U.S. EXPAT TAX GUIDE – INDIA
How Do US Citizens Report Indian Business Income to the IRS?
If you’re a US expat living in India and hold US citizenship or a Green Card, you must file Schedule C along with your Form 1040 to the IRS. Schedule C is used to report all your business income and expenses, allowing you to calculate your net profit from self-employment.
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This net profit is then included in your Form 1040 as taxable income. Additionally, if your self-employment income is earned while located outside of the US, you may also need to file Form 8858.
It’s important to complete Form 8858 accurately, as failing to do so can result in penalties starting at US$10,000, which can escalate to US$50,000.
How can US expats reduce their tax burden while living in India?
US expats in India can lower their tax burden by restructuring their business from self-employment to a private limited company. This change involves setting up an Indian company to manage your income and expenses.
Instead of reporting your earnings as self-employment income, your company would handle it through the business’s tax return, which can offer significant tax advantages.
By setting up a private limited company, the income you generate becomes subject to corporate taxes in India rather than self-employment tax in the US.
Why do US expats consider establishing an Indian corporation, and what is Form 5471?
The Tax Cuts and Jobs Act (TCJA) brought significant changes to the way foreign corporations owned by US citizens are taxed. Before the TCJA, US expats could defer US taxation on foreign corporate profits until those profits were distributed as dividends.
For instance, if an Indian company earned US$100,000 in profit and distributed only US$20,000, US taxation would only apply to the US$20,000.
However, the TCJA introduced provisions where the IRS may tax the entire profit if the company is controlled by a US person, regardless of distributions. This means that the US expat could end up paying taxes twice—once in India and again in the US.
To comply with these regulations, US citizens owning more than 10% of an Indian company must file Form 5471, which details the foreign corporation’s finances, including profits, assets, and income distributions.
How does the high tax exemption prevent double taxation?
The high tax exemption is a provision that helps US citizens avoid being taxed twice on foreign corporate income. If the tax rate in the foreign country is at least 90% of the US corporate tax rate, no additional US tax is required.
Given that the current US corporate tax rate is 21%, the high tax exemption threshold is 18.9%.
In India, corporate tax rates are generally around 30%, which is well above the exemption threshold. This means that if you own an Indian company and pay taxes at this rate, you usually will not owe any additional US corporate taxes on those profits, as long as the profits remain within the company.
Only when you take distributions do you need to consider the US tax implications.
What complexities are involved in filing Form 5471 for an Indian company?
Establishing an Indian company requires filing Form 5471 annually with the IRS. This form is used to provide detailed information about foreign corporations controlled by US citizens, including income, expenses, and distributions.
However, filing Form 5471 can be complex due to the need for extensive records and various supporting schedules.
Should US expats in India consider forming an Indian corporation to reduce their tax burden?
Setting up a private limited company in India offers multiple benefits, such as reducing self-employment tax, leveraging lower corporate tax rates, and using the high tax exemption. But it’s essential to weigh the administrative and compliance costs, including the complexity of keeping accurate records and filing forms like Form 5471.
For many US expats, the long-term tax savings and reduced exposure to self-employment tax make establishing a corporation a favorable option.
What other considerations should US expats keep in mind about self-employment in India?
- FBAR and FATCA reporting: If the value of your foreign bank accounts exceeds US$10,000 at any point during the year, you must file the Foreign Bank Account Report (FBAR). Additionally, Form 8938 under FATCA may be required if your foreign assets surpass certain thresholds.
- Quarterly estimated payments: Self-employed US expats must make estimated tax payments quarterly to avoid penalties for underpayment. These payments include both income and self-employment tax.
- Dual social security contributions: Without a Totalization Agreement between India and the US, self-employed expats must contribute to both countries’ social security systems.
Why partner with a specialist Expat accountant?
Living outside of the US can make your tax filing requirements complicated. To ensure you pay the minimum amount of taxes, it’s critical to work with an accountant who understands every aspect and avenue for reducing your tax liability. We have a dedicated team of tax accountants who work exclusively with US expats earning and investing in Germany. Partnering with a specialist expat accountant can help you navigate complex tax regulations and optimize your tax situation.
