Many people living in the United States have considered starting up a business in a low-tax country. By doing so, they believe that they can reduce their corporate and personal income tax burden. But are they mistaken? Is this actually possible? Read on to find out more about this.

US Tax Resident & Tax Person Status

Every country has its own methods of determining who is a tax resident of that country. Some countries may be more stringent than others in this regard. In the United States of America, factors such as an individual’s US citizenship, or lack thereof, and location of residence play a role in determining one’s status as a US tax resident or tax person. This status also has implications on whether an individual can set up companies based in low-tax countries to conduct business while living in the US.


US Tax Resident Status

In the US, the term “tax resident” is a subdivision of the broader category referred to as US tax persons. US tax residents are foreigners who fulfill the criteria specified in one of two tests. The first of the two tests is the green card test. The green card test makes any foreigner who is a Lawful Permanent Resident of the US at any time during a particular calendar year of the US a tax resident. A Lawful Permanent Resident is defined as a foreigner to whom the US government has granted permission to permanently reside in the US as an immigrant. To attain this status, foreigners generally need to receive Form I-551, often referred to as the “green card”, from the US Citizenship and Immigration Services (USCIS).

People deemed to be US residents for tax purposes under the green card test will continue to be regarded as such unless one of three conditions apply. The first takes place if the foreigner voluntarily renounces and abandons the existing US tax resident status already possessed. The second condition occurs if the USCIS opts to terminate the foreigner’s status as an immigrant. The third scenario in which US tax resident status can be lost takes place if a US federal court judicially terminates the resident’s status as an immigrant.

Foreigners who fulfill the criteria mentioned in the second test, the substantial presence test, are also regarded as US tax residents. According to this test, to be a US tax resident, a foreigner must maintain a long-term physical presence in the US. This is defined as being in the US on a minimum of 31 days during the current calendar year and 183 days during the three-year period that includes the current year and the two years directly preceding it. However, this latter figure does not mean exactly 183 days. To calculate the figure to be used, one has to add the totals of all the days present in the US in the current year, one-third of the days present in the year directly preceding the current year, and one-sixth of the days present in the year directly preceding that.

In certain circumstances, certain days on which a foreigner is present in the US are not counted towards the total to be used under the substantial presence test. Such days include the following: days on which the foreigner commutes from other countries in North America to the US for work purposes if such is a regular occurrence for the foreigner, days on which the foreigner is in the US for less than 24 hours and in transit between two locations outside the country, days on which the foreigner is in the US as a crew member of a foreign vessel, days on which the foreigner must remain in the US because of a medical condition that developed while the foreigner was there, and days on which the foreigner is an exempt individual. Exempt individuals include foreign government-related individuals, teachers, trainees, and students temporarily present in the US under certain visas, as well as professional athletes who are temporarily present in the US to take part in a sports event being held for charitable purposes.

Those who qualify as US tax residents under the green card test at any point during a calendar year but do not meet the criteria substantial presence test for that year will have the first day of their status as a resident set as the first day on which they are present in the United States as a Lawful Permanent Resident. However, foreigners who have been present in the United States at any time during the calendar year as a Lawful Permanent Resident have the option to be regarded as a tax resident for the entire calendar year.

In certain scenarios, foreigners may take steps independent of the green card and substantial presence tests to become tax residents. One way that they may do this is by making the First-Year Choice. The First-Year Choice is a numerical formula under which a foreigner may qualify as a resident under the substantial presence test one year earlier than they would under ordinary circumstances. They could also elect to be treated as a tax resident if their spouse is one. Foreigners may also claim closer connections to a foreign country to become a US tax resident. Finally, foreigners could take advantage of the effects of any relevant tax treaties which may give further definitions of tax residence.

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US Tax Person Status

As has already been mentioned, US tax residents are one of many groups of persons and businesses classified as US tax persons. It is necessary to be able to differentiate those who are tax persons and those who are not because these two groups are treated differently by US tax laws.

Among the persons and businesses who are US tax persons are the following: US citizens, foreigners who are US tax residents, domestic partnerships, domestic corporations, estates which are not based abroad, and trusts if certain conditions apply. People born in US land area, including the US territories of Puerto Rico, Guam, or the US Virgin Islands, are regarded as US citizens for tax purposes. Those residing in the US territories of Commonwealth of the Northern Mariana Islands or American Samoa are not treated as US citizens if they do not already have citizenship. If a court located in the US is able to exercise primary supervision over the administration of the trust and one or more US tax persons are authorized to control all important decisions of the trust, the trust will be regarded as a US tax person.

US tax persons are taxed based on their worldwide income. This means that even if a US tax person lives and works in a country other than the US, this person is nevertheless required to pay US tax if the person’s income earned exceeds the taxable threshold. This rule even applies to those who spent the entire tax year abroad, earned all their income outside the US, and paid tax to the tax authorities in the country they are currently living in. However, such persons often qualify for certain exclusions and tax credits. US expatriates may also avoid double taxation by using the Foreign Earned Income Exclusion (FEIE), Foreign Housing Exclusion/Deduction, and the Foreign Tax Credit (FTC). These methods can do much to reduce one’s tax burden. Federal income tax rates imposed on US tax persons range from 10% to 39.6% of the person’s taxable income, while state income tax rates range from 0% to 13.3%.  All federal tax returns are due by April 15 of each year.

Foreign tax persons include individuals and businesses in the following groups: foreign individuals who are not US tax residents, foreign corporations and their US branches, foreign partnerships and their US branches, foreign trusts, and foreign estates. Persons who are not US tax persons are only taxed on income from US businesses or sources. The tax rate imposed on most non-resident persons is 30% of the person’s gross income. However, this figure can usually be reduced through the use of tax treaties.


Corporate Residence

A US corporation is to be regarded as a domestic corporation, and thus a corporation with US tax person status, if it is organized and created under US national laws or the laws of any of the 50 states of the US. This rule applies equally to small businesses and major corporations alike. Domestic corporations are regarded as residents even if they do not conduct business or own any property in the US. There are also certain statutory provisions that cause certain foreign corporations to be treated as domestic ones. Several of these provisions are applicable for all purposes of the US Internal Revenue Code. Some of them are involuntary, while others are elective.

Corporations which are tax residents of both the US and a tax jurisdiction with which the US is involved in a tax treaty may consult a tiebreaker rule contained within the treaty. This step has to be taken to determine the sole jurisdiction to which the corporation belongs. Such a step must be taken for treaty purposes. However, the corporation’s location as spelled out by the treaty has no bearing on its status as a domestic corporation.

Domestic business entities may default into becoming either a disregarded entity or partnership unless they choose to be treated as a corporation. Disregarded entities have one owner, while partnerships have multiple. Foreign business entities may likewise opt to be treated as corporations or default. Business entities which are treated as corporations are liable to taxation for treaty purposes.

Partnerships and disregarded entities are fiscally transparent for US tax purposes. For these purposes, fiscal transparency means that these entities are not subject to taxation, and the owner or owners of the entity will take into account on a current basis their share of the entity’s income, regardless of whether it has been distributed. The character and source of the income to the owner will also be determined as if the income was directly realized. by the owner or owners. Fiscally-transparent entities may be US tax residents. Fiscally-transparent entities are not to be denied treaty benefits on income derived from abroad as long as the person who accounts for the income derived through the fiscally-transparent entity is a tax resident of the US.


Tax Implications of Setting up Businesses abroad from the US

The information presented has important implications for those who wish to gain tax advantages by setting up a business based in a country with low tax rates while living in the US. For the purposes of illustration, the example to be used here will be that of a US tax person who intends to set up a company based in Singapore. This US tax person will intend to conduct business transactions with the Singapore-based company while living in the US.

The corporate income tax rate in the US is 21%, while Singapore has a corporate tax rate of 17%. The US also has higher personal income tax rates when compared to Singapore. US federal personal income tax rate range from 10% to 39.6%, while Singapore’s highest personal income tax rate is just 22%. So, in theory, the US tax person would not need to pay as high a tax amount by paying corporate and personal income tax to Singaporean tax authorities. However, this is not necessarily the case. Since US tax persons are taxed on worldwide income, this person would also be liable to be taxed by US tax authorities. As this person is living in the US, the person in this example is not able to utilize any of the primary methods provided by US tax authorities to avoid double taxation.

However, if the person in this example is also a Singapore tax resident, the person may be able to take advantage of Singapore’s limited tax treaty with the US. With regard to corporations, this treaty specifies that a tax exemption will be in effect if either or both of two conditions are fulfilled. The first condition is that at least 50% of the value of the corporation’s stock must either be directly or indirectly owned by citizens of the US or any other country which also grants reciprocal exemptions to Singapore tax residents. For the purposes of the treaty, Singapore tax residents include both resident individuals and corporations alike. The second condition is that the corporation’s stock must primarily and regularly be traded on an established securities market in the US or be fully owned by a corporation whose stock is also traded in such a way and which is also organized in the US. As the income earned in this example has its source in Singapore, it also does not qualify for any tax exemptions provided by Singapore tax authorities. Therefore, the person in the example given only gains a tax advantage if the person is also a Singapore tax resident and the business that has been set up fulfills at least one of the necessary criteria.

As a Full Practicing Member of the Institute of Certified Public Accountants of Singapore (ICPAS), Paul Hype Page & Co is able to assist you and your company with its tax prep for Singapore and beyond. Our tax professionals will use their considerable tax knowledge and expertise with tax software to help achieve the best possible results for your company.