Setting your own work hours and creating the business of your dreams is what many self-employed individuals aspire to do. However, when it comes to expat taxes, things can get a bit complicated. In this post, we break down the needed expat tax support for self-employment taxes for Americans abroad.
How to Determine if You are Self-Employed by IRS
It is important to make sure that you as a US citizen abroad are really self-employed. As a freelancer, you need to correctly identify whether you are giving services as an employee or an independent contractor.
The IRS determines this by looking at the degree of control and independence that you have.
Facts that provide evidence of the degree of control and independence fall into 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?
You must weigh all these factors when determining whether you are an employee or an independent contractor. Some factors may indicate that you are an employee, while other factors indicate that you are an independent contractor. There is no set number of factors that “makes” you an employee or an independent contractor. No one factor stands alone in making this determination.
The key to determining what your position is, is to look at the entire relationship. Consider the degree or extent of the right to direct and control. Finally, document each of the factors used to come up with the determination.
If you feel that you were actually an employee rather than self-employed based on the IRS Employee Common Law here, then you should categorize your income as salary, rather than self-employment income.
Essentially, if the company you work for can control what is done and how it is done, then you may consider yourself an employee. Even so, when you have the freedom to do what you want to do (freedom of action). What matters is that the company has the right to control the details of how the services are performed.
Self-Employment Tax for US Expats
If you determined that you work for yourself and are in control of the services you perform, then you are self-employed. You earn self-employment income, which is subject to pay self-employment tax.
Every time we use the term ”self-employment tax” we are specifically talking about US Social Security and Medicare taxes. The term does not include any other taxes that self-employed individuals may require to file.
- US Social Security taxes: Help fund the Social Security program. Social security tax pays for retirement, disability, and survivorship.
- Medicare taxes: Pay for health insurance and benefits that you as an American abroad can still receive when you become a senior. Medicare is a health insurance program largely funded by employment taxes. Both the employer and employee split the cost to pay 1.45% into medicare taxes.
Normally, as a salaried employee in the United States, the IRS withholds these types of taxes. Both from the employer and employee during the year.
As a self-employed individual, you are both employer and employee. You will need to pay this tax separately after calculating your net profit. Medicare and Social Security taxes will primarily be for you. Plus the process will be similar to what wage earners in the US withhold from their pay.
Since you are your own boss, you’ll need to figure out self-employment taxes by yourself. You can use the self-employment tax (SE tax) Schedule SE on Form 1040. Or better yet, our app.
Remember, you can also deduct your employer-equivalent portion of your self-employment tax.
Filing US Taxes as a Self-Employed American Expat
If you are a self-employed American abroad, the filing threshold for US tax returns is very low. You’ll need to file if you have net earnings of at least $400 of worldwide income.
Additionally, you’ll also need to file Schedule C. This form reports to the IRS profits and/or loss from your company.
For tax years 2018 and prior, you would still be required to file Schedule C if you:
- Have in the past year unallowed passive activity losses from your business
- Deducted business use of your home
- Had employees
- Are required to file Form 4562 that reports amortization (a technique from accounting that is used to lower the book value of an intangible asset or loan periodically over a set period of time) and depreciation (the value of your business/assert reducing due to wear and tear) of your business
If you have a foreign corporation, you’ll have to fill out Form 5471. If you are involved in a foreign partnership, you’ll need to file Form 8865. To read more about small business structures and taxes, do check out our small business guide.
Paying Social Security and Medicare Taxes
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.
As of this year, 2023, the IRS states that self-employed US expats will be taxed 12.4% on earnings of up to $160,200, which can be offset by income tax provisions. Then an additional 2.9% tax on all earnings to take care of the Medicare portion.
Effectively, you can budget about 15.3% self-employment tax on your net profit.
Since you arean American abroad, your host country will have its own laws on social security, health programs, and other fees. Please check up if your country is on the tax treaty Totalization Agreement list. You must see what other legal measures to take to ensure your taxes in the foreign country are being properly handled.
Are you subject to US self-employment tax as an expat?
- If you are self-employed, living in totalization treaty country, AND you are registered in that social security system = NO
- If self-employed and living in a non-totalization country = YES
Self-Employment & Tax Debt
Due to living overseas as a self-employed American abroad, estimated payments may incur if tax debt has happened because of your business.
If you are expected to pay the IRS $1,000 or more by April 15th (yet this year it’s April 18th), you are required to file these estimated payments on a quarterly basis during the year.
If the IRS finds out you skipped out on making quarterly payments, they can charge you an additional underpayment penalty on the tax balance owed.
How to Reduce Self-Employment Tax
You can reduce self-employment taxes as an expat by increasing your business expenses and therefore decrease your business earnings. For business meetings and events you travel to, you can lessen your net income which will lessen the Social Security tax.
Additionally, you could lower your net income through the Section 179 deduction. It serves to deduct the cost of specific fixed assets used for business. You can speak with us once you sign up for our expat tax software to see if you qualify.
Our app lists all the most popular business deductions that expats have. It will also help you calculate new ones like a home office, listed property and more.
Getting US Social Security Benefits Through Self-Employment Earnings
Paying self-employment tax does help you earn credits towards receiving US Social Security benefits later on.
According to the US Social Security Administration, in 2023, self-employed individuals receive one credit for every $1,640 of earnings – with up to four credits per year. The credits you earn over the years will stay on your Social Security record, regardless if you change businesses later on.
If your net earnings are $6,560 or more you will reach your maximum of getting four credits. If you receive less than $6,560 you can still earn partial credits for every $1 of self-employment earnings you have.
You must have worked and paid Social Security taxes for a certain length of time to get benefits. The amount of time you need to work depends on your date of birth. However, no one needs more than 10 years of work (40 credits).
Keep in mind, the maximum is 40 credits. You might still be eligible to receive partial social security benefits if you don’t hit the full 40.
The Social Security Office sends hundreds of thousands of payments internationally. If you have an interest in getting US social security benefits later, it will be important to:
- Understand how many credits you already have from working in the US prior to moving abroad
- Determine how many more credits you want to earn as a self-employed expat. This will mean you will need to pay a self-employment tax now for benefits later!
Check out our app to file US taxes and stay tax compliant with your small business abroad! Free file first and pay when satisfied.