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Expat Tax Essentials
The life of an entrepreneur comes with plenty of perks—but also plenty of complications. This is especially true for self-employed expats, who may have additional tax reporting requirements.
The good news is that you can pursue your dream career while still maintaining a reasonable tax bill. In this guide, we’re going to talk about how to report foreign self-employment income and what taxes you can expect to pay as a self-employed expat.
Generally speaking, self-employment taxes refers to any tax on the income of a self-employed individual, such as a business owner or a freelancer. However, there is also a specific tax known as the “self-employment tax” that all self-employed Americans must pay.
The self-employment tax is designed to replace the Social Security and Medicare taxes that would typically be imposed on an employer-employee relationship. Every employee is required to contribute 12.4% of their income to Social Security and 2.9% to Medicare. This comes to a total of 15.3%, which is split between the employee and employer, with each paying half.
As a self-employed American, the IRS views you as both employer and employee. This means you must pay the full 15.3% yourself. That is the self-employment tax.
If you are a high earner, you could also be subject to the Additional Medicare Tax. The income threshold for this depends on your filing status.
The rate for the Additional Medicare Tax is 0.9%.
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All US citizens are required to file a US tax return every year if they meet certain income thresholds. This applies regardless of where you live, and the thresholds are the same for Americans living in the US or abroad.
For self-employed expats, the filing threshold is $400. If you’ve earned at least $400 in self-employment income in a single year, you must report it to the IRS. This is done by filing Form 1040, Schedule C.
And just like an entrepreneur based in the US, the income you report will be subject to the US income tax as well as the 15.3% self-employment tax mentioned above.
If you expect to owe $1,000 or more when filing your annual return, you will have to make estimated quarterly payments to the IRS. (Typically, these estimated payments are withheld by an employer when paying their staff. Because you are self-employed, you are responsible for estimating and submitting those payments yourself.)
Unfortunately, there is no magic bullet to erase your US tax obligations when working abroad. Unless you renounce your citizenship, you will have to file a US tax return every year. However, the IRS does have various tax treaties and benefits in place to help expat entrepreneurs reduce how much they have to pay.
Just as expat business owners must file the same taxes as a domestic business, they can also claim the same deductions on their return. For example, you can deduct qualifying expenses for:
The US has tax treaties in place with more than 60 countries around the world. These treaties clarify which country can tax a given stream of income. As a self-employed expat in a country with a tax treaty, you can file Form 8833 to protect yourself from double taxation on your self-employment income.
Totalization agreements are similar to tax treaties. However, while standard tax treaties relate to income tax, totalization agreements deal with Social Security taxes. This means that if you live in a country with a US totalization agreement, you shouldn’t have to pay the self-employment tax to both countries.
Using the Foreign Earned Income Exclusion, qualifying self-employed expats can exclude a certain amount of foreign income from US taxation ($120,000 for the tax year 2023). However, while the Foreign Earned Income Exclusion can reduce or erase your US income tax, it cannot be used to offset the self-employment tax.
The Foreign Tax Credit gives you a dollar-for-dollar credit based on taxes paid to a foreign government. For example, if you owe $20,000 in US taxes but can claim a $15,000 credit based on taxes paid to a foreign country, you will only owe $5,000 to Uncle Sam. Like the various tax treaties the US has signed, this tax credit is designed to protect against double taxation.
Like the Foreign Earned Income Exclusion, the Foreign Tax Credit does not apply to the US self-employment tax.
You cannot claim the Foreign Tax Credit and the Foreign Earned Income Exclusion in the same year. You must choose one or the other.
Self-employed expats can use the Foreign Housing Deduction to exclude certain foreign housing-related expenses from US taxation. This applies regardless of whether you rent or own your home.
Expats who are traditionally employed will use the Foreign Housing Exclusion rather than the Foreign Housing Deduction.
Yes. The type of business you set up can have a major impact on your self-employment taxes. Let’s look at a few of the most common choices.
A US-based limited liability company (LLC) is automatically considered a disregarded entity. This means that it is ignored for tax purposes. Any income you receive through the LLC is personal income that must be reported on your individual tax return and taxed accordingly. The self-employment tax will also apply. However, you can elect to have your LLC taxed as an alternate structure, such as an S-corporation. (More below.)
What about a foreign LLC? Unlike a US LLC, an LLC established under the laws of a foreign country is not automatically treated as a disregarded entity for US tax purposes. Instead, it is considered by default a foreign corporation unless another classification is elected.
If you conduct your business through a foreign LLC, your salary paid by the foreign LLC would not be subject to US self-employment tax. This income can also be excluded from US taxation using the Foreign Earned Income Exclusion.
However, establishing a foreign LLC can create new complications. For example, any income that is not paid out as salary may be subject to a GILTI tax.
An S-corporation is taxed as a separate entity from the owner. The owner of the S-corporation will have two types of taxable income: salary and distributions. Any income regarded as salary is subject to the self-employment tax, with half paid by the S-corporation itself and half by the owner receiving that salary. Any income regarded as distribution is exempt from the self-employment tax.
While this would make it tempting to maximize your distribution income to avoid the self-employment tax, the IRS requires that you draw a “reasonable compensation” in the form of salary. If you take too much income as distributions, the IRS may take issue. Furthermore, while S-corporation salary income is eligible for the Foreign Earned Income Exclusion, distributions are not.
We hope this post has helped you understand how to report your foreign self-employment income and how you can optimize your US taxes. Still have questions about your foreign self-employment taxes? We have the answers.
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