Do S-Corps Make Sense for Expats? Understanding the Implications.

Updated on February 18, 2024

In this week's Real Tax Questions From Real Expats, we examine if an S-Corporation structure is suitable for a US citizen operating a business from abroad.

The Scenario

A US citizen moved to Costa Rica and continues to run a US-based business structured as an S-Corporation.

Benefits of an S-Corp

S-Corporations, known for avoiding double taxation, are popular among small US businesses. They're pass-through entities, meaning income and deductions flow through to shareholders’ tax returns. Crucially, S-Corp income isn't subject to self-employment taxes, potentially saving significant tax.

S-Corp and Self-Employment Taxes

S-Corp owners must draw a "reasonable salary," subject to self-employment taxes. Any remaining business income avoids these taxes. This structure can yield tax savings compared to sole proprietorships or partnerships where total net income is subject to self-employment taxes.

Implications for Expats

For expats, the key consideration is how an S-Corp impacts the Foreign Earned Income Exclusion (FEIE). The FEIE applies to "earned" income, as defined by the IRS. S-Corp salary qualifies, but pass-through income does not. In contrast, sole proprietorships could allow the full income to be excluded under the FEIE.

Specific Factors for Expats

Totalization Agreements: Some countries have agreements with the US, exempting taxpayers from US self-employment taxes. Without such an agreement, the S-Corp's benefits diminish.
Tax Rates in Resident Country: In countries with higher tax rates than the US and no totalization agreement, the FEIE may be less relevant, maintaining the S-Corp's advantages.

Conclusion

In Costa Rica, where local taxes are lower and no totalization agreement exists, it's more efficient to forgo the S-Corp to maximize the FEIE benefits. Each expat's situation varies, so it's crucial to consider all factors.