The US Tax system is one of the most complicated and least understood in the world. Yet it’s really very simple. But like with everything American, capitalism has made a business out of tax preparation ‘the tax industry’.
First, let’s understand a key difference between TAX AVOIDANCE and TAX EVASION.
Tax Evasion is ILLEGAL, and is defined as failure to report income. It has nothing to do with offshore trusts, loopholes, or any tax structures, it has to do with lying. If you fail to report a dollar your neighbor gave you to help him carry in a sofa, you theoretically could be liable for tax evasion. Further reading http://en.wikipedia.org/wiki/Tax_evasion
Tax Avoidance, on the other hand, is the legitimate reduction of your tax bill by use of deductions or tax efficient vehicles. Tax Avoidance is legal, and encouraged by the IRS. The IRS provides guides explaining the tax code in simple terms, and offers free seminars taxpayers can attend. Also the IRS has helplines to answer tax specific questions, all free. Most people simply don’t know how the tax system works or are lazy to read the rules which are 100% free and available at the IRS site. Some deductions are common but did you know about the hobby deduction? You can deduct expenses for your personal hobby if you earn an income from it. For example if you are a gardener and spent $1,500 on plant seeds and paraphernalia, and sold some of them for a total of $300, you could deduct the $300 as an expense. It’s a strange rule that not many people know about, of course for individuals who don’t itemize it probably won’t add up to much. Further Reading http://en.wikipedia.org/wiki/Tax_avoidance
Now let’s separate US tax code from jurisdiction. US Citizens are liable to pay taxes on their worldwide income (minus a small <100k exemption if you physically work overseas). The US tax code doesn’t care where you live or do business – if you are a US corporation or US entity you pay tax in USA. This is where many people get lost – they think if it’s international, it’s dodgy. The fact is that both tax evasion and tax avoidance happen both in US and offshore. The IRS provides tax avoidance schemes which are 100% based in the US and 100% legal, such as the tax-free exemption for foundations, charities, and churches 501(c). Similar types of exemptions exist for offshore entities, but here’s where it gets tricky. Once you leave the US, you are then subject to the tax rules of that jurisdiction. Many countries, in order to attract capital and thus more taxes, will offer foreigners reduced tax rates – the way they look at it getting 5% from a foreigner is more than 0%. In many countries foreigners have tax breaks that don’t apply to locals. Malta is a great example, they offer several tax programs for foreigners who can pay as little as zero tax on capital gains and income about $5 Million, but the tax rate for local Maltese is greater than 30%. But just like a US Citizen gets a tax break in Malta, a Maltese corporation gets a break if it operates in the United States. Foreign owned and controlled corporations that are domiciled in the US are treated differently than 100% American owned and addressed corporations. The point is that it doesn’t matter what side of the pond you are on, the point is that with the tax system it pays to be a foreigner, in any country!
What many were doing in Switzerland, they were using Swiss banking privacy laws to hide assets, and thus hide income, which is Tax Evasion. But the same thing would have been illegal in the US, and it happens all the time.
Now let’s separate one last item which is muddied too often; tax schemes and money laundering. Countries that offer huge tax breaks seem to also turn a blind eye to the type of business you are engaged in, so these jurisdictions attract both those seeking to lower their tax bill (legally) and those who want to launder money. Utilizing a legal tax efficient vehicle is not money laundering. Lying is lying – if you fail to report income which is in your personal name it’s likely tax evasion (doesn’t mean you will get caught, but it’s still tax evasion). With the move to electronic transactions, anyone who thinks they can get away with tax evasion in the long run is foolish.
Some tax facts:
- The US has one of the highest corporate tax rates in the world at 35%, but US corporations’ effective tax rate (tax they actually paid) was 12%, one of the lowest in the world. These corporations that are utilizing tax structures aren’t your local mob boss, they are the Fortune 500, Google, Amazon, Microsoft, HP, etc.
- The IRS allows you to pay more tax than you owe, if you choose
- In 1920 top tax rates for income above $1 Million were as high as 77%
It is possible to lower your tax bill significantly 100% legally, ethically, based on the current rules. Contact Structured Consulting about tax efficient structures.