Finanzamt.”
As an American, I want to rant about my rights being infringed and simultaneously laugh at the irony of a country filled with the most logical and practical people I’ve ever met having the most illogical and random tax system I’ve ever encountered.
But if I did, I’d be a hypocrite.
The US tax system is renowned for being the only one in the world that taxes the income of its citizens living abroad. You have likely heard stories of people renouncing their US citizenship because of this burden, including Facebook co-founder Eduardo Saverin. Most notably, the current Mayor of London, Boris Johnson, who previously had dual British and American citizenship, paid a hefty IRS bill and then renounced his citizenship. In fact there was a 221 percent increase of Americans abroad doing just that in 2013.
While this has been receiving a lot of press lately, it has never been a huge concern of mine as it only affects those making near $100,000 (currently around €91,720) a year. And as a young entrepreneur I regrettably haven’t reached the 1 percent. Even if I had, I have always assumed that the benefits of easy travel to see my family back home would surely be worth the additional effort.
I do know I need to file my taxes living abroad, though. No US tax software is set up for the edge-case lifestyle of an expat freelance entrepreneur. So every year I would download what I thought were the appropriate IRS forms, fill them out as best as I could, saying I earned less than $100,000 and that it was all earned while I was a resident of a foreign country, and call it a day.
Young entrepreneurs tend to think they can do everything themselves. I thought exactly this with my US tax filings. This is the double-edged sword of the entrepreneurial mindset. We will take on any challenge, no matter how unprepared we are for it, with gusto and confidence.
Eventually we learn though. We learn that delegating some tasks we are really not skilled at allows us to focus on those at which we excel. After about ten years of filing my own tax returns, I decided it was about time to take this approach. While focusing on all my other companies in Germany, I realised I had missed the filing (and extension) deadline for my 2013 US income tax return. I didn’t expect much more than a slap on the wrist and maybe a fine of a couple of hundred dollars so I sought out some help. I enlisted the services of a company called Greenback Expat Tax Services which specialises in helping American citizens abroad file their taxes. When I did they uncovered the hornets’ nest of misguided tax legislation that could potentially cripple any American entrepreneur or investor living (or even just doing business) outside the US.
Enter Form 5471
This is an innocuously named document, but one that could have dire consequences to any US citizen holding shares in a company outside the US.
Form 5471 states that if you own more than 10 percent of a foreign (i.e. outside the US) company, you have to declare the income, revenue, expenses, etcetera of this company to the IRS every year. There is very little wiggle room here and a lot of potential issues. And the fine for not filing? $10,000 PER YEAR PER COMPANY! That’s half a year’s salary to a fledgling startup founder in Berlin (if they’re lucky).
In trying to work through and back file all my 5471s for my three companies that barely made any profit each year, I also encountered some really difficult problems with this system. Firstly, while the people at Greenback are a great help, they don’t speak German, and I wouldn’t expect them to. That means I had to go through each Jahresabschluss (Annual Report) and translate it line by line. Then there is the problem of US taxes being due by April 15 of each year and German taxes being due at the end of the following year. This means that I either needed to rush my German accountant into filing my German company’s taxes early at a huge expense or take a guess on the US form. If I’m not the director of the company I hold shares in, for example, as an employee or angel investor, the first option may not even be open to me.
So that tiny 10 percent share that you fought for as CTO of a startup which barely made it to a seed round before going bust could end up costing you $10,000. I’m not an accountant or an economist so I can only speculate at why this policy is in place. It seems like it’s aimed towards big corporate execs with a lot to gain, but it could give pause to any American thinking of starting up or investing in a foreign country.
The FBAR
Sounds like a hip cocktail bar in Brooklyn, right? Unfortunately the Report of Foreign Bank and Financial Accounts is nowhere near as cool. The IRS requires all American citizens who personally hold, or are signatories on, any foreign bank accounts that have an aggregate balance of $10,000 to file an FBAR each year.
Let’s look at that a bit closer. This means if you had access to over $10,000 in a foreign country at any time during the year, you need to file this document. How do you calculate this exactly? Simple: look though your bank statements for every account you had access to (checking, savings, your company accounts) and find the highest balance for the year, add them together, calculate against the yearly exchange rate and if the total is over $10,000, congrats, you get to file an FBAR.
So, that means the tiny startup you ran that received €15,000 in angel cash, combined with your measly foreign checking account, put you way over the limit for this year. Hell, even if you had £5,000 in a UK bank account and the exchange rate was reasonably favourable for the year, you might not be able to afford a two-month lease on a London flat, but you would still have to file this document.
And the fee for not filing an FBAR? Up to $10,000 PER YEAR!
Trying to get up-to-date on my FBARs unleashed a myriad of headaches as well. For starters, anyone familiar with the German banking system knows that a Kontoauszug (bank statement) doesn’t list the balance after every transaction like it would in the US. This means you have to go through each bank account and manually calculate each transaction to find the point at which that account had the most money in it that year. I had to do this for my personal account, the joint account with my wife, my savings account and four accounts for startups where I was a signatory. Some accounts had barely €1,000 in them at their highest point in the year, but since in total they added up to more than $10,000 I had to file a form for each account.
The OK News
I‘m still waiting on the final verdict for the back filings on about six years of US taxes. In the end it’s going to cost me at least $3,000 in preparation fees to Greenback just to file the forms. Hopefully I wont be writing the epilogue to this story from a US prison or poor house but there is a ray of hope for anyone who has developed a knot in their stomach while reading this.
It’s not all gloom and doom. The folks at Greenback let me know there is an “amnesty” program in place with the IRS for filing these documents. If you qualify for the Streamlined Foreign Offshore filing you still have a chance to get these documents in and potentially avoid any big problems. But don’t quote me on that. I’m still waiting for the hammer to fall.
The final thought I’d like to put forward on this is that I know the US State Department is using American entrepreneurial spirit as their latest tool for spreading our good will and values around the globe. I can’t think of a better thing to be doing either, because by teaching others to be entrepeneuers we’re showing them the way to rise up out of poverty, take pride in themselves and their communities and really make a difference. But the US can’t have policies in place that cripple those of us on the front lines. It’s like sending a marine into battle in his underpants.
