Just when I was planning on publishing my post on foreign free lance income and tax consequences- the big news headline of 2017 dropped! Today special prosecutor, Robert Mueller brought charges against Manafort & Gates for money laundering and foreign bank accounts among any other things. While those fireworks continue and you think that you may not be in the same league as them, let me assure you that many U.S. citizens who live abroad and have freelance income do not understand its tax implications.
You may already be aware that U.S. citizens and green card holders are taxed in the United States on their worldwide income, regardless of where they live. Freelance income is reported on Schedule C, Profit or Loss from Business (Sole Proprietorship). “Ordinary & necessary” expenses related to this work can be deducted on the same Schedule C. The net income, that is gross minus the allowable expenses is then subject to tax.
You may be able to avoid some or all of the U.S. Income Tax on this income, either through foreign tax credits (taxes paid to your resident country on this same income) or the foreign-earned income exclusion (by satisfying one of two residency tests). Operating as a “business” one’s net income from this source may be subject to U.S. Self Employment tax. The Self Employment tax is rate is currently set at 15.3%. The rate consists of two parts, 12.4% for Social Security and 2.9% for Medicare.
What is Self-Employment Tax?
When one operates as a freelancer, or is self-employed, one is effectively both employer and employee. So, the responsibility for the Self Employment tax (Calculated on net income on Schedule C) falls on one-self. Foreign tax credit and/ or the foreign-earned income exclusion cannot be used to offset U.S. Self Employment tax due.
The only way to exclude the self-employed income of a U.S. citizen or Green Card holder from U.S. Self Employment tax is through the application of a totalization agreement, if available.
What is a Totalization Agreement?
The United States has entered into totalization agreements with several countries. If such an agreement exists between the U.S. and your country of residence, your business net income may not be subject to U.S. Social Security taxes.
To avail of this exemption from U.S. Self Employment tax, you may need to be registered as self-employed in your resident country. You also will likely need to obtain a certificate of coverage from the tax authority in your resident country. This may take some time and effort in the country of residence in, hence you should give yourself time to file by either filing an extension or sending in some preemptive taxes/estimated taxes. If there is no totalization agreement in place between the US and your resident country, then you will owe U.S. Self Employment tax on your Schedule C net income.
It is funny that the idea for this post came about when an old college friend and I connected through social media after a couple of decades. She needed help with her foreign freelance income and was trying to understand how it would affect her U.S. taxes. Soon we started to talk of other (less mundane things) and how we met for the first time in college in the Principal’s office since we both needed a pass for being late after a heart stopping 1986 FIFA World Cup which in India (where we were at that time) was broadcast live in the middle of the night! Diego Maradona’s performance in that FIFA World Cup is unforgettable to say the least, the principal joined us in gushing over him and we believe we got off lightly!
Today also happens to be Diego Maradona’s 57th birthday. Thanks to Maradona I made a friend in college whose love of soccer kept me forever entertained in sleepy Commercial Geography lectures!
If you, dear reader want to talk about that some more or have foreign freelance income, do contact me.
Have a question? Contact Manasa Nadig
Your comments are welcome!