It’s a well-known expat tax basic that U.S. citizens living abroad have a number of unique tax challenges and opportunities.
This is particularly true for self-employed expats, whose income can be subject not only to U.S. income taxes, but also U.S. self-employment taxes, including social security taxes, depending on the circumstances.
In this blog, we review the basics of the U.S. self-employment tax system, summarize the key tax exceptions, and include some practical issues that self-employed expats should consider in order to minimize their overall worldwide tax burden.
Self-employment and Social Security Taxes on an Expat’s Income
Under U.S. tax law, if you’re self-employed and your net earnings from self-employment equal $400 or more (a very low threshold), you must do two things:
- File Schedule SE
- Pay self-employment tax (which includes Social Security taxes)
The IRS considers you to be self-employed if you own your own business or are an independent contractor.
Self-employment tax is not the same as income tax. The self-employment tax rate is 15.3% of net earnings. That rate is the sum of a 12.4% Social Security tax and a 2.9% Medicare tax on net earnings.
- For the 2022 tax year, the first $147,000 of earnings is subject to the Social Security portion. In 2023, it rises to $160,200.
- A 0.9% additional Medicare tax may also apply if your net earnings from self-employment exceed certain thresholds
It’s important to note that if you’re self-employed abroad, you’ll still owe U.S. self-employment taxes on foreign earned income that is exempted from income tax due to the foreign earned income exclusion.
The Role of Social Security Totalization Agreements
Social security totalization agreements between the United States and many foreign countries may prevent you from being subject to self-employment taxes in both countries.
Totalization agreements are similar to tax treaties, but they are relevant for social security and Medicare taxes instead of income taxes.
Totalization agreements serve two purposes:
- Eliminate double social security taxation issues
- Help dictate social security benefit protections for individuals potentially subject to two social security systems
So, in brief, if you’re self-employed abroad or earn income abroad and you pay the equivalent of social security taxes to another country with a totalization agreement, then you likely won’t have to pay self-employment taxes to the U.S.
A list of countries with a totalization agreement can be found here:
https://www.ssa.gov/international/agreements_overview.html
Planning Strategies for Self-Employed Expats
The imposition of the self-employment tax, on top of income tax, can be significant, if not devastating, for a growing business. This is especially true for those living in a country that does not have a totalization agreement, which could render a self-employed individual subject to double self-employment taxation.
For this reason, tax planning should be considered to reduce self-employment taxes for citizens abroad, to the extent allowable under the U.S. and local tax systems.
Planning in this area usually involves the setting up of a company structure, which on the one hand can reduce self-employment taxes, but on the other hand, can invite a number of potential tax and reporting traps for the unwary.
Our recommended approach is to tailor a strategy based on your overall profile (e.g., including your country of residence and its tax rules), and your current and anticipated economic situation (e.g., gross and net profits and sources of income). A comparison of various company structures can then be analyzed from a tax perspective to achieve the optimal structure for you and your business.
