I get plenty of emails promising a “secret” way to “pay no income taxes.” I’m sure you do as well. After all, it’s a status most of us would enjoy. And it’s true: Under the right circumstances, it’s possible to pay no income taxes at all. (Avoiding ALL taxes — including sales taxes, air travel excise, and so on — is impossible, unless you hunker down in a cave on a desert island and live like a hermit.)
To pay no income taxes at all requires a very specific set of circumstances. I know exactly how it can be done.
Although I haven’t avoided paying income taxes altogether, I did avoid paying any U.S. income tax … legally … for more than 20 years. It’s not that difficult … and it can be the world’s best retirement plan if you do it right.
An Open Secret
Want to pay no U.S. income tax, like I did? Read on … and get your passport ready for a trip abroad.
Most countries around the world tax their citizens only on their income earned within that country. They don’t tax income earned abroad, whether from employment, business ventures, or investments.
Not the United States. Uncle Sam taxes us on everything we earn everywhere in the world. (In fact, one tax expert believes U.S. astronauts in deep space would also owe federal income taxes.)
Now, that poses a problem for a U.S. citizen living and working abroad. When I earned income in South Africa for more than two decades, the South African Revenue Service taxed me like everyone else resident in that country. But as U.S. citizen, I owed the IRS U.S. income tax on the same income.
Double tax! OMG!
In its gracious wisdom, however, the U.S. Congress waved its magic wand and decreed that if a U.S. citizen is truly resident abroad — passing a residence “test” set by the inquisitors at the IRS — then a certain amount of their annual income would be “excluded” from U.S. tax. Not a tax credit, mind you: The income itself is simply not taxable by the United States. You still have to file a U.S. tax return, but if you’re under the threshold, your taxable income is zero, zip, nada.
The Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion (FEIE) for 2015 is $100,800 per person, or double for a married couple filing jointly. To qualify for it, your “tax home” — the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual — must be in a foreign country. In addition, you must be:
- A U.S. citizen who is a bona fide resident of a foreign country for an uninterrupted period that includes an entire U.S. tax year (January 1 through December 31). The IRS test for “bona fide” basically measures your “intentions” — whether you regard the foreign country as your true “home.” A big part of it is whether you are considered subject to the income tax of the foreign country;
- A U.S. citizen or green card holder who is physically present in a foreign country for at least 330 full days during any period of 12 consecutive months;
- Or a U.S. green card holder who is a citizen of a country with which the United States has an income tax treaty and who is a bona fide resident of a foreign country for an uninterrupted period that includes an entire U.S. tax year.
Great! But there are two catches. First, the FEIE only applies to “earned” income, i.e. salary income from an employer. It doesn’t include “unearned” income, such as dividends, investments or pension payments. Those are taxable by the U.S. at normal individual rates.
The second catch is that if your salary comes from a U.S. employer, you still pay Medicare and Social Security taxes (7% payroll deduction and 7% paid by you). If you are self-employed with no foreign corporate structure, or a U.S. structure (like a limited liability company), you pay self-employment tax at 15%.
If you work for a foreign employer, however, or you operate your business through an offshore corporation, you can avoid Medicare and Social Security taxes. In either case, you would qualify for the full FEIE and pay no U.S. taxes at all.
But it gets better. If you set up a foreign corporation and pay yourself (and your spouse) a salary from it that doesn’t exceed $201,600, you pay no U.S. income tax OR Medicare and Social Security taxes. Any profit above that can be treated as retained corporate earnings. U.S. taxes on that income are deferred until you take it out as salary. That means you could keep your foreign profits in the corporation until you retire, then draw on it at a rate that keeps you eligible for the FEIE.
How Do You Pay No Income Taxes AT ALL?
What about the Holy Grail: pay no income taxes at all? After all, that’s what the advertisements seem to imply.
As in my career abroad, most people can expect to pay income taxes to a foreign government according to their laws. There are certain countries, however, where you no pay no income taxes: Saudi Arabia, the United Arab Emirates, Qatar, Oman, Kuwait, Bahrain, Brunei Darussalam, Bermuda, The Bahamas, and the Cayman Islands.
If you can wangle a residence permit and a job or business in one of those places, and you qualify for the FEIE or form a foreign corporation, you’ve achieved it: You pay no incomes taxes…legally!
If you want to know more, read my new book How to Stash Your Cash (Legally) … and start packing your bags.
Offshore and Asset Protection Editor