Q&A: I’m self-employed and confused– what do I need to do about US Self-Employment taxes if I have already paid into a foreign system?

Posted by Don W on May 13, 2010 under Business Tax Issues, Expatriate Taxes

Q: I have been in Finland for 12 years, and I am returning the the United States and filing previous year’s taxes. I am confused by the apparently contradictory information that I find in the the 2009 IRS publication 54, page 11, titled “Exemption from Social Security and Medicare Taxes”.

I paid all my self employment taxes in Finland dutifully all the years I lived there, and understand the Totalization Agreement with Finland means I don’t have to pay them again in the US, but my accountant says I have to pay the 15.3% Self-Employment tax.

Who is correct?

A: The basic rule is this – you must be paying into one system or the other (assuming there is a Totalization Agreement).

In your case, if you have been paying into Finland’s social system then you would not be required to pay Self-Employment tax on the income.  You would just be required to pay income tax.

Please check out the SocialSecurity.gov overview of the Totalization Agreements by country (you can also find full text of the Agreements on the site).  Keep in mind that these agreements only apply to the years spent abroad.  Once you return to the US you will again be responsible to US system.

Q&A: I’m a partner in two offshore companies — how do I file?

Posted by Don W on under Business Tax Issues

Q: Hello, I am a U.S. citizen living in Europe and I am a partner in 2 separate companies here, with 50% in one and between 30% and 50% in the other. I am very confused and have several questions.

  1. As I live full time abroad, I get a 2-month extension for filing until June 15th, correct?
  2. What forms do I need to include with my 1040? As I understand it, I need the 2555 and the 5471?
  3. As I am a partner and receive distribution of earnings rather than a salary, this does not qualify as foreign earned income so I cannot elect the foreign earned income exclusion, correct? So would I still need the 2555 form?
  4. Income taxes and SS are taken from my earnings here. Do I qualify for US tax credit?

A: I will answer your questions in the order you presented them.

  1. Yes, you an get automatic extension until June 15th.
  2. From what you have presented you will need at the very least Form 2555, Form 1116 and
  3. If you are receiving distributions — and NOT dividends — for work done then yes, it does qualify as Earned Income.  Additional details about your situation would help us to provide a more specific answer.
  4. Income taxes and Social Security are two different issues.  If you paid income tax you probably qualify for the Foreign Tax Credit (see number 1).  Social Security is governed by whether or not there is a Totalization Agreement with the country in which you are residing.  If there is, then, generally, you are only required to pay into one system.  But you must pay into one or the other.

Q&A: Is it better to be a contractor or an employee of a foreign corporation, for tax purposes?

Posted by Don W on February 22, 2010 under Business Tax Issues, Expatriate Taxes

Q: I’m an American citizen considering a 3 month contract with a Japanese company. I would be working in Japan and they would pay me as a contractor, not an employee. Right now I’m a sole proprietor.

Would it be better for tax purposes to incorporate (LLC or S Corp)? Would I pay any taxes in Japan? We’re also discussing a longer term contract where I would be in Japan for 270 days per year. Would I be better off as an employee or a contractor?

A: The short answer is an LLC or S Corp would pass through just like a sole proprietorship. Unless you would be making large sums it would not really be worth it, from a basic tax perspective. There may be legal or industry specific issues which make them attractive options.

The employee or contractor question is a tricky one. The big difference is whether you pay into US Social Security or into the Japanese system. Employees of foreign corporations are generally not required to pay into US system because they are paying into the foreign system. Those self-employed would be required to pay into the US system. Both statuses are eligible for the Foreign Earned Income Exclusion, for which you must meet the Physical Presence Test to qualify. However, self-employed taxpayers must pay Self-Employment Tax. This is comprised of the employee and employer portions of Social Security and Medicare. These taxes are not eligible to be excluded. It is possible to have all of your foreign income excluded and still have to pay Self-Employment Tax. We invite you to visit the Expat Tax Basics page on our main site for more information.

Tax returns for those filing as self-employed can be more complex– something to take into consideration.

Q&A: Do I need to file taxes for my company that doesn’t have revenue to date?

Posted by Don W on January 29, 2010 under Business Tax Issues, Expatriate Taxes

Q: I live in Pennsylvania.  My personal taxes will be comprised of a 1099 as I was hired by an American company as a consultant for a couple months and then as a standard employee thereafter.

In September 2007, I started an LLC in Alaska that is to be taxed as a partnership.  The company has no employees and no income to date, and neither my business partner nor myself are getting paid from that company.  My business partner is a citizen of Germany but is currently a resident of Japan.  When we first set up the partnership they had mentioned that he should apply for an EIN which he has not yet done. Do you know if this is necessary? I am not sure what the requirements are for him as a foreign member.

A: Your LLC has to file an annual return by April 15th, even if it has no income.  Your partner will certainly need to get a TIN (Taxpayer ID Number). It should go on the LLC tax return and on his personal tax return.  Since he is a foreign partner there are some additional reporting requirements for the  partnership as well – Forms 8804 (PDF) and 8805 (PDF) – instructions for both are here.  This is for the LLC to report to the IRS, and withhold taxes, any income received by the foreign shareholder.  There are penalties associated with not filing these forms.

Your personal tax return is much less complicated.  Any time you have spent outside the US in 2007/2008 will determine whether or not you qualify for the Foreign Earned Income Exclusion.  If you have paid any income tax to a foreign country then you may be eligible for the Foreign Tax Credit.  If neither of these were to apply you would simply file your return like you lived in Pennsylvania.  For more information on the Exclusion and Credit please visit our Expat Tax Basics page on our main site.