From freelancers to entrepreneurs, self-employed individuals enjoy the freedom to set their own schedules, choose their clients, and work on projects they're passionate about. Particularly for those who've moved their businesses online, being self-employed means having complete control over where, how, and when you work.
However, these advantages come at a cost. Being self-employed makes filing taxes more complex and can increase tax liability in comparison to other types of employment. To offset these costs, adventurous entrepreneurs may want to consider moving their home offices to their favorite overseas destination to reduce their tax bills with special tax credits for U.S expatriates. (Of course, you'll need to make sure you can travel safely while following all of the current Covid-19 health precautions.)
Self-Employment Tax Basics
When it comes to taxes, self-employed individuals are treated as both the employer and the employee. This means that they're responsible for paying both halves of the Social Security and Medicare taxes that employers typically withhold from salaries.
The self-employment tax rate is 15.3 percent, which covers contributions to Social Security (12.4 percent) and Medicare (2.9 percent). Plus, if the individual's income is over $200,000 ($250,000 for married couples filing jointly), they'll have to pay an additional 0.9 percent to Medicare (a stipulation added by the Affordable Care Act).
Self-employed individuals who earn just $400 or more during the tax year are required to file a federal tax return--which means that most freelancers and contractors should be prepared to file every year. When preparing their returns, self-employed taxpayers will need to use Schedule C to report profits or losses from their business. Additional forms may also be required depending on the structure of their business, which can make filing confusing and costly.
Tax Breaks for Americans Living Abroad
The U.S Tax Code includes special provisions for Americans living abroad that can help balance some of the costs of self-employment tax. These include the Foreign Earned Income Exclusion, the Foreign Tax Credit, and the Foreign Housing Exclusion:
- The Foreign Earned Income Exclusion allows qualifying expat taxpayers to exclude up to $107,600 from taxation in 2020 ($108,700 for 2021).
- The Foreign Tax Credit gives Americans working abroad a dollar-for-dollar credit on taxes paid to a foreign country.
- The Foreign Housing Exclusion can be used to deduct certain housing expenses while living abroad.
It's important to note that these tax breaks cannot be used to directly eliminate or reduce self-employment taxes, which are calculated based on your full income (before any credits or exclusions are applied). However, these reductions can help minimize self-employed individuals' general income tax liability.
How to Qualify
To qualify for these tax savings, you'll need to prove that you live overseas. Specifically, you'll need to spend at least 330 days of any 365-day period outside the U.S.--or you'll need to live outside the U.S. for a full year with no intention of returning (in which case, there is no specific requirement for the number of days you spend outside the U.S.).
The IRS strictly enforces the requirements for both of these tests, so it's important that self-employed Americans understand them fully before moving abroad. If you miss the requirement by just one day, you will not be able to qualify for any of these expat tax breaks.
Understand the Tax Implications Before You Move
Keep in mind that, while moving your freelancing job or business to a foreign tropical island can help you qualify for tax breaks, it can also trigger additional tax requirements, like foreign financial reporting. On top of this, you'll also need to consider the current travel environment. Make sure to research and follow the current health and safety measures for the coronavirus pandemic for both your current location and your destination.
If you decide a move abroad is right for you and your business, make sure you understand the tax implications so you can maximize your savings and minimize confusion when it's time to file.