If you’re a self-employed US expat, understanding your tax obligations is essential. Self-employed US expats are not only subject to income taxes but also Social Security taxes. Unlike working for an American employer (or some foreign employers1), you are responsible for keeping track of Social Security taxes when you’re self-employed. This is best done proactively so that you can determine whether you’re subject to them and avoid a surprise at tax time.
In this article, we delve into the specifics of how self-employed US expats can fulfill their Social Security tax obligations while living outside of the US, leading them to then qualify for Social Security benefits.
What qualifies as self-employed income?
The IRS defines self-employed income as “income that arises from the performance of personal services, but which cannot be classified as wages because an employer-employee relationship does not exist between the payer and the payee.”2
Generally, you are considered to be self-employed if you:
- Carry on a trade or business as a sole proprietor or independent contractor
- Are a member of a partnership that carries on a trade or business
- Are otherwise in business for yourself (e.g., business owner, part-time business owner, gig worker, freelancer, etc.)3
Social Security for self-employed US expats
As a self-employed US individual, you will generally be on the hook for both income taxes and self-employment taxes (with certain exceptions for particular business structures, which we’ll go into more detail about later).
2023 Social Security and Medicare tax rate
The US self-employment tax has two components: one that funds Social Security, and another that funds Medicare. The Social Security component of the self-employment tax is set at a rate of 12.4%, while the Medicare component is set at a rate of 2.9%, totaling 15.3%.
Self-Employment Tax Rates, 2023
Note: Social Security tax is only charged up to a certain income threshold. This limit is called the maximum taxable earnings and changes every year to adjust for inflation. For the 2023 tax year, Social Security tax applies up to $160,200.4 Medicare, on the other hand, is charged regardless of income.
Mitigating self-employment tax liability
There are a couple of ways to reduce or even eliminate self-employment taxes:
- Reduce net earnings: By claiming business expenses as tax deductions, you can lower your net income. This then reduces the amount of income that is subject to taxation. As a result, deductions then lower the amount you pay in self-employment taxes.
- Change your business structure:
- Incorporate within the US: By establishing an LLC in the US, and then electing to have your US business taxed as a C-corp or an S corp, you will pay US Social Security taxes on the income you define to be your employment income (which must be a reasonable amount per IRS standards), rather than the entire net earnings of the company.5
- Establish a foreign LLC: If you create a foreign LLC and pay yourself a salary, you become an employee of that LLC rather than a self-employed individual. This will generally save you US self-employment tax. Additionally, your LLC will also be subject to US tax reporting requirements, which have some tricky elements to keep in mind (such as Form 5471 and GILTI tax).
Changing your business structure and making US tax elections can trigger additional filing, reporting, and taxation obligations, so whether or not it is beneficial for you will depend on your unique circumstances and level of income.
Social Security credits for self-employed workers
In order to collect US Social Security payments in retirement, you must first qualify for the program by earning 40 Social Security credits (equivalent to 10 years of work).
You can begin claiming these benefits at 62, although you must wait until 67 (if you were born in 1960 or later) to claim the full benefit. If you delay benefits until age 70, however, you will receive a higher monthly Social Security benefit.6
Calculating retirement benefits
As of 2023, individuals who work for themselves earn one credit for every $1,640 of earnings, for a maximum of four credits per year (although, over time, this earning threshold will increase to keep pace with inflation).7 Any additional earnings you generate will not earn additional credits or accelerate eligibility for benefits.
It’s worth noting that working outside of the US, both for a foreign employer or for yourself, can impact your ability to earn US Social Security Credits. More on that below.
The US has treaties called Totalization Agreements with 30 other countries8 that are intended to prevent expats from paying social security taxes twice: once to the US, and once to the country where they reside and work.
These agreements generally specify that if an American is working in the other country for a fairly short amount of time before returning to the US, they will continue paying US Social Security taxes and not need to pay them in the foreign country. A short amount of time is typically between two and five years, as specified in the individual treaty.
If an expat plans to be abroad longer, however, they will pay social security taxes to the government of the country where they live, and not to the US. Ultimately, the contributions made to either country under the terms of the treaty count toward both countries’ state pension entitlement.
Living in a country without a Totalization Agreement may impact self-employed US expats’ ability to qualify for US Social Security payments. If you move to such a country before putting in your 10 years toward the US Social Security program, then set up a foreign LLC to avoid US self-employment taxes, you won’t be earning the credits you need to qualify for US Social Security.
Paying Social Security tax as a self-employed expat
As mentioned above, the self-employed pay Social Security taxes in the US at a rate of 12.4% of their net income. They should pay these — along with their Medicare taxes at a rate of 2.9% of their net income — via quarterly estimated payments. These estimated tax payments can be paid via mail or on the phone, online, or through the IRS’ mobile app.
The deadlines are typically April 15th, June 15th, September 15th, and January 15th, unless any of those days fall on a weekend or national holiday (in which case, they will be moved to the next business day).
Failure to pay estimated payments will often lead to a large tax bill when filing your return, as well as a possible “Estimated Tax Penalty,” which is essentially interest based on IRS established rates on the amount of estimated tax that you failed to pay.
LLC social security tax
If you register your self-employed business as an LLC, you will pay the same US Social Security tax rate as above. That is unless you elect to be taxed as an S Corp or a C Corp, in which case you will be responsible individually for half of the self-employed rate (6.2% versus 12.4%). This would leave your employer (the corporation) responsible for the other half (6.2%)
Sole proprietor social security tax
Sole proprietors must also pay US Social Security taxes according to the self-employment tax rate of 12.4%. This rule applies unless they fall under a Totalization Agreement, which deems them exempt.