Nearshoring vs Onshoring: Tax Implications for U.S. Companies

Note: This article is for informational purposes only and does not constitute legal, tax or financial advice. Companies should consult qualified legal counsel to understand specific compliance requirements.

The way we work has changed forever. Remote teams, distributed workforces, and global talent pools aren't just trends, they're the new reality. But here's what many U.S. companies don't realize: where your team works can dramatically impact your tax bill.

Whether you're running a scrappy startup burning through runway or leading a Fortune 500 company optimizing for efficiency, the choice between hiring offshore, nearshoring to places like Mexico or Costa Rica, or bringing everything back home involves tax complexities that can make or break your financial strategy.

This isn't just about staying compliant (though that's important). It's about making smart decisions that align with your growth goals and protect your bottom line. Get it wrong, and you could face surprise tax bills, compliance nightmares, and missed opportunities worth millions.

Let's break down what you really need to know.

1. Understanding Onshore and Offshore Operations

First things first—let's get clear on what we're actually talking about when we say "onshore" and "offshore." These distinctions matter more than you might think.

1.1 What qualifies as onshore vs offshore employees?

Onshore employees work within U.S. borders, period. It doesn't matter if they're citizens, green card holders, or visa workers. A software developer coding from a coffee shop in Portland? Onshore. A customer service rep working from home in Miami? Also onshore.

Offshore employees are anyone working outside the U.S., regardless of their citizenship. Here's where it gets interesting: a U.S. citizen working remotely from Lisbon for your San Francisco startup? That's offshore from a tax perspective. Meanwhile, a Mexican national coding from Austin is considered onshore.

The IRS doesn't care about passports—they care about geography. Where the work actually happens is what drives your tax obligations.

1.2 Corporate and payroll tax obligations in each model

When you hire onshore, you're playing by familiar rules. You'll handle the usual suspects: FICA taxes (Social Security and Medicare), federal and state unemployment taxes, workers' compensation, and all the fun of state-specific employment laws. Plus, you're withholding federal and state income taxes like every other U.S. employer.

Offshore gets more interesting. Pay foreign contractors? You typically skip U.S. payroll taxes entirely. But set up foreign subsidiaries with actual employees? Welcome to the world of international tax compliance—think controlled foreign corporation rules, transfer pricing documentation, and foreign tax credit calculations that'll make your head spin.

Here's the kicker: some offshore arrangements can still create U.S. tax obligations, especially when foreign workers support U.S. operations or clients. The lines aren't always as clear as you'd hope.

2. U.S. Corporate Tax Treatment for Offshore Activities

Bad news: expanding offshore doesn't mean escaping U.S. taxes. The U.S. tax system is designed to capture your global income, creating challenges that many companies don't see coming. Recent changes to Section 174 have made this even more complex for companies with R&D activities abroad.

2.1 U.S. taxation of foreign income and controlled foreign corporations (CFCs) Here's a term you need to know: Controlled Foreign Corporation (CFC). If U.S. shareholders own more than 50% of a foreign company's voting power or value, it becomes a CFC. Translation: your Mexican subsidiary that you thought would shelter income? The IRS wants their cut.

With a CFC, you might owe U.S. taxes on certain foreign profits immediately—even if that money never leaves the foreign bank account. It's called "Subpart F income," and it can create tax bills on profits you can't even access yet.

2.2 Section 174 R&D capitalization and its offshore impact The 2017 Tax Cuts and Jobs Act fundamentally changed how R&D expenses are treated, with rules that became effective in 2022. Previously deductible R&D costs must now be capitalized and amortized over 5 years for domestic activities and 15 years for foreign R&D.

This hits offshore operations particularly hard. If your Eastern European development team is conducting R&D, those $500,000 in annual development costs can't be deducted immediately—they must be spread over 15 years. Recent legislative changes in 2025 have provided some relief, but the basic framework remains challenging for international R&D operations.

2.3 How GILTI, Subpart F, and global intangible low-tax income rules apply The 2017 tax reform added another complexity: GILTI (Global Intangible Low-Taxed Income). If your CFC's effective tax rate falls below 13.125%, you'll need to include some of that income on your U.S. tax return.

Real-world example: Your Eastern European dev team generates $1 million in profit and pays $100,000 in local taxes (10% effective rate). Under GILTI, you'll likely owe additional U.S. taxes to bring that rate up to the minimum threshold. Combined with Section 174's amortization requirements, your R&D costs provide less immediate tax relief while foreign profits face additional U.S. taxation.

These rules can quickly erode the cost advantages that made offshore operations attractive in the first place. That "tax-efficient" jurisdiction might not be so efficient after all.

3. Payroll & Employee Tax Considerations

Employment taxes represent the most immediate difference between onshore and offshore operations. But the rules aren't as straightforward as they first appear.

3.1 Payroll taxes for offshore employees: are they enforceable?

The basic rule seems simple: foreign contractors or employees of foreign subsidiaries don't trigger U.S. payroll taxes. But there are gotchas.

If foreign workers are considered U.S. employees under common law tests, you could still owe U.S. payroll taxes regardless of where they sit. The IRS looks at factors like how much control you exercise, whether they use company equipment, and how integrated they are into your operations.

Also, if foreign workers spend time in the U.S.—for training, meetings, or project work—this can trigger partial payroll tax obligations. The rules around the 183-day threshold and other factors can create surprises.

3.2 Withholding requirements and nexus issues for remote or offshore staff

Nexus, the connection between your business and a tax jurisdiction—becomes critical with remote or offshore teams. If your offshore developers regularly work with California clients, California might argue you have economic nexus there, potentially subjecting you to California corporate taxes on worldwide income.

This isn't theoretical. States are getting increasingly aggressive about nexus, especially with distributed teams. A few video calls with clients in high-tax states can create expensive obligations you didn't expect.

Withholding requirements vary dramatically by country and can create administrative headaches. Some require you to withhold taxes on local worker payments, others handle it through their own systems. Each jurisdiction has its own rules and penalties for getting it wrong.

4. Foreign Tax Credits and Avoidance of Double Taxation

One of the biggest fears with international operations is double taxation—paying both U.S. and foreign taxes on the same income. The foreign tax credit system provides relief, but it's complex and has important limitations.

4.1 How to claim FTC on offshore earnings

The Foreign Tax Credit lets you offset U.S. tax liability dollar-for-dollar with qualifying foreign taxes paid. You'll file Form 1116 with detailed calculations of foreign-source income and corresponding foreign taxes.

The process involves properly categorizing income as foreign-source versus U.S.-source, calculating foreign tax credit limitations, and determining how much of your foreign taxes can be used immediately versus carried forward. Get any step wrong, and you could miss valuable credits or trigger compliance issues.

4.2 Limitations and key exceptions to FTC eligibility

The credit system has several important limitations. You can only use foreign tax credits against U.S. tax on foreign-source income—you can't use them to offset U.S. taxes on domestic income.

Passive income creates additional complexity with separate limitation buckets. High-tax jurisdictions present their own challenges—if foreign taxes exceed the equivalent U.S. rate, you can't use the excess to offset other taxes, though you might carry them forward for up to ten years.

5. State-Level Taxes & Domestic Incentives

While federal taxes get most of the attention, state-level considerations can be equally important for location decisions, especially when comparing offshore to domestic alternatives.

5.1 State tax obligations when work is done offshore or onshore

State nexus rules vary dramatically. California aggressively pursues companies with minimal in-state activities, while states like Nevada and Texas impose no corporate income tax at all.

Offshore work generally avoids state nexus, but there are exceptions. If your offshore team supports state-specific clients or operations, or key decision-makers are located in particular states, you might still trigger obligations.

Onshore operations typically create automatic nexus. A remote employee working from Colorado creates Colorado nexus, potentially subjecting your company to Colorado corporate taxes and compliance requirements.

5.2 U.S. tax credits, deductions, or stimulus incentives for reshoring

Federal and state governments offer substantial incentives to bring operations back to the U.S. The CHIPS Act provides massive incentives for semiconductor manufacturing. The Inflation Reduction Act offers credits for domestic clean energy production.

State-level incentives can be even more generous. Texas offers the Enterprise Fund for job creation. Georgia provides film tax credits up to 30% of qualified expenditures. New York's Excelsior Jobs Program provides refundable credits for companies creating jobs and making capital investments.

These incentives can completely change the economics of location decisions. A software company might find Georgia's incentives make Atlanta more cost-effective than lower-cost international markets, especially when factoring in international compliance complexity.

6. Risk Assessment & Compliance Considerations

International operations introduce compliance risks that can result in significant penalties and unexpected liabilities. Understanding these risks is crucial for informed decision-making.

6.1 Exposure to transfer pricing and cross-border audits

Transfer pricing rules require that transactions between related entities in different countries occur at arm's length—the same terms unrelated parties would use. If your U.S. company pays your foreign subsidiary for services, the IRS will scrutinize whether the pricing reflects fair market value.

Inadequate documentation can trigger penalties of 20% to 40% of any adjustment, even if your underlying pricing is reasonable. Many foreign jurisdictions impose similar penalties, creating potential double jeopardy.

Cross-border audits are increasingly common as tax authorities coordinate enforcement. A routine audit in one jurisdiction can quickly expand worldwide, creating significant administrative burdens and professional fees.

6.2 Changes in tax law or trade policy that impact location decisions

Tax laws affecting international operations change frequently and sometimes with little warning. The 2017 Tax Cuts and Jobs Act fundamentally altered international taxation. Ongoing OECD initiatives around digital taxation and minimum tax rates promise additional changes.

Trade policy adds uncertainty. Tariffs, export restrictions, and sanctions can quickly make attractive jurisdictions less viable. Companies with substantial operations in specific countries have needed to relocate due to changing trade relationships.

Political risk extends beyond formal policy changes. Even the possibility of future restrictions can affect long-term viability, making domestic operations' stability more attractive.

7. Decision Framework: When Nearshoring or Onshoring Makes Financial Sense

Making the right choice requires a systematic approach considering costs, taxes, compliance burdens, and strategic factors.

7.1 Balancing labor costs, tax burden, and regulatory complexity

Your decision matrix should evaluate several key factors. Labor costs are obvious but just the starting point. Factor in fully-loaded employment costs including payroll taxes, benefits, workers' compensation, and compliance expenses.

Tax burden analysis requires modeling various scenarios. That low-cost offshore jurisdiction might become less attractive when you include GILTI inclusions, transfer pricing compliance costs, and inability to claim domestic tax credits.

Regulatory complexity translates to real costs in professional fees, administrative time, and compliance systems. You might spend $50,000 annually on international tax compliance for a subsidiary saving $200,000 in labor costs—net savings of $150,000.

But if domestic incentives reduce that gap to $75,000 while eliminating complexity, onshore might be preferable.

7.2 How to forecast tax impact and break-even points

Effective forecasting requires multi-year modeling accounting for tax rate changes, incentive phase-outs, and scaling effects. Break-even analysis should consider both direct costs (salaries, taxes, compliance) and indirect costs (management time, communication challenges, quality control).

Start with five-year projections modeling different growth scenarios. Include assumptions about tax rate changes, incentive availability, and potential compliance cost increases. Factor in the option value of domestic operations—easier capital access, reduced regulatory risk, simplified expansion.

Many companies find break-even points shift significantly over time. Initial offshore savings may erode as compliance costs increase, domestic incentives improve, or wage differentials narrow.

8. Case Studies & Hypotheticals

Real-world scenarios illustrate how these tax considerations play out in practice and can guide your decision-making.

8.1 Example: U.S. company with offshore staff only

TechStart Inc., a Delaware C-corporation, employs 20 software developers through a wholly-owned Polish subsidiary. The subsidiary pays 15% effective tax on $2 million annual profits.

Under GILTI rules, TechStart must include $1.65 million of subsidiary income on its U.S. return. With 21% U.S. corporate tax and foreign tax credits for Polish taxes, TechStart's additional U.S. liability is approximately $99,000.

TechStart also incurs $25,000 annually in international compliance, transfer pricing documentation, and reporting requirements. Total additional cost: $124,000, reducing but not eliminating Polish operation advantages.

8.2 Example: U.S. company moving jobs back onshore

ServiceCorp relocated its 15-person customer service operation from Costa Rica to Austin, Texas. The move increased annual labor costs from $450,000 to $900,000 but eliminated $30,000 in international compliance costs.

Texas offered ServiceCorp $2,000 per job over five years for job creation—$150,000 total incentives. Federal work opportunity tax credits added $45,000 over two years for targeted group hiring.

Net additional onshore cost: $255,000 annually after incentives, compared to $450,000 gross additional labor costs. ServiceCorp also benefited from improved customer satisfaction and reduced management complexity.

Making the Right Choice for Your Company

The decision between nearshoring and onshoring involves far more than simple labor cost comparisons. Tax implications, compliance burdens, available incentives, and strategic considerations all play crucial roles.

The bottom line? Model multiple scenarios comprehensively, accounting for direct and indirect costs over realistic time horizons. Engage experienced international tax professionals to navigate complexity and ensure you're not missing opportunities or obligations.

Remember: location decisions aren't permanent. Many successful companies adopt phased approaches, starting with contractor relationships to test markets before making larger subsidiary commitments.

Whatever path you choose, align it with your long-term strategy, risk tolerance, and growth objectives. The lowest-cost option today might not build the sustainable, scalable business you need tomorrow.

Ready to make smarter location decisions? The complexity is real, but so are the opportunities. Get the analysis right, and you'll have a significant competitive advantage. Get it wrong, and you'll be dealing with the consequences for years to come.