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Tax Tips for Self-Employed American Expats

Tax Tips for Self-Employed American Expats
Ines Zemelman, EA
25 May 2021

Are you an American expat who has started or is seriously considering starting your own business? Whether you wish to engage as an independent contractor or start your own company, having the flexibility of being your own boss comes with a long list of benefits. However, there is a heightened degree of responsibility not only in terms of running your firm but also in terms of meeting your international and US tax requirements.

Getting a solid grasp of how the IRS calculates your US tax due as a self-employed US expat can help you make informed business decisions and be better prepared to file your US expat tax return when tax season rolls around. This article intends to boost your awareness of two central issues: your responsibility to the US as an American expat earning self-employment income and the additional deductions available to you as a US taxpayer with business costs. Consider this as your nifty guide to self-employed taxes for dummies.

But before we get to the meat of your deductions and liabilities, let’s start by defining what “self-employment income” is.

Self-employment income is any money you make in exchange for goods or services you provide under your own name or under an official DBA (Doing Business As) name. This does not include any wages you receive as an employed worker. You should document these independently if you earn income as a hired employee (reported as salaries and wages on Form 1040) and extra money as an independent contractor or business owner (reported as self-employment income on Form 1040). You could choose to file both your personal and business income tax on the same Form 1040, but you will need to support and adapt each form of income utilizing separate lines and additional forms.

1. How Does the IRS Determine if You are Self-Employed?

It is critical to ensure that you are truly self-employed as a US resident living overseas. You must appropriately distinguish whether you are providing a service as an employee or as a freelancer. The IRS assesses this by considering your level of authority and independence.

Facts that offer evidence of the degree of control and independence fall into these three categories:

Behavioral: Does the company control or have the right to control what you do and how you do your job?

Financial: Are the business aspects of your job controlled by the payer? (These include things like how you are paid, whether expenses are reimbursed, who provides tools/supplies, etc).

Type of Relationship: Are there written contracts or employee-type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

When deciding whether you are an employee or an independent contractor, you must consider all of these characteristics. Some indicators point to you being an employee, while others point to you being an independent contractor. There is no one-size-fits-all formula for determining whether you are an employee or an independent contractor. There is no single factor that can be used to make this decision.

Examining the entire relationship is crucial to determining your position. Consider the extent to which the right to direct and control is exercised. Finally, make a list of all the factors that went into making the decision. If, based on the IRS Employee Common Law, you believe you were an employee rather than self-employed, you should categorize your income as salary rather than self-employment income.

Essentially, you may be deemed an employee if the organization you work for has control over what gets done and how it is done. Even so, having the flexibility to do whatever you want (freedom of action) is a great thing. What is important is that the company has the authority to direct the manner in which the services are delivered.

2. What are the Filing Requirements for Self Employment Tax on Foreign Self Employment Income? How to Report Self Employment Income?

Self-employment is defined as working for yourself. However, there are numerous methods for achieving this title, such as an independent contractor or an entrepreneur who owns your own business. Self-employment income includes remuneration for a part-time or full-time job you do inside or outside your house for the purposes of expat tax guidance. Even if you work for a corporation as a W2 employee, you may be able to earn self-employment income.

The most significant distinction between someone being self-employed and working for a company is how you submit your taxes. Unlike a W2 employee, you are directly responsible for tax deductions from your paycheck; they will not be automatically deducted before payday. In most cases, in addition to income tax, you will have to pay self-employment tax, which includes Social Security and Medicare taxes. You'll need to utilize the Schedule SE tax form, Self-Employment Tax, to calculate this tax. You'll have to make anticipated tax payments, which means you'll have to pay taxes on income that isn't withheld.

Is foreign income subject to self-employment tax? For expats who are self-employed, the thresholds for triggering a filing obligation are different. You must file a tax return if you earn more than $400 in a calendar year. Self-employment taxes are charged at a rate of 15.3 percent. Social Security is covered at 12.4 percent, and Medicare is covered at 2.9 percent. Additionally, if you make good money, you may be liable to additional Medicare taxes; the threshold is $250,000 for married couples filing jointly and $200,000 for single filers. The Medicare tax has no upper limit, while the Social Security tax applies only to the first $128,400 of your income. 

3. How to File Self Employment Taxes?

The filing threshold for US tax returns is quite low if you are a self-employed American living overseas. If you have net profits of at least $400 from all sources, you must file. In addition, you'll have to file Schedule C. This form is used to record your company's profits and/or losses to the IRS. Schedule C-EZ, a simplified form of Schedule C, was once available. However, beginning in 2019, you will no longer use Schedule C-EZ and will instead utilize Schedule C. Form 5471 must be completed if you have a foreign corporation. You must file Form 8865 if you are a partner in a foreign partnership.

4. Are You Required to Make Estimated Tax Payments?

If you don't have taxes deducted from your self-employment income and don't use a professional bookkeeping or accounting service, you may have tax debt and be obliged to make quarterly estimated tax payments. Even if your tax burden isn't high enough for the IRS to require anticipated tax payments, avoiding a large tax bill with penalties at the end of the year may be in your best interest. Estimate your tax debt using Form 1040-ES. If it's more than $1000, you'll almost certainly have to pay estimated taxes.

5. What are Other Potential Additional Tax Liabilities?

US taxpayers’ earnings from self-employment are generally liable to paying Social Security tax while working abroad as well as Medicare in addition to regular income tax. There is a chance you may not be responsible for these taxes either by terms defined in your host country’s tax treaty with the US or because you have a net loss from your business rather than a net income. You most likely will be required to pay Medicare and Social Security taxes if you have a net profit from self-employment income; but it’s definitely worth your while to find out the details, as your host country may offer you tax credits or other deductions to help minimize your overall liability.

6. Do Expats Pay Medicare Tax?

Since you are your own boss, you’ll need to pay for both your Social Security and Medicare taxes that your employer would otherwise withhold from your salary. So that means after calculating your net profit on Schedule C, you will need to continue onward to Schedule SE.

7. Get to Know the Active Tax Treaties, Totalization Agreement or Bilateral Social Security Agreements Between the United States and Your Host Country

If you've lived and worked as an American expatriate in a foreign country and filed a US expat tax return in the past, you're probably already aware of any active tax treaties between the US and your host nation. If, on the other hand, you've never worked for yourself as a US expat, you might want to go over the conditions of the treaty again. Knowing the individual requirements and allowances for each country will enable you to make the most advantageous tax decisions. If you have any questions about the treaty, contact TFX, we're here to help.

Ines Zemelman, EA
Founder of TFX