🐧 US self-employment taxes 101

Self-employment is the greatest thing since sliced bread, minus the taxes.

According to my onboarding survey, 33% of Money Abroad readers know what I’m talking about. If you’re self-employed, hit reply and drop me a line. I’d love to hear from you.

Today, in 10 minutes or less, you’ll learn:

• 🤔 Self-employment taxes 101
• 🗾 How they work for self-employed US expats (at a high level)
• 🧰 Strategies that work/don’t work for reducing your US expat self-employment taxes

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💼 US expat self-employment taxes 101

US expat taxes get complicated.

Particularly for the self-employed, small business owners, and freelancers.

I know this because I’m one of them. I’m a US expat running my businesses through my LLC.

In this newsletter, I’m going to share what I’ve learned about US expat self-employment taxes 101.

Let’s dive in:

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1/ Self-employed US expats should consider two types of taxes

• Income Tax - All US citizens, including expats, are required to file US income tax returns on their global income above a minimum filing requirement ($400 of net earnings for self-employed).
• Self-Employment Tax - All US self-employed folks, including expats, are required to pay Social Security and Medicare taxes (minus some exceptions covered below).

For the purposes of this newsletter, I’m going to focus on the latter: self-employment tax.

If you want to learn more about income taxes, Foreign Earned Income Exclusion, Foreign Tax Credits, then read my previous newsletter.

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2/ Self-employed US expats have a 15.3% self-employment tax up to ~$169k, then 2.9% above that

In 2024, the IRS states that self-employed US expats are taxed 15.3% self-employment tax on net profits, which breaks down to:

• 12.4% tax on earnings of up to $168,600 for Social Security
• 2.9% tax on earnings for Medicare*

*If your earned income is >$200k ($250k for married couples filing jointly), you could also be subject to the Additional Medicare Tax of 0.9%

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3/ Living in a totalization treaty countries + pay foreign social security is an option to reduce self-employment tax

Let’s start off with a tip that I found fascinating.

There are 3 types of tax-related agreements relevant to US expats:

1. Income tax treaties (list) - minimize and avoid double taxation of income earned between the US and the resident country of the US expat
2. Totalization agreements (list) - minimize and avoid double taxation of Social Security tax/contributions between the US and resident country of the US expat
3. Estate and gift tax treaties/provisions (list) - minimize and avoid double taxation of estate and gift taxes between the US and resident country of the US expat

(2) is the most relevant for self-employment tax.

Essentially, If you reside in one of 30 countries with a US totalization treaty and are registered in their social security program, then you may avoid your self-employment tax.

For example, self-employed US expats in Japan pay Japanese social security taxes, not US, due to the totalization agreement. Pretty cool.

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4/ Foreign Earned Income Exclusion (FEIE) can NOT reduce your self-employment tax

If you’ve read previous newsletters, you know that the Foreign Earned Income Exclusion can help you reduce or limit your income tax liability.

Unfortunately, I’ve learned you cannot apply the FEIE to reduce your self-employment tax.

This is because your self-employment tax is different from income tax.

This is a bit of a bummer.

However, there are other strategies we can consider below:

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5/ Non-US corporation is an option to reduce US self-employment tax

I have not personally tried this strategy, but I’ve known several business owners who have used it.

Legal entity structuring gets complex, so please talk to a professional before trying any of this at home.

Here’s the high-level strategy:

• You incorporate a non-US corporation (ideally in a low-tax jurisdiction)
• You are employed by this non-US corporation, so you are paid salary
• You can apply FEIE to this salary and avoid self-employment tax (since you’re technically employed)

The main trade-off?

You have to file additional lengthy US tax forms and likely spend more money on the filing prep (typically thousands).

When I consulted with my tax preparer, he suggested that setting up a foreign entity would be considered a CFC (Controlled Foreign Corporation), which is subject to an onerous 5471 filing to report the activity of your corporation.

The form carries a $10,000 penalty for failing to file it correctly, is pretty complex, and expensive to file.

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6/ S Corp is an option to reduce US self-employment tax

When you’re a US expat sole proprietor or single-member LLC, your entire net profit is subject to self-employment tax.

However, by electing an S Corp treatment, you can split your income into two levels:

• Salary as a W2 employee (subject to self-employment tax)*
• Distributions (not subject to self-employment tax)*

Distributions are excluded from Social Security and Medicare taxes—leading to reduced self-employment tax.

Another consideration is FEIE:

• FEIE applies to your W2 income, but NOT to your distributions
• FEIE more efficiently applies to your W2 income as an S-Corp than as a self-employed Sole Prop/LLC , so you may see lower income taxes. (This is due to business expense treatment. Too complex for a newsletter, so you can check out the link for the math.)

*The IRS does require that in an S-corp you are paid a reasonable salary so you have to pay yourself what would be the normal and customary pay for your position.

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In Summary

Research your options. Know your priorities.

For example, I focus on simplicity. I’m OK with forgoing a bit of optimization in exchange for less time and hassle.

Be careful when fielding pitches from offshore agencies.

The reality is I’ve spoken with several US expat business owners who feel stuck with a convoluted offshore entity setup that they can’t get out of. (Good business for the firm who set it up!)

Talk to a trusted tax professional. Gain a basic understand so you can ask the right questions.

If you found this article useful, shoot me a reply. I read every email.

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