Starting a business abroad can unlock exciting opportunities—new markets, lower costs, and more freedom. But for a US citizen starting business overseas, the U.S. tax system doesn’t let go. As a U.S. taxpayer, you’re required to report and pay taxes on your worldwide income, even when your business overseas is incorporated in a foreign country and serving non-U.S. clients.
In this tax guide, we’ll walk you through how foreign businesses are treated under U.S. tax laws, how the default tax treatment works (and why it’s often harmful), and which elections or strategies—like the foreign earned income exclusion, foreign tax credit, Section 962 election, and check-the-box election—can help reduce your U.S. tax liability.
The Hidden Risk: The Default Method of U.S. Taxation
When you form a foreign corporation, by default the U.S. treats it as a separate entity. If that entity is owned more than 50% by U.S. persons, it becomes a controlled foreign corporation (CFC). Once that happens, two major rules come into play:
Subpart F income: Certain passive income like dividends, interest, or royalties is taxed to U.S. shareholders whether or not it’s distributed.
GILTI (Global Intangible Low-Taxed Income): Active foreign income above a 10% return on tangible assets is taxed annually to U.S. owners, again—even if no money is actually paid out.
This default method can result in a large tax bill, especially if your business operates in a foreign country with low taxes. The IRS is essentially taxing income you haven’t received, leading to severe cash flow issues and potentially double taxation.
How to Avoid SubPart F/GILTI classification?
Fortunately, there are specific tools and elections you can use to restructure how your foreign entity is treated for U.S. tax purposes. These include:
1. Check-the-Box Election
By making a check-the-box election, you can choose to treat your foreign entity as a disregarded entity. This means all income flows directly onto your personal tax return—simplifying reporting and avoiding GILTI and Subpart F. But, this triggers self employment tax, since you’ll now recognize self employment income and may have to pay self employment taxes.
Additionally, you’ll be required to file Form 8858 to report the disregarded foreign entity and its activities.
2. Section 962 Election
This allows individual U.S. shareholders of a foreign corporation to be taxed as if they were a U.S. corporation. With a 962 election, you can:
Apply the lower corporate tax rate on GILTI
Claim the Section 250 deduction, which cuts the GILTI inclusion in half
Use the foreign tax credit to reduce your U.S. income tax liability
This election can significantly cut your taxable income, especially in high foreign tax jurisdictions.
3. Foreign Earned Income Exclusion (FEIE)
The foreign earned income exclusion allows you to exclude up to ~$120,000 of wages or personal income earned while living abroad. To qualify, you must meet the physical presence test or be a tax resident of the foreign country. This is one of the most powerful tax benefits available to expats. If you pay yourself wages through a foreign corporation, you may be able to use the FEIE to eliminate that earned income from U.S. taxation.
4. Foreign Tax Credit
To prevent double taxation, the foreign tax credit lets you offset U.S. income tax with foreign income tax paid. You can combine this with a 962 election or FEIE, depending on what best suits your structure.
5. Totalization Agreements
If your host country has a totalization agreement with the U.S., you may avoid paying social security taxes in both countries. This is vital for self employed professionals offering personal services abroad.
Reporting Requirements of U.S. business owners
As a US citizen with a business abroad, you’re still on the hook for U.S. compliance:
File Form 5471 for foreign corporations, or Form 8858 for a foreign disregarded antity
File FBAR to report foreign bank accounts
Disclose foreign financial assets under FATCA (Form 8938)
Report net earnings, income earned, and total taxes due on your annual tax return
Setting up a limited liability company or other business structure may affect your personal liability, corporate taxes, and eligibility for certain tax credits or tax breaks.
Even small businesses abroad must meet these tax filing requirements.
Why the Default Method Is a Problem
Too many expats fall into the trap of forming a foreign corporation and assuming that, because the business is foreign and money isn’t repatriated, they won’t owe U.S. taxes. But under the default method, your foreign income is taxed in the U.S.—even if you don’t see it. This means your income tax goes up without increasing your cash on hand.
Ignoring GILTI or Subpart F leads to surprise tax bills, complex forms, and missed tax credits. Planning ahead is critical.
Talk to a Tax Professional Before You Act
We offer tax consultations with a seasoned tax professional who can help you:
Avoid default taxation traps
Evaluate the best business structure for your goals
Make informed 962 or check-the-box elections
Maximize foreign earned income exclusion, foreign tax credit, and other tax benefits
Stay compliant with income tax, corporate taxes, and social security requirements
Whether you’re launching in the right country for expat-friendly rules or planning services rendered from your laptop abroad, we’ll help you do it right.
Final Thoughts
The dream of starting a business overseas is very real—but so are the U.S. tax laws that follow you. Don’t fall victim to the default method of taxation. With the right planning and structure, you can significantly reduce your tax liability, avoid costly surprises, and build your international business on solid ground.
If you’re a US citizen ready to start a business abroad, book your consultation now. We’ll help you choose the right path and protect your income from unnecessary taxes.
