The promise of flexibility has lured more and more Americans overseas for work. By becoming an expat independent contractor, they get to see new sights, experience different cultures, and work anywhere they want.
However, working abroad as an independent contractor can also be complicated, especially if you fly from one country to another in the course of a single year. Unlike regular employees, independent contractors have to figure out their tax liability and file their tax returns themselves.
Here’s everything you need to know about expat taxes if you’re an independent contractor.
Independent contractor vs. employee
The IRS considers you an independent contractor or self-employed if you are in business for yourself. Your clients only have control over the result of your work and have no say over what will be done and how it will be done.
You are not an independent contractor if you are in a formal employer-employee relationship. However, if you do freelance work on the side while holding on to a full-time job, you will need to report both sources of income.
Americans employed overseas by a foreign employer (i.e. enjoy a formal employer-employee relationship) do not have to pay Social Security and Medicare taxes. Meanwhile, self-employment income is subject to self-employment taxes whether it was earned in the United States or abroad.
U.S. taxes for foreign contractors
According to the Internal Revenue Service (IRS), all United States citizens and permanent citizens (also known as Green Card holders) have to file a federal tax return if they meet the minimum filing threshold. This applies to all Americans at home and overseas.
If you have foreign financial instruments such as bank and investment accounts with a combined worth of over $10,000, you also need to file an FBAR, or a Report of Foreign Bank and Financial Accounts.
For income earned in 2020, the income threshold is $12,400 for those filing Single, $24,800 for Married Filing Jointly, $5 for Married Filing Separately, $18,650 for Head of Household filers, and $400 for Self-Employed filers.
Independent contractors that earn more than $400 in a year are required to file a federal tax return. They also have to pay a 15.3% self-employment tax (also known as FICA tax) for Social Security and Medicare. While you can take advantage of tax deductions and exclusions to reduce or eliminate your tax liability, the self-employment tax is mandatory even if you are able to fully exclude your foreign earnings from U.S. income tax.
Overseas taxation for foreign contractors
American expat independent contractors have to be compliant with their host country’s tax obligations. Depending on your location and situation, you may need to pay income tax as well as other taxes to your host country on top of U.S. income tax.
It is important to note that your expat tax obligations depend on the source of your income (e.g. local or foreign) and your tax status in your host country (e.g. resident or non-resident). Please consult a tax professional if you have any questions about your tax status and your host country’s tax system.
Other tax implications of working overseas
Independent contractors that stay in one place only need to follow the tax rules of their host country and the United States. Working in multiple countries means you have to comply with multiple tax rules, further complicating your tax situation.
You may encounter a situation where you have to contribute to the social security systems of your host country and the United States. To combat double taxation of income with respect to social security taxes, the United States has entered into Totalization Agreements with some countries.
Setting up an LLC before moving abroad
Some independent contractors in the United States are forming single-member limited liability companies (LLC). Like corporations, LLCs are distinct legal entities and can provide legal cover for the owner.
Establishing an LLC also allows the owner to take advantage of corporate tax rules. However, there have been cases when the IRS will not recognize the LLC to be separate from the owner. Consult a tax professional if you have any questions about forming an LLC prior to moving abroad,
Tax savings for foreign contractors
Independent contractors that have paid income tax to their host country can take advantage of credits and exemptions to reduce their U.S. tax liability on the same income.
Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion (FEIE) allows you to exclude up to $108,700 (2021) of earned income. Income within that threshold is exempt from federal income tax. However, you still need to file a federal tax return and declare your income even if you have eliminated your tax liability.
You need to meet the Physical Presence Test to claim the FEIE. That means you need to physically live in a foreign country for at least 330 days in a 365-day period if you want to take advantage of this benefit.
It’s important to note that the FEIE only applies to your earned income. It doesn’t apply to capital gains, interest, dividends, pensions, alimony, and annuities.
Foreign Tax Credit
You can also take a foreign tax credit to prevent double taxation.
According to the IRS, you cannot take a foreign tax credit on income that has already been excluded under FEIE. However, you can take a tax credit on earned income above the FEIE threshold ($107,600 for 2020, and $108,700 for 2021).
Filing an expat tax return
If you’re an independent contractor, filing a U.S. tax return is already stressful enough without having to deal with self-employment taxes and the tax rules of multiple countries.
At TFX, you will find all the help you will need. We know the ins and outs of tax codes all over the world, which has saved our clients lots of money. Our clients also enjoy our easy-to-use online platform and our fast service.
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