As a CPA, one of the topics we talk about with entrepreneurs most frequently is how to choose the proper business legal entity to operate out of.

The topic is quite important as it can drastically impact the business owners tax liability as well as legal liability, how they pay themselves, what investment accounts they are eligible and much more.

In my opinion there are few decisions more important to a profitable business.

For the most part, it ends up being a very easy decision. We look at their profits and whether or not they have any potential legal liability they want to help protect and make a recommendation.

But for entrepreneurs wisely taking advantage of the foreign earned income exclusion, a whole new layer is added to the decision.

Your choice of entity is so important and so specific to each individual case it’s impossible to give you a pure guide on which one to choose, but here’s a look at a few things to consider.

Not a C Corp

For 95 percent of more of the clients and entrepreneurs we work with, a C Corp is an awful choice of entity for their business.

Despite all the misinformation out there about it, and even with the new lowered tax rates starting in 2018, it just makes absolutely no sense for most people.

For entrepreneurs taking advantage of the foreign earned income exclusion, it’s an even worse choice.

A C Corporation is the only entity that pays its taxes at the corporate level. Every other entity is a “pass through entity”, meaning its profits pass through to the owner or owners and the taxes are paid on their personal tax return.

And since the foreign earned income exclusion applies to personal taxes, with a C Corp you are left getting nothing.

I know that’s a lot of technical tax talk, but here’s the bottom line: If you are an entrepreneur a C Corp is probably a bad choice for. If you are an entrepreneur living out of the country for 330 days or more a year, a C Corp is almost definitely a bad choice for you.

Be Careful With an S Corp

For almost all of our clients with businesses making $40,000 or more per year in profits, our recommendation is going to be to go with an S Corp for their business entity.

The reason is simple; when done right it will drastically reduce your social security and medicare taxes.

For those using the foreign earned income exclusion, there’s one big problem with an S Corp; profits in an S Corp are considered unearned income.

So what’s that mean in laymans terms? Well just look at the name of the exclusion, it’s an earned income exclusion, meaning S Corp profits, which are unearned, will not qualify for the exclusion.

Does this mean you are screwed if you are an S Corp and want to take advantage of the FEIE? Absolutely not.

But it does mean you have to plan accordingly.

Under normal circumstances, the goal with an S Corp is to keep your salary as low as legally possible.

But in the case of utilizing the earned income exclusion, only your salary will be eligible.

So you will want your salary will be high enough to max out your credit.

LLC’s/Sole Props/General Partnerships

For tax purposes, an LLC, a sole proprietor and a general partnership are all treated the exact same way, so I’m lumping them all together here.

In the case of these three entities, there will be no change in strategy or tax consequences when taking advantage of the FEIE.

You will simply go about business as usual and all profits (assuming you are an active partner in the case of a partnership) will be eligible for the exclusion.

Which Entity is Best

Again, there is so much involved in this decision – your profits, your legal exposure, the state you are in, and much more – there’s simply no way to give you a cut and dry answer in one article.

But I hope you can walk away with this: It’s an incredibly important decision.

Talk to a professional, make sure they know you plan to take advantage of the earned income exclusion, and make the best decision for your personal situation.

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