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Expat entrepreneurs are facing some unfavorable tax changes. Offshore corporations will no longer take advantage of their retained earnings in excess of the FEIE or Foreign Earned Income Exclusion of the corporation’s tax-deferred.

Although the IRS did not provide specific guidelines on how President Trump’s tax reforms may affect US expats, tax experts agree that retained earnings may be out of the picture. Trump’s tax campaigns allowed multinationals to not pay US tax on profits earned abroad among their international entities. However, those expats with small to medium-sized businesses are the ones taken advantage of. Here are some important related ideas.

American Expats Qualified for the FEIE and Retained Earnings 
An American expat refers to a green card holder or a US citizen residing in another country. Those who are out of the US for 330 days in a year or who had become a legal resident of another country for over a year are qualified for the Foreign Earned Income Exclusion or FEIE.

Before, qualified expats for FEIE can exclude up to $104,100 from their US tax return. This was one of the benefits of being an expat entrepreneur. The $104,100 value can mean tax-free salary or business income. All other salaries and capital gains beyond FEIE is taxable. Traditionally, expat business owners would hold the FEIE excess profits as retained earnings. This will help defer US tax on these profits.

Tax Cuts and Jobs Act
Since the introduction of the Tax Cuts and Jobs Act, there had been major tax structure changes related to US expat entrepreneurs. Expats may now be subject to the following:
– A “toll tax”
– A tax on GILTI (Global Intangible Low-Taxed Income) and BEAT (Base Erosion and Anti-abuse Tax)

These reforms may lead to the loss of the US tax deferral on excess FEIE income. Specifically, these changes lead to the following:
– Payment of US tax at 15.5% of profits gained through foreign retained earnings from previous years which can be done within eight years.

– Elimination of the expats’ option to retain earnings from their foreign corporations

Expats are now mandated to pay tax on profits beyond the FEIE. One expat business owner can earn $104,100 tax-free or a couple working in the same corporation can cut a combined $208,200 off their federal income tax.

A net income of $1 million would mean that the expat only needs to pay tax for the $897,000. The only exemption is those expats living in the US territory of Puerto Rico.

Subpart F Income
A small change to the tax law caused the elimination of the foreign retained earnings. It placed every income (except for oil revenue) under Subpart F of the tax code. Offshore corporations under Subpart F income means they are not eligible to be retained tax-deferred. Shareholders are the ones who pay tax on Subpart F income. The income works like that of the US LLC where shareholders pay the tax whether they receive or not. Generally, a CFC foreign business’s income is now under Subpart F income. It is now taxable as earned income.

Expats also do not enjoy the US tax breaks available for pass-through entities like domestic LLCs and S-Corporations.

Practical Steps to Take
Expat business owners must first pay the previous years’ repatriation tax from the old corporation, then form a new foreign corporation that adheres to the new tax guidelines.

Starting out a new business corporation can help reduce your US corporate tax by up to 50%. Currently, the rate is 21% and can be lessened to 10.5% with 50% credit in some conditions. By 2026 and onwards, the rate will increase to 13.1%. Building a new business structure requires careful planning and a long-term tax plan. It is necessary that double taxation is minimized.

Another way to go around this tax conflict is to change the CFC (Controlled Foreign Corporations) status of the business. A CFC refers to an offshore corporation owned by US citizens, residents or green cardholders. Also, if more than 50% of the business is owned or control by US persons, it can be considered as a CFC.

There are ways to change the CFC status of a business. If you have a non-US partner, you can choose to make each party own 50% of the shares or have 50% control over the business. Another way is to purchase a second passport in another country and then renounce your US citizenship.

But if a US expat business owner wants to retain US citizenship and has a net earning between $500,000 to $1 million per year, moving to the US territory of Puerto Rico can be the solution. Why Puerto Rico? Because Trump’s tax plan does not affect Puerto Rico.

If you move to Puerto Rico and spend 183 days per year there, you can cut up to 4% on your corporate tax. You can also cut your capital gains rate up to 0% on the assets you acquire after you become a resident. The zero percent tax rate can also be used to Act 20 company’s dividends.

Puerto Rico Corporate Tax Guidelines
– A US expat entrepreneur can be the only employee of the business when it is moved to Puerto Rico. Act 20 no longer requires hiring five employees.

– Like other foreign corporations, corporations in Puerto Rico can no more retain their earnings. Tax deferral is no longer available to shareholders of Act 20 companies living in the US. But Puerto Rico’s Act 20 is available to US persons who relocate to the island and stay there for 183 days annually.

A portable offshore US business netting $500,000 to $1 million per year should ideally move to Puerto Rico. This rate applies after considering the fair market salary the business owner has to pay. Puerto Rico will tax this salary at their ordinary rates. Your corporate profits then will be taxed at 4%. These profits can be distributed to the business owner as a tax-free dividend. Upon moving back to the United States, an expat does not have to pay personal income tax on the dividend.

To sum up, the tax deal in Puerto Rico is the opposite of the FEIE. The tax has to be paid on the first $100,000 of the salary and 4% on the excess. For the FEIE, the $100,000 is tax-free and tax is imposed on any excess.

What if an expat business owner does not want to relocate to Puerto Rico? Then the international business should be operated in a low or zero-tax country. To eliminate the Self-Employment tax, expat entrepreneurs should operate inside an offshore corporation. Doing so can also maximize the value of FEIE. An expat then reports the salary through IRS Form 2555 together with the personal return Form 1040.