With the start of the new tax season in Israel, many Israelis who are self-employed or plan to become self-employed should consider the advantages of setting up an Israeli corporation as opposed to remaining an atzmai (a self-employed individual). This article explores some of the often overlooked benefits of doing business as an Israeli corporation.
The first thing one needs to understand when dealing with an Israeli corporation is that these entities are taxed at two levels:
- At the corporate level, the company must pay income taxes on its profits at the rate of 23%
- At the individual level, when you decide to take money out of the company as a dividend, you pay personal income taxes at the rate of 30% (or 25% in some cases).
With this mind, it is easy to assume that you will pay more taxes as a corporation than as self-employed. But is that really the case? The next few paragraphs will address several instances in which you will pay less taxes as a corporation than as self-employed:
Optimizing Salaries and Dividends
If your business profits are over 250,000 NIS, you can combine dividends with a salary to reach an optimal compensation from your Israeli company that will be taxed at lower rates than if you were self-employed. For this purpose, you will need to work with an Israeli accountant who can review the numbers regularly and will help you decide how much to claim as dividends.
Dividends of shareholders who own at least 10% of the shares of the company are taxed at 30% in Israel. However, every few years the Income Tax Authority announces Tax Holidays in which this tax is temporarily reduced to 25%.
Avoidance of US self-employment taxes (Social Security and Medicare)
If you are a US citizen and live in Israel, you are required to pay US social security and medicare at the rate of 15.3% on your income earned as self-employed in Israel. This is in addition to Israeli bituach leumi, resulting in double taxation on Americans who are self-employed in Israel.
The good news is that this can be legally avoided by using an Israeli corporation to pay yourself a salary. In that manner, you will only be required to pay Israeli bituach leumi and will be exempt from US social security and medicare.
It is important to note that Israeli corporations carry several additional costs that are not applicable to self-employed individuals, such as annual registration fees and much higher accounting fees. This article discusses the costs and benefits of setting up an Israeli corporation. We normally recommend Americans who earn over 70,000 NIS as self-employed in Israel to consider the corporate form.
Higher Keren Hishtalmut deductions
As a self-employed individual, you are allowed to claim 4.5% of your keren hishtalmut contributions as a deduction subject to an annual limit of 264,000 NIS, resulting in a maximum deduction of 11,880 NIS. If you use an Israeli corporation to pay yourself a salary, the maximum deduction goes up to 14,140 NIS (7.5% of your salary subject to an annual limit of 188,544 NIS).
Deferral of personal income taxes until dividends are claimed
We already discussed how profits from an Israeli corporation are taxed when you distribute them to yourself. But what if you don’t want to take all the money out and prefer to leave it in the company to allow for future growth? A corporation allows you to pay only the corporate tax and defer your personal taxes until you decide to take a distribution.
My personal recommendation to Israeli residents who are self-employed or consider becoming self-employed in the near future is to hire an experienced Israeli CPA to run the estimated numbers and give a recommendation on whether it is time to set up an Israeli corporation. As part of the tax planning process, special attention should be paid to several tax laws that could potentially make this decision unfeasible, such as Israel’s “wallet company” rules and the US GILTI tax.
The content of this article is intended to provide general information on the subject and does not constitute legal or tax advice. You should consult with a tax professional where appropriate.