Join Toby Mathis, Esq., as he speaks with international tax expert Jimmy Sexton, LLM., the Founder & CEO of Esquire Group, about unraveling the enigma of offshore banking and its impact on US taxpayers. Despite popular belief, Jimmy reveals that the era of offshore banking providing substantial tax benefits is over, with the true perks lying elsewhere such as asset protection and market access. We navigate through the murky waters of tax evasion myths and scrutinize how various income structures, including disregarded and taxable entities, bear on one’s tax obligations. Moreover, Jimmy illuminates the effects of the GILTI and Subpart F tax regimes on foreign company profits, stressing the importance of understanding the intricate US tax code to avoid hefty penalties and ensure compliance.
- Offshore banking myths vs. reality for US taxpayers
- Tax advantages from asset protection, not tax savings
- Misconceptions about offshore tax evasion
- Implications of GILTI and Subpart F tax regimes
- Complexities of international business operations
- Benefits of Foreign-Derived Intangible Income (FDII)
- Major corporations adapting to tax law changes- Google and Amazon
- Tax reforms encourage repatriation and competitiveness
- Severe penalties for non-compliance with FBAR regulations
- Compliance demands of offshore structures versus domestic
- Corporate Transparency Act and international standards
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Full Episode Transcript:
Toby: Hey, guys. Toby Mathis here, and I have Jimmy Sexton, a longtime friend, colleague. He’s in the world of international tax. We’re going to demystify offshore banking, doing business offshore, and when that stuff makes sense. First off, welcome, Jimmy.... Read Full Transcript
Jimmy: Thanks for having me, Toby. Excited to be here.
Toby: Where are you sitting today? What country is it?
Jimmy: I’m sitting in Vienna, Austria today, but headed back to Dubai tomorrow.
Toby: Yeah. Jimmy spends all his time working with affluent taxpayers throughout the globe, making sure that they understand the difference between different jurisdictions and taking advantage where they can. Is that a fair statement?
Jimmy: That’s a fair assessment, Toby.
Toby: All right. What I want to dive down into is for our US folks. They hear about going offshore, how great it is, and they can move all their money offshore. What’s the reality for those folks? What types of different taxes do they need to be aware of? Does it work that way?
Jimmy: The US tax code has pretty much taken most of the advantages that you can get from going offshore away. There’s not a big tax advantage amount in terms of how much taxes you’re going to wind up paying by going offshore. Usually, the advantages that you’re going to get by going offshore, for example, are going to be heightened asset protection or access to different markets that you wouldn’t otherwise have available to you.
Toby: You’re not doing this to avoid us taxation. When people hear that, hey, you can move your money offshore, you don’t have to pay tax, is that just a bunch of garbage?
Jimmy: That’s just a bunch of garbage. Those days are long, long gone. There are some instances where there can be some tax savings going offshore. If you’re partnered in a company, and you don’t own more than 50%, and the other 50% are foreign people, then you can defer income within the foreign company, for example. That might be advantageous to doing something offshore. Or with some more complex structures, you might be able to get a little bit of a lower current tax rate. But for the most part, there’s no advantage to going offshore from a tax perspective anymore.
Toby: Let’s dive into that for a second. You also have FBAR regs, and you have all these penalties that are going to get you if you don’t disclose. Let’s just say US taxpayers, they hear one of these folks, and they go, let’s go offshore, we’re going to go to the Cook Islands, or we’re going to go to Dubai. They set something up. They put a bunch of their money offshore. What are the taxes that are going to hit them?
Jimmy: It depends on the structure, because as you well know being a tax expert yourself, you have fiscally transparent entities like disregarded entities, where essentially everything just flows through to you, and then you have entities that are viewed as taxable entities by the US. They’re not transparent.
Let’s say for example, you put your income into a foreign trust. In that instance, the US is going to continue to tax you as if you still own those assets. Whatever income those assets generate, you’re still going to have to pay taxes on those in the US, depending on what character it is. Long term capital gains will still be taxed as long term capital gains. Qualified dividends is qualified dividends, interest is ordinary income, so on and so forth.
What I think people oftentimes make a mistake is they’ll invest through an offshore company. They’ll either think that, hey, that income is going to be sheltered in that company until I take it out, which also isn’t the case. They instituted this tax called the GILTI tax, basically two regimes that are out there. There’s the GILTI regime and the Subpart F regime, and both of these seek to tax the profits of a foreign company to the US shareholders.
If you have an offshore company that’s more than 50% owned by US shareholders, if that company is receiving passive income, so rents, royalties, dividends, interest, then that is going to be taxed to the individual US shareholder regardless of whether they receive it. Anything that doesn’t fall under Subpart F is then going to get hung up in GILTI and be subject to tax there. Anything that’s not Subpart F income winds up being GILTI income. For individual shareholders, both of those are going to be taxed at the ordinary income tax rate. There’s not a lot of benefit from a tax perspective.
Toby: I set this up. I set up a corporation. I go to the UAE, because I heard that it’s really low tax or almost no tax. I make some money over there, I think I’m being super smart, and it doesn’t matter. I leave it over there, and I’m thinking, oh, I’m so smart. Your accountant is going to say, hey, you got to treat it just like you received 100% of it here in the US. Is that right?
Jimmy: That’s right. If that foreign company had to pay foreign income taxes, which you now have in Dubai at 9%, it’s the US income taxes on top of the 9%, for example, that the UAE company would have paid.
Toby: Do you get any tax credits for that at all?
Jimmy: You can. This is another mistake you see people make a lot. In most Dubai companies, you can do a check-the-box to have it treated as a disregarded entity. If you do that, then you can take advantage of the 9% paid by the Dubai corporation to offset your US tax. You can use it and get tax credit for it. But if you don’t do the check-the-box and elect for it to be a disregarded entity, then the 9% is just gone.
Toby: You get 9%, then you also get whatever your ordinary. Is it your personal ordinary rate, or is it the corporate rate?
Jimmy: No. It is your individual rate, by default. There is an election you can do under 962 so that you as an individual can be treated as a corporation for purposes of this tax, which would allow you to only pay. Basically, corporations, if they own a foreign corporation, they get a deduction for 50% of the tax rate they pay. If a corporation owns a foreign corporation, the US corporate tax rate would be 21% on the profits of that foreign corporation, but they get a 50% deduction. They’re effectively only paying 10½ %.
The difference is when a corporation takes dividends out of a foreign corporation, they don’t pay any additional tax, because if they own 10% or more of it, you have 100% dividend received deduction. But as an individual, you’d still have the tax when you took a dividend out. Usually, it’s better to check the box and take the foreign tax credit rather than being taxed like a corporation for that purpose.
Toby: Depending on the country, the tax credit should vary, right? It could vary from 100% to something less.
Jimmy: If you take the foreign tax credit as an individual, and you check the box to make your foreign corporation treated like a disregarded entity, then you should be able to use 100% of that foreign tax credit. If however you elect to be treated as a corporation for purposes of the guilty tax, you can only get a deduction of 80% of that foreign tax credit.
Toby: But then the dividend that’s paid out of that foreign company, you don’t have to pay tax on in the US if you’re that company. But if you take it out of the company and you give it to yourself, then you’re just going to be taxed as an ordinary dividend?
Jimmy: Yeah. If you take a dividend out of the US company, ordinarily, it would be a qualified dividend with the maximum of 20%.
Toby: Yup. It’s like your long term capital gains rates. The aggregate tax then, you’re not blowing your doors off. If you don’t check that box, you could be doing yourself some serious harm. It sounds like your ordinary rate, plus you might get hit with another tax over there if you check the box. Maybe you get a credit. Maybe you’re not getting completely shellacked by it, maybe you’re looking at maybe 30%.
Jimmy: Yup. So the other thing that you have to think about is the US reporting you have to do with regard to your foreign activities. The US has a slew of what they call international information returns that generally need to be filed with your personal income tax return or corporate income tax return. Some of them are separately filed to basically disclose all this stuff that you’re doing overseas.
If you don’t check the box with regard to a foreign corporation, you’d have to file Form 5471, which is a super complex form. It’s really long, the calculations, to calculate all this guilty, subpart F, and all this stuff. It’s very complex. Whereas if you check the box and you’re a disregarded entity, then you’d file Form 8858, which is a much simpler form.
To me, in most cases, checking the box and being taxed a disregarded entity in terms of foreign corporations is usually easier and results in slightly better taxation. But one thing I didn’t mention that I would mention is for both of these subpart F and guilty, which are the two sections of the code that seek to tax the foreign profits of a foreign corporation to the US shareholders, is there’s something called the high tax exception.
If a foreign company is subject to foreign income tax of at least 90% of the US corporate tax rate, then you don’t have to pay this GILTI or Subpart F. Basically, you can defer the income within the foreign corporation until you take it out. I think if I remember correctly, 90% of 21% is 19.6%.
Toby: If you’re running a company, again, this is going to be helpful for people out there that are like, hey, I do overseas transactions, what’s my requirement? Am I going to get tripped up? This isn’t for the people that are like, hey, I’m gonna move money offshore and protect it that way, which I would caution against. Let’s just say that that’s the case, and they’re in a country that’s charging the same as the US or more. This isn’t going to hit them, like the GILTI taxes, smack them, and bring it back to the US and make it taxed at ordinary rates.
Jimmy: Not at all. Those people have a little bit of an analysis to do, because if they don’t check the box, then because the foreign corporation is subject to an income tax same as the US’s, they would have no income attributed to them. They wouldn’t have any US tax until they took an actual dividend distribution out of the company. But you still need to analyze it to see if that makes sense, because the foreign corporation is paying the income tax, and then you’re paying income tax again when you take it out. Whereas if you had checked the box, you can take a foreign tax credit for the foreign income taxes paid by the foreign corporation.
Toby: You just have to run the numbers to see whether it’s better. I suppose that if you were in a country that has a higher tax regime, you’re better off just taking the tax credit, right?
Jimmy: In my opinion, for most US people, whether you qualify for this high tax exemption or not, if you’re a US individual, it’s almost always best to check the box if you can. You have the list of per se corporations on which you can’t check the box, so it’s not always possible. But generally, for individuals, it’s going to be better to check the box. For US corporations that own foreign corporations, it’s generally best to not check the box.
Toby: Let’s say that you’re a US company or an individual, you’re doing business overseas, you’re going to Europe, you’re going to the Middle East or whatever, even China, Japan, the far east, and you’re driving, is it ever just better just to have a US company and say, forget it, I’m not going to mess around with all these foreign jurisdictions?
Imagine that there’s going to be withholding in some places. Hey, I was going to pay your company, but I’m going to make you pay tax here too. If you’re working in a particular country that does that, and you might have a withholding, they might never give you the money. They just give it to their taxing authority. But is there ever a situation which is better? Hey, I’m just a US company, and I’m just going to leave it that way.
Jimmy: I think that’s absolutely right. When they did the Tax Cuts and Jobs Act back in 2017, they introduced this thing called FDII, Foreign Derived Intangibles Income. Basically, it’s more complex than this. But in short, it says, income derived by a US company from abroad is only subject to 13.125% corporate income tax rather than 21%.
A lot of times, especially when you factor in all the complexities and costs that the US company would have to file with regard to its foreign subsidiaries or whatever and the compliance risk of being audited and penalized for potentially not have filed those correctly or having made a mistake, if you just do it through a US company, the income that’s derived for services that have been provided abroad, even if they’re provided from within the US to customers abroad. What they really look at is who the paying entity is. If it’s a foreign company, you’re generally going to get that lower FDII rate. I think that’s a huge benefit, right?
Toby: Yeah, so you could be getting 13% rate on certain types of income. I could be going around the globe. I could be doing my business overseas. People could be paying me from overseas, even if I’m residing in the US, regardless of whether I travel around, and that income is going to be taxed at the corporate rate of 13.125%. This is not individual, this is quarter. This is a C-corp, US, LLC taxed as a C-corp, US C-corp, and it’s just going to pay a much lower tax. If I want that money, then it’s going to give a qualified dividend to me which would be taxed at my long term capital gains rate.
Jimmy: Correct. What I would add to that, Toby, is that you don’t even have to be running around the world. It’s even possible in certain instances that you can be sitting in the US doing your work in the US for a client located abroad and that’s still subject to 13.125%.
Toby: What types of things are covered underneath that? Do you have any guidance there?
Jimmy: Most services are going to be covered under that. In some instances, even products that are sold to foreign customers.
Toby: This is primarily because prior to 2017, people would keep the money offshore and not declare it in the US, and the US got zero income. They basically said, hey, we’re going to give you a reduced rate here so that you bring it back in the US, and we’re not going to mess around. Were there any large taxpayers that took advantage of that? Are there any things where you’ve seen practically companies changing the way that they’re doing business to report more in the US?
Jimmy: Absolutely. Some of my own clients really scale back their offshore structures because they just weren’t necessary. I think probably the biggest one is Google. I think Google made an announcement, if I remember correctly, that they were unwinding their entire offshore structure because it just didn’t make sense anymore.
Toby: Yeah. I know that Amazon is still fighting the heck out of the European Union. I think they just won.
Jimmy: They just won a big one. Apple won a big one against the EU too.
Toby: Yeah. Everybody’s like, the EU wants PCU, the United States wants PCU, everybody wants a PCU when you’re a big company, they see you as a revenue source. This was the olive branch. The Trump administration said, hey, we want you to pay something instead of doing nothing. Yeah, you have a big incentive to do all these elaborate structures to avoid overpaying, but here, we’re going to knock it off by about a third. Please go ahead and pay that, and then please reward your shareholders and pay them so we can tax that too.
Jimmy: Yup. I think with Trump’s tax cuts, I think there were essentially two olive branches, one was this FDI, and the other one was the 100% dividends received deduction. Let’s say you have a US company that owns 100% of a Dubai company. The Dubai company is going to pay 9% on its income in Dubai.
The US company would have to pay basically 10½ % GILTI tax on the profits of the Dubai company. They would get an 80% foreign tax credit of that 9%. They’d get to use 80% of that to offset that 10½ % GILTI tax. But then when they eventually take a dividend out of that Dubai company, there’s no tax because there’s 100%, dividend received deduction. Those were the two major olive branches that came up.
Toby: If you’re still paying 80% of the 9% is 7.2%. You still have 2% plus the 10%. You’re still around that 11%, 12%, 13% range. They made it to where there’s some parity there, which is really interesting.
Again, I always find this stuff fascinating, especially when I have clients that are pushing, pushing, pushing. Hey, I don’t want to pay tax in the US and they move offshore. I’m going to move this over here, I’m going to move this around there. It doesn’t work that way anymore.
Jimmy: I think in the movies, you don’t make it sound like you can just run down to the Cayman Islands, set up a company in a bank account, and avoid a bunch of tax, but that’s not the case.
Toby: Yeah, not anymore. Let’s talk about some of the unspoken ugliness that occurs when you move the money offshore. The big one is that FBAR Reg. What have you seen there as far as people, oops, they didn’t report the $10,000 or more value?
Jimmy: I think there’s a bunch of stuff with the FBAR that makes it a lot more complicated than it seems on the surface. First, a lot of people think it’s just bank accounts. The FBAR is bank and other foreign financial accounts. That means life insurance with cash value. If you had money in an escrow account, if you had potentially a security deposit on an apartment, all of those things could be considered a foreign financial account.
Especially since FATCA became law I think back in 2010, knowledge about the FBAR has become much more widespread. The IRS is really not taking a very friendly view of people who fail to file it. The penalties can go up to 50% of the account balance that’s unreported. If you’ve looked at any of the recent court cases that have come out, there’s even one in front of the Supreme Court, maybe even more than one.
Basically, there’s a reasonable cause exception with most penalties, where if you can prove that your file was willful, you should get out of the higher penalties. You might be subject to the non-willful penalties, but you can avoid the higher willful penalties. But only when you look at some of these facts, with the courts deeming willful, it’s almost impossible to have it ruled not willful.
Toby: They’re just hammering. It’s like half the account value per year. There was a gal, a multi million dollar account. I think she inherited it or something. They were hitting her for half the money. It’s per year, so could it be more than 100% of the account value?
Jimmy: Yeah, I believe so. It gets even worse. That lady you’re talking about. If I remember the facts correctly, she was an immigrant. She was in her 80s, and she was still preparing her own taxes with forms that she got from the library by hand. She just had no idea. She was still ruled to have been willful.
Toby: I had a client. He sold a condo in Canada. They left some of the money sitting in an account that they used to pay the mortgage up there. It was $70,000. If I remember right, it was $30,000 something penalty on that account. He took an amnesty on it. He wasn’t going to sit there and fight it. I think it was twice. I think they gave him a 25% penalty instead of the 50%.
You’re like, okay, I’ll take it. It was really a sad situation when you’re looking like, this is just so punitive. But it is because in the past, people would move money offshore and they’re just not reporting the income. It was that same sense that they like to pull.
All right, last one is people trying to run offshore. Hey, I’m going to do an offshore structure. I’m going to put X dollars offshore, so nobody can get it here in the US. We’ve all seen the cases where they grabbed people, throw them in jail, or they take their US assets. But what’s the reality as far as maintaining these things and what they actually have to do for compliance?
Foreign compliance is way more difficult than US compliance. This Corporate Transparency Act, everybody’s freaking out about, that’s been around for years in Europe and other countries? What does it actually look like cost wise, time wise, to actually run something effectively overseas?
Jimmy: A few things to say on that. First of all, the typical structures that are used to protect assets overseas are foreign trusts and foreign foundations, not charitable foundations, but statutory foundations kind of like incorporated trust. A lot of the foreign countries do have stronger asset protection laws than the United States has, like a non-recognition of foreign judgments are very short, fraudulent conveyance statutes, and all kinds of stuff like that.
The issue is that I think a lot of Americans fail to recognize is, and this is taxes aside, they set up this foreign trust or foundation, but all the assets inside of it are still in the US. As long as they’re still in the US, the US is going to have interim jurisdiction over those assets, and they’re going to do whatever they want anyway.
If all the assets are in the US, just forget about going offshore. It’s not going to give you any benefit. In order to get the offshore asset protection benefits, the assets need to be outside of the United States.
Toby: What if they do the drawbridge? What if they do this, hey, as soon as there’s a creditor, we’re going to move the money offshore?
Jimmy: I think in practical terms, it doesn’t work. Even if you were to be faster than the court to act, you have to think about it, and this is part of the realities of going offshore, if somebody wants to hire you, you’re another lawyer or something, to do something in the United States, it’s pretty easy. You’d go to them, you sign an engagement letter, they give you some money. In the rest of the world, you have to go through pretty substantial due diligence and know your customer to prove where your money came from, to prove your address, and to prove all these things.
It may take you more than a month. Most likely, it can take up to 90 days to get through due diligence with a foreign trustee or a foreign company service provider to even be able to move the structure. The only way you can even have a hope of something like that working is if you already have a backup structure set up overseas, you have everybody on-boarded, and then you still have got to be quicker than the court.
The other thing you have to be concerned about is, if you’re still physically going to be located in the United States, you always run the risk of the US court holding you in contempt, and then you need to decide whether or not you want to just sit in jail for being in contempt and protect your assets or bring the money back.
That’s another thing with setting up the offshore structure. Unless you’re truly handing over control to an independent trustee that’s potentially going to ignore a US court order, if you’re still in control, the US court is just going to hold you in contempt until you comply with their order.
Toby: They do that all the time. I remember there was a case recently that again, it was a gal. She was living off the money. The trustee just kept giving her money. The court said, you control that trustee obviously, and you’re going to bring it all back, or you’re in contempt. They just put you in jail if you don’t do it.
Jimmy: Yeah, exactly. On top of that, you have significant reporting with regard to foreign trusts and stuff like that. They’re tax transparent, so there’s not going to be any tax advantage or disadvantage, but there’s going to be a slew of filings you need to do. You’re going to have to do a form 3520, 3520-A, potentially an FBAR. You’re going to have to file potentially form 8938 with your individual tax return.
Toby: You’re going to be like this, hey, look at my return, please. I only wanted to be examined.
Jimmy: Exactly. In all honesty, I don’t think I’ve ever had one of those audited, but that doesn’t mean it doesn’t happen. The other part of it is the cost. Setting them up and keeping them going can easily cost 10 times what it does in the US.
I remember when I first got into this business, anybody that wanted to set something up, I was like, okay, set it up for them. Then I started noticing that a few years down the road, they wanted to shut it down, because the cost and admin was just too much.
Unless the assets in the structure are making more than enough money to cover the expenses of the structure, it’s not worth it. If you’re talking about maintaining an offshore trust with an offshore trustee, for example, you’re probably looking at at least $20,000 a year.
Toby: Yeah, if you’re doing it right. If you’re doing it right, then maybe get below that. But the reality of it is, you need to have millions of dollars that you’re parking. It can’t sit in the US. These guys that drawbridge, I’m always thinking, exhibit A of the of the plaintiff lawyer when they’re doing collections is going to be the marketing brochure of the company that says, look, we’re going to have this drawbridge, and when there’s a creditor, we’re going to move it.
It’s actually a textbook fraudulent conveyance or avoidable transaction. I think the lawyer will probably be on the hook for it, too. We’re actually seeing some of those cases come to fruition, too. I just never understand it. Unless you have a reason, don’t go offshore. If you have a reason to go offshore, then make sure you have good counsel.
Like Jimmy just put out there, you think you did a really good job of laying out that there’s some complexities, and it’s not the same as the US. You can make it as complex or take away as much complexity as possible. But at a minimum, if you are doing business overseas, you are going to be interacting with foreign countries’ taxing authority, and it’s bad enough to do with ours. Ours follows you everywhere.
There, they’re just looking at the money you’re making. But still, you’re going to be dealing with multiple taxing authorities and multiple sets of laws, and they don’t always play nice with each other.
Jimmy: No, they don’t. They don’t always interact friendly. I think you said it absolutely correctly. I think the biggest mistake people do is they decide they want to go offshore, and then they themselves run offshore, and just go find some lawyer that can set up a company or trust. You really do need to get some expert advice and explore how it’s going to be taxed. How is this thing going to function? Where are my risk points? What foreign legislation or regulations am I going to have to comply with and then decide whether or not it’s worth it?
Like I said, unless you have significant assets that you want to protect, and you’re willing to do it right, and you’re willing to put the assets overseas, it usually doesn’t make sense from an asset protection standpoint. Even if you’re doing business overseas, a lot of times as we were talking about with FDII, it makes sense to keep it based out in the US. A lot of times it only makes sense to set up a foreign company if it’s somehow required to access the local market, or an investment opportunity won’t allow US persons to invest, so you need to do it through an intermediate company.
Toby: Or you have foreign partners. Jimmy, I’m going to put your information into the show notes. I’ll put it up on the screen so people can find you. I would encourage you that if you are overseas or you’re contemplating going overseas, you should talk to somebody who’s actually knowledgeable in it.
Jimmy was a US attorney, but he’s gone off into the foreign world. He’s been living in that world for years now. I sometimes track him down in a variety of number of countries. I just know that in Vienna, I see you at a lot. Ibiza, I see you at and then in Dubai quite a bit. If you ever go to those places, then go have a drink with Jimmy. Thank you sir, for joining us. Thank you for actually making it clear.
Jimmy: Thanks, Toby. Thanks for having me. It was a pleasure.