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When you plan to work abroad as an independent contractor, you are subjected to self-employment tax on your freelance earnings just as you would do if you are self-employed in the United States. To ensure you don’t overpay money, you can read our guidelines on how to avoid self-employment tax while you are working abroad.
What Is US Self-Employment Tax?
Self-employment tax includes social security tax which is 12.4% and Medicare taxes which is 2.9%. it applies to your net self-employment earnings, even if that same amount is entirely excluded from your regular income tax under the FEIE or the Foreign Earned Income Exclusion. When you are working for US employer then you have to pay 15.3% where half amount you pay and your employer pays the other half amount. If you are self-employed then you are both the employer as well as employee so you have to pay total 15.3%.
How to Shape Your Business to Avoid Self-Employment Tax
You can minimize your self-employment burden of tax varying on the structure of your business. As a freelancer, you might have an established Limited Liability company to regulate your business. A US Limited liability company with a single owner is not treated as a separate entity for filing income tax. It is considered as a disregarded entity where income and expenses are claimed on your Schedule C of your income tax return and the net income is subject to self-employment tax.
You can choose your LLC to be treated as a corporation by filing form 8832 then it can be treated as S corporation by filing form 2553. You can regulate your business through the S corporation, where clients will pay for S corporation and not you personally.
An owner of an S corporation has two types of income salary or distributions. The salary portion will be subject to Medicare tax and Social Security tax where half tax will be paid by the employer and half will be paid by you who is the employee.
There might be a temptation to reduce the amount paid as distributions as well as minimize the earning paid as salary, be aware of the fact that S corporations must draw a reasonable amount as salary or risk the ire of the IRS.
Can You Avoid Self-Employment Tax with a Foreign LLC?
An alternative way to establish a US LLC that elects S corporation status is to set up a foreign LLC. A Foreign LLC FOR US tax purposes is not treated automatically as pay any attention to the entity. It is considered by default a foreign corporation if another classification is not elected. If you regulate your business through a foreign LLC, then your salary paid by the foreign LLC would not be subject to Medicare tax as well as US social security tax. It would be eligible for FEIE.
Do you wish to Minimize Self-Employment Tax? Then you must plan ahead
There is no magic bullet for how to ignore paying self-employment tax while you are working abroad. With careful planning, you can reduce your income tax burden. You can use a Foreign LLC or S corporation, it is important to maintain records of your business to produce accurate financials at the year-end. It is also important to take professional suggestions before proceeding with either of the structures described, as there are detailed information and other matters where both tax and non-tax are considered.
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