The United States is only one of two countries that have adopted a citizenship-based taxation system, the other being Eritrea in Northeast Africa. This means that all U.S. citizens and permanent residents (also known as Green Card holders) are required to file a return and pay tax on their worldwide income, even if they are based in a foreign country.
For self-employed expats who are thinking of starting a business abroad, this could mean an additional layer of complexity to an already complicated system of tax filing and reporting. But just because the U.S. tax system works against expat taxpayers doesn’t mean you should give up on your goals.
Here’s a quick guide to filing taxes as a self-employed expat.
What is self-employment?
People who work for themselves are considered self-employed. While the term is generally associated with small side hustles, working as an independent contractor or opening a business also counts as self-employment.
According to the IRS, a person can be considered self-employed if:
- They carry on a trade or business as a sole proprietor or an independent contractor
- They are a member of a business or trade partnership
- They are otherwise in business for themselves (including a part-time business)
It’s important to note that a person can be both self-employed and also work as a salaried employee. Many expats have started businesses on the side while holding down a full-time job.
Self-employed expat taxes
Self-employed expats often deal with heavier tax responsibilities compared to their salaried counterparts.
For starters, self-employed taxpayers have to withhold taxes from their income themselves, which results in extra paperwork and research. They also have to pay self-employment tax (for Social Security and Medicare) on top of their income tax.
Self-employed taxpayers may also have to pay estimated taxes quarterly. Ask a tax professional to clarify your tax situation to avoid a hefty penalty at the end of the year.
What is the threshold for self-employed tax
The reporting threshold for self-employed individuals is substantially lower than what most taxpayers are accustomed to. Self-employed expats who earn more than $400 in a year are required to file a tax return.
Is foreign income subject to self-employment tax
All income from self-employment, even from foreign sources, is subject to U.S. taxation. Self-employed individuals are required to pay a 15.3% self-employment tax: 12.4% for Social Security and 2.9% for Medicare.
However, you may claim an exemption from paying U.S. Social Security tax if the United States has signed a totalization treaty with your country of residence.
Self-employed tax deductions
The IRS allows self-employed individuals to deduct business expenses from their taxable income, reducing their tax bills. Make sure to take advantage of all the benefits available to you to minimize your tax liability.
Some business expenses you can deduct include:
- Legal and professional services
- Business-related travel
- Equipment and supplies
- Utility bills
- Business meals and entertainment
Just make sure to keep your records updated in the event of an IRS inquiry. Every deduction must be supported by documentation such as a receipt to justify the claim.
Self-employed tax exemptions
Self-employed expats who already pay income tax to their host countries can take advantage of tax exemptions to minimize their U.S. tax liability on the same income.
For instance, the Foreign Earned Income Exclusion allows you to exclude up to $108,700 (for tax year 2021) of foreign-earned income from U.S. tax if you are based in a foreign country.
You may also take a Foreign Tax Credit for foreign income taxes imposed on the same income. Self-employed expat taxpayers may claim a dollar-for-dollar tax credit on income tax paid to the host country’s tax service. This means you can use your foreign income tax bill to offset your U.S. taxes.
What if I’ve never filed self-employed taxes?
Self-employed American expats who haven’t filed a U.S. tax return may use the Streamlined Foreign Offshore Procedures program to report foreign-earned income and pay back taxes without facing penalties.
Tax planning for self-employed expats
Filing taxes as a self-employed expat can be confusing and time-consuming. You are expected to stay on top of your tax obligations while running a business abroad. You also risk incurring heavy penalties if you make a mistake on your tax return. If you want to make sure your taxes are done correctly, your best option is to work with a professional tax service .