What Qualifies as Self-Employed?
To begin with, a person who is classified as an “employee” under US common law ...
does not qualify as self-employed. Detailed definitions of employee status are provided in the Employment Tax Regulations, under sections on FICA Regulations, FUTA Regulations and Federal Income Tax Withholding Regulations. In general, these sections state that an employee is someone who works for an employer. An employer, on the other hand, is a person or company that has the authority over the employee regarding the work he has to do.
The Internal Revenue Service has provided guidelines on what it means to be an employee under common law. The label of “employer” or “employee” are not necessarily definitive. Twenty factors need to be considered to sufficiently define an employer-employee setup, and these serve to determine the amount of authority the employer has over the worker. For instance, an employee is required to follow instructions regarding how, when and where to work. Overall, an employer has complete control over hiring, directing and paying the employee for his services, and is responsible for providing the resources (such as tools and training) for accomplishing the work.
If the IRS guidelines determine that the worker is essentially an independent contractor or freelancer, he will be considered by the IRS as self-employed and he thus liable for self-employment tax.
Whether you are a US citizen living in-country, a permanent resident, or an American citizen living abroad, the same rules apply. Of course, things can be rather confusing when you’re working overseas, since local employment laws may have an effect. If you have any uncertainty about your employment status, it will benefit you to seek expert advice on US taxation.
How Often is Self-Employment Tax Paid?
You’re likely required to pay estimated taxes every quarter if you’re self-employed. Estimated tax may be used as reference for paying your self-employment tax. If you need more information, you can consult the IRS Publication 505, on Tax withholding and Estimated Tax.
How Does the Foreign Earned Income Exclusion (FEIE) Apply?
To take advantage of the FEIE, you need to take into account your entire profit from self-employment, including earnings that have exemptions. If you aren't acquainted with the FEIE, here is a brief explanation: The FEIE states that Americans living and working abroad may qualify for certain tax exemptions for their income and accommodation expenses funded by their employers. If you are self-employed however, you won’t have exemptions for employer-paid accommodations. Instead, a housing deduction may be considered, which will decrease your taxable income. In this case, both the housing deduction and the FEIE will be computed based on your net income. Naturally, you will need to determine your business income correctly for you to come up with the accurate exemptions.
These basic rules apply whether you incur any foreign taxes or not. Perhaps most importantly, the benefits can only be claimed if you file a US tax return.
Is There a Way to Avoid Self-Employment Tax?
Self-employed individuals working abroad may choose to circumvent this tax by creating a foreign entity, like a company, and then establish themselves as paid employees of this entity. This entitles them to the FEIE and eliminates self-employment tax.
However, this option needs to be evaluated cautiously. Several factors need to be considered, such as the US tax requirements for a privately-owned foreign company. It is, of course, best to consult an expert on US expat taxation.
With clients in over 150 countries, Bright!Tax is a leading US expat tax services provider for the 9 million Americans living abroad. If you have any questions regarding your tax situation, don't hesitate to get in touch for some advice.