US Self-Employment Taxes for Citizens Living Abroad
Of all the expat tax basic rules, the most basic of them all is the rule that U.S. citizens living abroad are subject to U.S. taxation just like citizens residing within the United States.
This holds true for both employed and self-employed individuals. For the self-employed, this means that both income taxes and self-employment (“SE”) taxes are at play, even when living abroad.
The application and extent of self-employment taxes, however, may differ depending on where the expat lives and how much income is earned.
Who is responsible for self-employment taxes abroad?
Unlike employees who often have their SE tax withheld, self-employed taxpayers are responsible for determining their own SE tax liability. This, again, is also true for U.S. citizens who are self-employed abroad.
The income threshold for owing self-employment taxes is not the same as for income tax purposes, in fact it’s significantly lower. The SE tax applies if the individual’s net earnings derived from self-employment are equal to or greater than $400 for the year.
Further, the foreign earned income exclusion and foreign income tax credit cannot be used to reduce self-employment taxes. A self-employed expat with an annual profit of $75,000 (after deducting business expenses) could use the foreign earned income exclusion or foreign tax credits, for example, to eliminate their income tax liability, but they would still be subject to U.S. self-employment tax.
How do you calculate self-employment taxes abroad?
To put it simply, the self-employment tax is a tax of your net earnings at a maximum rate of 15.3%. The tax consists of two parts. The first part is the social security tax at the rate of 12.4%. The maximum amount of net earnings subject to this part is $137,700 for the 2020 tax year (any amount above this threshold is not subject to this part).
The second part is the Medicare tax, which applies at the rate for of 2.9% to all of your net earnings regardless of how much you earn. In 2013, an additional 0.9% Medicare surtax was added for certain high-income earners.
When are self-employment taxes abroad due?
While income taxes are due on April 15 (and citizens living abroad have an extension to file until June 15), estimated self-employment taxes are required be paid quarterly.
The IRS schedule of due dates for 2020 estimated tax payments is as follows:
- 1st Quarter – July 15, 2020 (extended from April 15, 2020 due the Coronavirus pandemic)
- 2nd Quarter – July 15, 2020 (extended from April 15, 2020 due the Coronavirus pandemic)
- 3rd Quarter – September 15, 2020
- 4th Quarter – January 15, 2021
Totalization agreements are a game changer
In order to avoid paying self-employment taxes in both the U.S. and the foreign country, U.S. expats may be able to rely on a social security totalization agreement between the U.S. and the foreign country. The agreement will assign the social security taxes and benefits to the country of resident of the self-employed individual.
In order to benefit from the provisions of a totalization agreement, a self-employed individual living abroad must present the IRS, when requested, with a Certificate of Coverage from the social security agency of his or home country.
In recent months, in fact, we’ve seen an uptick in requests by the IRS for Certificates of Coverage from our clients. Each totalization agreement has instructions on how to obtain such certificates from the relevant country’s agency.
Planning for self-employment taxes abroad
Planning for self-employment taxes basically comes into two forms – one is planning to reduce self-employment taxes when living in a country that does not have a totalization agreement with the United States, and the second is planning to reduce self-employment taxes when a pass-through structure (e.g., running your business through an LLC or foreign equivalent) is otherwise the most advantageous from an income tax perspective.
These types of planning should always take into account the tax implications as well as the overall impact the planning will have on the expat’s ability to claim social security benefits in retirement.
How we can help
Given the complexities and nuances of the self-employment tax abroad, as well as its interplay with federal income taxes and local income and social security taxes, it’s best to consult with an Expat Tax Professional to craft the most tax-advantageous structure for your business abroad.
Of course, the timely and proper payment and filing of your taxes are equally important for self-employed expats, so professional help is highly recommended.
For more information, reach out to an Expat Tax Professional today. Whatever expat tax issue you're facing, we've been there - and we're here to help.