Day 12: Step #5, Understanding The Tax Implications Of Your Move Overseas

What About Your New Tax Liability In Your New Country Of Residence?

Dear Student,

Yesterday, I walked you through a plan for setting yourself up as an employee of your own corporation. As I explained, follow the structure I detailed in yesterday’s lesson, and (as a legally non-resident American—that is, as an American residing full-time outside the United States) you can legally, compliantly, and comfortably earn up to US$105,900 per year (per person; if you’re a married couple moving overseas together, double it) completely tax-free.

In fact, though, I need to qualify that statement. Follow the strategy I detailed for you yesterday, and, as an American abroad, you can legally, compliantly, and comfortably earn up to US$112,000 (2022) per year completely free of any U.S. tax.

However, because you’re an American residing abroad, you may have another jurisdiction’s tax code to worry about.

Today, therefore, I’m going to walk you through the fundamentals of addressing any tax obligation you may acquire in your new country of residence. This information and advice, to do with how you address, plan for, and mitigate any local tax burden in the country where you take up residence, applies to any foreign resident, not only to Americans abroad.

First let’s define the various ways that countries tax income. The United States is one of a handful of countries that taxes its citizens on worldwide income no matter where they reside. As I’ve explained, one of the big benefits of relaunching your life overseas can be the options and opportunities it can create for you to mitigate (maybe even eliminate) your U.S. tax burden. Notable on this front is the Foreign Earned Income Exclusion, which we’ve discussed.

Most countries, however, tax income based on residency. If you’re living in the country, you’re meant to pay taxes to that country on your income. For the American abroad, this means, again, that you can end up with two tax masters. However, with help from the Foreign Earned Income Exclusion, foreign tax credits, and other tax treaties that prevent double taxation, you needn’t end up with an increased tax burden.

Take France as an example. People generally think that France is a super high-tax jurisdiction. When you do the math, though, you find that, an American living in France, for example, wouldn’t likely pay any more in taxes than he would living in the United States.

First, France has a taxation treaty with the United States effectively eliminating the risk of double taxation. Second, in France you have only the central government tax to worry about, no state taxes. In the United States, you have state taxes in most states, and, in some, you also have a county or a city income tax to worry about. Finally, the way that income taxes are calculated in France (it’s a complicated and unique system) means that your tax rates are greatly reduced if you’re a couple or a family.

Ecuador is another interesting example. Technically, this country taxes residents on worldwide income. They impose a tax on worldwide income… but they don’t collect it. For practical purposes, therefore, as a foreign resident in Ecuador, you won’t pay taxes on your worldwide income but only on income earned in Ecuador (if you have any). This is the reality, but it’s a risk. At any time in the future, Ecuador could decide to invest in the infrastructure necessary to collect the tax they’re constitutionally allowed to impose.

Another approach to taxation is jurisdictional. This is when a country taxes you on income earned in that country only, even though you’re a resident. It is this approach to taxation that creates the biggest opportunity. Residing in a country where taxation is based on the jurisdiction, it’s possible to organize your affairs in a way that can reduce or even eliminate your tax burden.

Panama is a good example of this approach. As a resident in Panama, you are taxed in Panama only on income earned in Panama. It is possible, therefore (easy, in fact), to live in Panama and owe no taxes locally. I walked you through this strategy yesterday. By setting up a non-Panamanian company (for an internet or a consulting business, for example), meaning your income is considered earned outside Panama, you are not liable for Panama tax on it.

Countries that take this approach to taxation are referred to as tax havens. Belize and Uruguay are two other good examples.

Another approach a country can take to taxation is referred to as a remittance-based system. This is when a country taxes you only on income you bring into the country. Income earned outside the country and not brought into the country (not remitted) is not taxable.

This can be a brilliant situation. Imagine that you live in Country A but are paid by a corporation (in another jurisdiction) for work done outside Country A. That income wouldn’t be taxed as long as you didn’t bring it into Country A. Meaning that, in theory, you could earn millions of dollars but remit, say, US$50,000 a year (enough to live on). That’s all you’d owe tax on.

Ireland took this approach to taxation for many years (including the years we were living here), they changed the regulations so that taxation is now based on where the income is earned rather than on where it is paid. When Ireland followed the remittance-based system, many executives of U.S. companies moved to the country, lived and worked there, but were paid in the United States. They were liable for Irish tax only on the money they brought into Ireland to live on.

Note that, the current Irish approach to taxation continues to allow for a remittance approach for income earned outside Ireland. This means that a consultant, for example, or perhaps an oil industry worker, living in Ireland but performing their work elsewhere and paid for that work outside Ireland would owe no tax on that money in Ireland as long as he didn’t bring it into Ireland.

Thailand is the only country on my top havens list for this course with a remittance-based tax system.

All countries charge tax on income you earn in that country, regardless of your residency status. You’re liable for tax on income earned in France or the United States (or Uruguay or Malaysia, etc.), for example, even if you’re not a resident of those countries. This fundamental point has implications for investment income, from dividends, interest, or rental investment properties, for example.

One additional tax to be aware of is what’s termed a wealth tax. This is a tax on your net worth or assets. France, Italy, Argentina, and Uruguay all impose a wealth tax. Depending on your net worth, you can be liable for this tax at some point after establishing residency. In France, for example, the wealth tax doesn’t become an issue until you’ve been resident for five years. Keep in mind, even if you’re not a tax resident of one of the countries listed above, their wealth tax will still apply to any assets held in country with a value exceeding the threshold.