Chapter 10: Paying into Social Security – #Americansabroad, double taxation and the payment of “Self-employment” taxes

Introduction:

The article reference in the above tweet includes:

Although 25 countries have signed a bi-national social security agreement (what the IRS calls a Totalization Agreement) with the U.S. that prevents double taxation of income with respect to social security taxes, Morocco isn’t one of them. In fact, not one country in the Middle East has signed the agreement, and Chile is the only Latin American country to do so. In Asia, only Japan and South Korea have totalization agreements with the U.S.

“The double taxation makes me crazy, especially because Morocco and the U.S. have so many treaties relating to trade, the military, and many other things,” Ms. Ponzio-Moutakki said. “This just penalizes Americans who are living abroad.”

 

The problem:

Self-employed “Homelanders” are required to pay a tax on self-employed earnings. This is a tax “Social Security” tax. This tax is found in the Internal Revenue Code. The Internal Revenue Code treats Americans abroad and “Homelanders” the same.

An excellent description from U.S. tax lawyer Virginia La Torre Jeker includes:

What is Self-Employment Tax?

The self-employment tax is a social security and Medicare tax based on net earnings from “self- employment”.  We’ll review what it means to be “self-employed” later in this posting.  The dollar threshold trigger for paying self-employment tax is quite low – you must pay self-employment tax if your net earnings from self-employment are at least US$400.

For self-employment income earned in 2013, the self-employment tax rate is 15.3% imposed on your net earnings. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).

If you are a “self-employed” US citizen or US resident, the rules for paying self-employment tax are generally the same whether you are living in the United States or living and working overseas.

Effect of Foreign Earned Income Exclusion (FEIE)

You must take all of your self-employment income into account in figuring your net earnings from self-employment, even income that is exempt from income tax because of the FEIE. Briefly, for those who may not be familiar with the FEIE, Americans working abroad may be eligible to exclude certain foreign earned income (wages, compensation for services) from US taxable income under the rules governing the Foreign Earned Income Exclusion (FEIE), and certain foreign housing costs paid by their employers. If one is self-employed, then instead of taking a housing exclusion, a housing deduction is taken which further reduces the amount of taxable income. For self-employed persons, both the FEIE and the housing deduction will be calculated based on the individual’s net income as figured on Schedule C or Schedule F. Calculating the right amount of the exclusion depends on figuring one’s business income accurately.

The above-mentioned beneficial rules apply regardless of whether any foreign tax is paid on the foreign earned income or housing amounts. These tax benefits can be claimed, however, only if a US tax return is filed within certain time deadlines. More details can be found in my write-up here.

Therefore the question becomes:

Under what circumstances do Americans abroad become exempt from paying the U.S. “self-employment” tax? There are two possible ways to avoid the U.S. “self-employment tax”.

First – the “Totalization Agreement”

Americans abroad are exempt if they reside in a country that has a “Totalization Agreement” with the U.S. Government. So, what’s a “Totalization Agreement” and what purpose does it serve?

The short answer is that if you are “self-employed” in a country that has a “Totalization Agreement” you will NOT have to pay the U.S. Social Security tax.

This means that as a “self-employed” U.S. citizen abroad your U.S. tax liability is largely determined by your country of residence. If you don’t live in a country with a “totalization agreement” you will pay higher U.S. taxes! You cannot use your Foreign Tax Credit to offset Social Security taxes. The message is:

The takeaway: U.S. citizens abroad need to carefully consider the implications of being “self-employed”!

The Social Security site describes “Totalization Agreements” in the following way:

107. Totalization Agreements

107.1 What are Totalization agreements?

The Social Security Act allows the President to enter into international agreements to coordinate the U.S. Social Security Act’s title II (old age, survivors and disability) insurance programs with the social security programs of other countries. These agreements are known as “Totalization agreements.”

107.2 With what countries does the U.S. have Totalization agreements?

The United States currently has social security agreements in effect with 24 countries – Australia (2002), Austria (1991), Belgium (1984), Canada (1984), Chile (2001), Czech Republic (2009), Denmark (2008), Finland (1992), France (1988), Germany (1979), Greece (1994), Ireland (1993), Italy (1978), Japan (2005), Luxembourg (1993), the Netherlands (1990), Norway (1984), Poland (2009), Portugal (1989), South Korea (2001), Spain (1988), Sweden (1987), Switzerland (1980), and the United Kingdom (1985).

107.3 What are the purposes of Totalization agreements?

Totalization agreements have three main purposes:

  1. To eliminate dual social security coverage and taxation. This situation occurs when a person from one country works in the other country and is required to pay social security taxes to both countries for the same work;

  2. To avoid situations in which workers lose benefit rights because they have divided their careers between two countries. Under an agreement, such workers may qualify for partial U.S. or foreign benefits based on combined work credits from both countries.

  3. To increase benefit portability by guaranteeing that neither country will impose restrictions on benefit payments based solely on residence or presence in the other country.

107.4 Totalization Agreements – Other Resources

For additional information on “Totalization agreements” see: http://www.socialsecurity.gov/international/agreements_overview.html

Second – the creation of a “Foreign Corporation”

I will create a separate chapter on this issue. For the moment, borrowing again from Virginia La Torre Jeker:

Circumventing Self-Employment Tax

One method that can be considered is the creation of a foreign entity, such as a foreign corporation and being hired by that entity as an employee, generally with full salary being eligible for the FEIE and elimination of self-employment tax concerns .  Whether this is a viable solution will require very careful consideration of many factors and professional tax advice should be sought.   For starters, one must consider the US tax impact of owning a foreign corporation.  Some initial guidance can be found in my tax blog posting here.

 

 

 

 

 

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