Becoming a freelancer or digital nomad has become more popular since the pandemic, as more people leave corporate life to work on their own terms. As such, many are grappling with how best to offer their services—individually or through a company?
Simplicity and cost-effectiveness are the advantages of offering them individually. There’s no separate company to set up, no additional bank accounts, no corporate governance, no renewal fees, and no cumbersome due diligence to go through with a company service provider. The downsides: There’s no limited liability protection and no legitimacy that a company offers. Limited liability is important because anything can happen in business, and one wants to protect their personal assets. Also, more legitimacy can equal more revenue.
If one prefers the advantages of operating through a company, the next step is to determine jurisdiction.. This depends on several factors, including whether the person is a US person (US citizen or resident).
US persons are taxed on their worldwide income regardless of where they reside, and owning and operating a foreign company triggers adverse taxation and onerous reporting requirements. It probably makes the most sense for them to set up a single-member LLC in the US because by default they’re treated as disregarded entities for US tax purposes.
All income is passed through to a single member (owner) who pays the tax. One gets all the advantages of a company—limited liability and legitimacy—without the double taxation that comes with corporations, or even having to file a separate tax return. The US LLC’s single member simply reports all the LLC’s income and expenses on their individual tax return.
US persons who are considered foreign residents under either the bona fide residence test or physical presence test, and who perform their services outside the US, can take advantage of the foreign earned income exclusion and foreign housing deduction to exempt some of their foreign earned income from US income tax.
Self-employment tax will still apply. Similarly, non-US persons who are tax residents of a country that taxes services income—most countries with a developed tax system do—should incorporate in their country of residence because the services will be provided from there and likely will be subject to tax there.
Many people mistakenly believe that they can set up a company in a no-tax jurisdiction to receive income from their services and avoid taxes in their country of residence. This generally isn’t the case, as most countries would deem the company to have a permanent establishment by virtue of having a place of management or office there and tax the revenue from services performed there.
An opportunity exists, however, for those freelancers and digital nomads who aren’t US persons and who are tax residents of a country that doesn’t have income taxes or that offers special tax incentives to digital nomads. They can often set up a company in a no-tax jurisdiction and avoid income taxes on their services income altogether.
It’s now easier than ever to become resident of such a country. While requirements and tax advantages vary, over 52 countries now have some sort of digital nomad visa.
But in which country should they set up the company? Most people turn to well-known offshore financial centers, such as the Cayman Islands or British Virgin Islands. While both are good options, they’re expensive, have rigid regulatory compliance requirements, and service providers must subject clients to overly cumbersome due diligence.
The US LLC is an often-overlooked alternative; their income and expenses pass through to their owner. It’s as if the LLC didn’t exist for US tax purposes. Where a nonresident of the US performs services through a US LLC, it is as if that person directly performed those services and received the corresponding income.
One must then look to where the services were performed to determine their source. If the services were performed outside the US, they’re not considered US source income and aren’t subject to US income taxes. A nonresident who performs services from outside the US through a US single-member LLC won’t be liable for US income taxes, even if the income was received from US clients.
This is significant because US LLCs offer all the same advantages as traditional offshore companies—limited liability, no tax, etc.—to freelancers and digital nomads at a fraction of the cost. Plus, one gets the legitimacy of a US company and none of the complicated regulatory compliance requirements or cumbersome due diligence of service providers.
The US LLC shouldn’t be overlooked by freelancers and digital nomads when deciding where to set up their company.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Jimmy Sexton, LL.M., advises private clients on international tax and wealth planning. He is the is the founder and CEO of Esquire Group and the chairman of the International Business Structuring Association (Middle East Chapter).
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