Expat entrepreneurs who are thinking of starting a business overseas should expect another layer of complication to their expat taxes. Fortunately, that’s no reason to abandon your career dreams! Read our tips first to ensure you understand all the implications for the self employment tax on foreign earned income.
Filing Requirements for Self Employment Tax on Foreign Earned Income
Self-employment means you work for yourself, but there are several different ways you can earn this title, including as an independent contractor or becoming an entrepreneur and owning your own business. For expat tax advice purposes, self-employment income includes pay that you receive for part-time or full-time work that you do, inside or outside your home. You could receive self-employment income even while working for a company as a W2 employee.
The main difference between being self-employed and being a W2 employee is how you file your taxes. Unlike a W2 employee, you are fully responsible for withholding taxes from your pay – they won’t be automatically taken out prior to payday. Generally, you will have to pay self-employment tax, which includes Social Security and Medicare taxes, in addition to income tax. To determine this tax, you’ll want to use Schedule SE, Self-Employment Tax. You’ll need to make estimated tax payments, which makes you pay taxes on income that isn’t subject to withholding. Expat tax advice tip: making estimated payments can prevent you from having to pay a penalty when you file your taxes, since the IRS can penalize you for not paying enough taxes during the year.
The thresholds for triggering a filing requirement are different for expats who are self-employed. If you earn more than $400 in a year, you will be required to file a tax return. The rate for self-employment taxes is 15.3%. 12.4% covers Social Security, and 2.9% goes toward Medicare. Further, if you are a high earner you could be subject to additional Medicare taxes; the threshold is $250,000 in income for those who are married filing jointly, and $200,000 for single filers. Medicare tax does not have a limit, but only the first $128,400 of your income will be subject to Social Security tax. Pro tip: determine if you need to make estimated payments so that you don’t end up with an underpayment penalty at the end of the year on the self employment tax on foreign earned income
Consider Your Location
A major factor in the amount of self-employment taxes you may owe is which host country you reside. Not only do the deadlines differ greatly, so does the amount of tax you owe on your business. If you live in the United Arab Emirates, you would not owe corporate taxes at all. However, in other countries, you may pay upwards of 40%!
Deductions for Ordinary and Necessary Expenses for the Self-Employment Tax for Expats
Appropriate business expenses can be deducted to help alleviate the burden of self-employment tax for expats. For example, the following expenses are often deducted using the Schedule C:
- Legal and professional services
- Car expenses
- Rent, including both business space and equipment
- Taxes and licenses
- Meals and entertainment
You should break the expenses down into the categories that are used on the Schedule C. You may not use every category, and some of your expenses may not fit in any category on the list. Expenses that do not fit the categories on the Schedule C will be included as “other expenses,” so you should list them and describe them as best you can. Business telephone and internet expenses are commonly reported as other expenses.
Your car and truck expenses can be calculated using either the standard mileage rate or actual expense method. With either method, you have to include a description of your vehicle and the total miles and business miles put on the vehicle during the year.
You can deduct your health insurance premiums on Page One of your US Form 1040 and not on your Schedule C. In order to qualify for this adjustment to income, you, the freelancer, must be the insured on the insurance policy.
If you provide customers with a product, you should report your purchases. This is your cost of the items that end up in your customers’ hands, or your “cost of goods sold.” Any purchases you have on hand at the end of each year will reduce your current year’s cost of goods sold deduction and will be inventory that you carry over and deduct in the year the inventory is sold.
You should make a list of all business assets that you bought or began using in your freelancing in the current year. These are things that last more than a year. Your list should describe the asset and include the cost and date purchased.
However, you should also be aware of the limits to these deductions. For instance, you will pay the self-employment taxes before you can apply the Foreign Earned Income Exclusion or the Foreign Tax Credit.
And although the FEIE and Foreign Tax Credit help to lessen the burden of paying US income taxes on your foreign sourced self-employment income, they do not affect your employment tax obligation related to your foreign self-employment income.
To help mitigate employment taxes for self-employed individuals working in certain foreign countries, the US has entered into an agreement called a Totalization Agreement with several nations for the purpose of avoiding double taxation of income with respect to employment taxes (e.g., Social Security or Medicare taxes).
To be able to claim this employment tax exemption, the self-employed individual must include a statement (a Certificate of Coverage from the Social Security agency in the country of foreign residence), which indicates that employment taxes are being paid in the country of foreign residence.
Generally, many self-employed expats will need to make estimated tax payments to the IRS since you’re earning income that isn’t subject to withholding. It’s important that you make these quarterly payments if required for your situation, as you may otherwise be subject to a penalty when filing your expatriate taxes. You could also be subject to a penalty for underpayment of your estimated tax obligations, so it’s always a good idea to consult a tax professional to ensure you are paying enough.
Self-employment is great for the US expat lifestyle, so long as you take the necessary steps to prepare for filing your US tax abroad. For more tax tips and deadline information, download our tax guide for Americans working overseas.
Don’t Forget About FBAR
The Foreign Bank Account Report (FBAR) is a critical component of self-employment tax for expats. If you have $10,000 or more in your foreign bank accounts (combined!), you will need to file FBAR. Have two accounts with $5,000 or more each in them? That means you need to file, even if those are your personal accounts. Skipping this step can result in steep penalties for those who are caught!
Corporate Structure Affects Self-Employment Taxes for Entrepreneurs Abroad
The type of business you set up can have a significant impact on your taxes. The most common type is the LLC – a limited liability company. Domestic LLCs are automatically considered “disregarded” which means that you can report this company on your individual tax return. However, for a foreign LLC to be considered “disregarded,” you must file Form 8832 once and then file Form 8858 annually for entrepreneurs abroad. If you don’t or can’t choose to have your LLC disregarded, you’ll need to fill out Form 5471, which is a much more onerous undertaking. And lastly, depending on your ownership in the company, you may be subject to the Repatriation Tax, a one-time tax for US owners of foreign businesses. However, if you’re considering starting a new company, this would not apply to you.
Leave Your Self-Employment Taxes to the Professionals
We have a service specifically for expat entrepreneurs so that you can get back to your adventure abroad and not worry about the self employment tax on foreign earned income! Get started with Greenback today, and you’ll know your taxes are done correctly.