Many of the around 9 million Americans living abroad are entrepreneurs, freelancers, and business owners. Those who travel between countries, working from high speed internet hubs rather than having a permanent home, are known as Digital Nomads.
All Americans are required to file US taxes, wherever in the world they may be. While they always have to file a federal return, however …
… they can employ a number of strategies, depending on their circumstances, to minimize the US taxes that they have to pay. In this article we’ll look at some of these strategies.
First though, let’s look at what taxes expat entrepreneurs, freelancers and Digital Nomads are required to do.
All Americans who earn over $10,000 or just $400 of self-employment income are required to pay US income taxes.
Expats can claim the Foreign Earned Income Exclusion however, which allows them to exclude the first around $100,000 of their earned income from US income tax. Expats can claim the Foreign Earned Income Exclusion by filing form 2555 when they file their annual federal return.
Americans who qualify for tax residence in a foreign country, normally by virtue of having a permanent base or financial or family ties there or by spending a certain amount of days physically present in the country in a year, depending on the rules in the particular country, may have to file foreign income taxes in that country too.
Expats who do pay foreign income taxes can claim the Foreign Tax Credit, which gives them a $1 tax credit for every dollar of tax that they’ve paid abroad. Expats can’t claim both the Foreign Tax Credit and the Foreign Earned Income Exclusion on the same income however.
Social Security Taxes
“U.S. citizens who live and work abroad are some of the country’s most important unofficial ambassadors. They play an important part in shaping how their international coworkers, friends and family members view the U.S. and American values.”
– NBC News
It still makes sense for many expat entrepreneurs, freelancers and Digital Nomads to establish a corporation in a low or no tax country to reduce their tax bill, despite the recent Tax Reform changes. Any corporation owned by an American is still liable to US corporate taxation, even if it’s registered abroad.
Owning a foreign registered corporation can trigger complex and expensive US reporting requirements however. This can be simplified by electing to have a foreign corporation treated as a ‘disregarded entity’. This then means that the corporation’s income and expenses can be reported on the expat’s personal tax return, rather than separately.
One advantage of establishing a foreign corporation is that expats employed by a foreign corporation (which they own) are not liable to pay US social security taxes (neither as employer or employee), while expats who own and are employed by a US corporation are.
This means that expats can pay no US income tax (up to the around $100,000 Foreign Earned Income Exclusion limit), and no US social security taxes either(which, including both employer and employee would be $15,300 on a $100,000 salary).
Expats should be aware though not paying social security taxes can impact their future entitlement to US social security payments.
Expat entrepreneurs, freelancers and Digital Nomads who earn over $100,000 may save further on their US taxes by establishing both a US registered corporation, and a foreign registered corporation that is owned by the US corporation.
A set of contracts must be correctly drawn up and signed (don’t attempt to do this without help from a qualified, experienced US expat tax specialist), but the principle is that the expat entrepreneur, freelancer or Digital Nomad pays no US income tax on a salary of up to around $100,000 by claiming the Foreign Earned Income Exclusion, no US social security taxes as they’re employed by a foreign firm, and as dividends received by a US company from a foreign company receive 50% tax discount, they can save on taxes on their earnings over $100,000 too.
Lastly, expats who pay foreign social security taxes in one of the 26 countries with which the US has a Totalization Agreement may not be liable to pay US social security taxes anyway.
Expats who are behind with their US tax filing because they didn’t know that they had to file US taxes from abroad can catch up without facing penalties or unnecessary back taxes bills under an IRS amnesty program call the Streamlined Procedure.
We strongly recommend that expats who need to catch up do so at their earliest opportunity, as the IRS has access to financial data globally.