Starting a company can often be a difficult and complicated process. It’s made even more difficult when you’re a digital entrepreneur without a physical place of business. This is often the case with digital nomads who want to run an online teaching business or some other type of location-independent start-up. This week, we break down if the Republic of Estonia’s E-Residency program may offer the answer.
What is E-Residency?
E-Residency is just like what it sounds like- a digital form of residency. It is not physical residency and does not allow you to live and remain in Estonia. It allows you to open a company based in Estonia with access to the Estonian banking system and EU markets.
What is the process for starting a company in Estonia?
Step 1: You need to apply for a digital ID in Estonia. This allows you to securely sign all business documents electronically. There is a 100€ cost to obtain this ID.
Step 2: Obtain an Estonian address and legal contact person. You can utilize a range of providers available on the Estonian government’s website. Some offer services that are limited to being a contact person and providing an address. Others offer guidance on accounting and compliance issues. The cost varies depending on the scope of the services provided (more info below).
Step 3: Register your Estonian company with the government. There is a 190€ registration cost.
Step 4: Open your company bank account in Estonia.
What is the cost?
There is a state fee for setting up the company in Estonia. This has risen considerably since this program was first introduced and now stands at 190€ (step 3). If you feel you can not navigate the paperwork yourself, you can hire an agency to do the work for you. Many consultancies offer this service for 250€ (which includes the state filing fees).
As mentioned above, you need a local office address and a local contact person. This results in a cost to you that is ongoing throughout the time you have the company open. Some consultancies will provide this service for approximately 125€ per year. You can seek out more full-service consultants who will also handle accounting, bookkeeping, and compliance issues. These all-in-one consultancies often have fees attached that are representative of the scope of their services.
How is E-Residency different from actual physical residency?
You are not permitted to remain in Estonia an E-resident. You are not a resident for tax purposes. Your company, on the other hand, is a tax resident of Estonia.
Are there tax consequences?
As you attempt to grow your business, you likely want to keep the money in the business. This means reinvesting what you make. In my opinion, this is the biggest benefit of the Estonian E-Residency scheme. You are not taxed on the money you earn until you withdraw money from the company. That is the money you reinvest (retained earnings) is not taxable.
If you pay dividends to yourself, you are taxed at a flat rate of 20%. If dividends are paid regularly, then you may be eligible for a reduced rate of 14%. There are certain guidelines that you must follow when declaring and paying a dividend, including registering and paying in adequate share capital. This is money that is used to run the business. The minimum share capital is 2500€. Dividends may not be paid out of this money. Dividends can only be paid out of the business’s earnings.
You can choose to pay yourself a director’s fee. This is also subject to a 20% income tax rate and may be subject to an additional Estonian social security tax. This is where it is helpful to have a local tax advisor.
Salaries paid to employees who are tax residents of Estonia incur income tax, as well as social tax withholding. If you are a one-person digital nomad, this is unlikely to apply to you.
Be aware that any payment of fringe benefits that you charge to your company may trigger an Estonian tax consequence. This may include income tax and/or social taxes.
The tax consequences of paying yourself out of the earning of your Estonian company can be a bit complex. It is always a good idea to contact a local tax professional.
Who might this be good fit for? Who might this NOT be a good fit for?
This is probably a good fit for digital entrepreneurs because of the luxury of reinvesting money in the business without tax consequences. If you anticipate a very healthy stream of revenue and don’t wish to have your business attached to your home country, the Estonian E-Residency program may be an option. It’s also a potential solution is you have no physical address in the USA. However, contracting a registered agent in the USA would also solve this problem and is relatively affordable – even more so than in Estonia.
If you have an income from teaching or some other location independent endeavor that you live off of, you can keep that separate from your Estonian company. Your Estonian company can be limited to your new entrepreneurial adventure. Again, you can keep reinvesting the profits as you attempt to scale the business. When you decide to withdraw profits, you can deal with the tax consequences of dividends.
I personally don’t see the E-Residency program as a good fit for digital nomad English teachers because of the relatively high tax rates, complexity of the tax laws in Estonia, and the cost of consulting for accounting & compliance issues. The start-up and maintenance costs also exceed what one might expect to pay in the US. I find the 20% tax rate to be outrageously high for online English teachers.
Final Take- not worth it.
US residents who own a foreign company need to fill out form 5471 and file it with the IRS indicating that you have an ownership interest in a foreign company. This does not trigger a tax consequence, but it is more of a disclosure. You need to let the IRS know that you own a foreign company.