Overseas freelancing vs. overseas salary

[jgombos]

What is the name of your state (only U.S. law)? fed

Given the option to either freelance or take a salary in the EU, which is favorable in terms of US tax? (Assuming the take-home income is about the same). Does it make a difference?

 

[LdiJ]

What is the name of your state (only U.S. law)? fed

Given the option to either freelance or take a salary in the EU, which is favorable in terms of US tax? (Assuming the take-home income is about the same). Does it make a difference?

There is not a simple answer to that question, because we don't know the laws of the country where the person would be working.

For US tax purposes its almost always better to be an official employee, with a salary.

 

[jgombos]

From the standpoint of US tax, I was initially assuming it would make no difference to the extent that the income level falls below the exclusion cutoff.

Then I saw some rumors/blogs saying that the foreign employment arrangement (employed or self-employed) can make a difference on US tax, although the details as to why or how are still unknown to me.

Why would the laws of the foreign country be relevant as far as US tax goes?

I'm not sure what foreign laws are of interest, but freelancing essentially implies slightly less overhead, thus slightly more take-home, but it would still be under the ~$83k threshold. The slight additional take-home pay is quickly consumed by the extra cost of a foreign accountant that's needed for VAT and the like.

So it breaks even on the foreign side of it, with the main benefit being some more freedom (Eg. the work authorization is no longer tied to a single employer for the whole year). But if freelancing comes at a higher price on the US tax bill, then it may kill the deal.

 

[jgombos]

Got my answer.

An accountant told me self-employed Americans abroad are subject to paying self-employment tax (15.3% of net business income) plus income tax.

Deductions can be applied to that income, but it's not even close to being as favorable as an exclusion up to $83k. Suddenly the freelance option looks like a poor choice.

Unless it's possible to meet the Belgian definition of freelancing, while meeting the US definition of employed. How does the US define salaried vs. self-employed? Would having a single client qualify as not being self-employed?

[EDIT] To confuse matters, the 2nd paragraph of this web page contradicts what the accountant told me:

http://www.taxmeless.com/page2.html

 

[LdiJ]

Got my answer.

An accountant told me self-employed Americans abroad are subject to paying self-employment tax (15.3% of net business income) plus income tax.

Deductions can be applied to that income, but it's not even close to being as favorable as an exclusion up to $83k. Suddenly the freelance option looks like a poor choice.

Unless it's possible to meet the Belgian definition of freelancing, while meeting the US definition of employed. How does the US define salaried vs. self-employed? Would having a single client qualify as not being self-employed?

[EDIT] To confuse matters, the 2nd paragraph of this web page contradicts what the accountant told me:

International Tax Tips for Expatriate Americans and Avoiding Tax Domicile Problems after Moving Abroad

The accountant was accurate, you are still subject to self employment tax if self employed.

 

[jgombos]

The accountant was accurate, you are still subject to self employment tax if self employed.

Looking around the net, I can see that most accountants are aligned on that. However, I just found a gem in paragraph 6 of this article:

http://www.fisken.com/news/fiscal_facts_6.html

So going freelance may not be as damaging as I thought.

The next mission is to find out if form 1116 can completely reverse the effect of US self-employment tax abroad - or to what extent it can.

 

[LdiJ]

Looking around the net, I can see that most accountants are aligned on that. However, I just found a gem in paragraph 6 of this article:

http://www.fisken.com/news/fiscal_facts_6.html

So going freelance may not be as damaging as I thought.

The next mission is to find out if form 1116 can completely reverse the effect of US self-employment tax abroad - or to what extent it can.

Here is paragraph 6:

6) Host Country Taxation: It is possible that an American employee living abroad will be subject to the income tax of the Host Country. Conceptually an American Taxpayer should NOT be taxed twice on the same income. Thus if an American overseas employee is subject to USA income tax and Host Country income tax on the same income, that employee is permitted to take a Tax Credit on income that is double-taxed. The protocol for taking that credit is to complete the IRS Form 1116 (Foreign Tax Credit). That Form 1116 is then attached to the employee's IRS Form 1040.

Please note that if the employee takes the Overseas Exclusions on the employee's IRS Form 1040, the income that has been excluded through the use of the Overseas Exclusions is NOT eligible for the Foreign Tax Credit since that income has NOT been taxed by the USA.

And it has absolutely nothing to do with self employment tax...so its not the "gem" that you think that it is. Form 1116 also has nothing to do with US self employment tax.

 

[jgombos]

Here is paragraph 6:



And it has absolutely nothing to do with self employment tax...so its not the "gem" that you think that it is. Form 1116 also has nothing to do with US self employment tax.

According to paragraph 6, any "tax on the same income" is eligible for the tax credit. Self-employment tax indeed taxes the same income that the host country also taxes. Are you saying paragraph 6 is incorrect, or are you interpreting it differently?

Does the tax code wording specifically exclude self-employment tax? (I'll try to look into that)

 

[LdiJ]

According to paragraph 6, any "tax on the same income" is eligible for the tax credit. Self-employment tax indeed taxes the same income that the host country also taxes. Are you saying paragraph 6 is incorrect, or are you interpreting it differently?

Does the tax code wording specifically exclude self-employment tax? (I'll try to look into that)

You are interpreting it wrong.

First, the second paragraph specifically states that you may not take credit for taxes paid for excluded income. Therefore you would only be able to take credit for taxes paid on income in excess of the exclusion.

If you are actually paying into a type of self employment tax in the host country, you may be able to take credit for that tax, but that would vary from country to country and would depend in part on individual tax treaties.

 

[jgombos]

You are interpreting it wrong.

First, the second paragraph specifically states that you may not take credit for taxes paid for excluded income.

Ah, that's where the confusion is. You're counting self-employment tax as something that is excluded by the income exclusion. The way I understand it, self-employment tax cannot be reduced by the foreign income exclusion. If the self-employment tax could be reduced by the exclusion, then I would agree - it would make perfect sense that the foreign tax credit would not be applicable.

You may not agree with this assumption, but assume for a minute that I am correct in saying that the the foreign income exclusion doesn't affect self-employment tax. Would you then agree in those circumstances that the foreign tax credit would apply? Certainly in that case the US self-employment tax would be applied to the same income that was already taxed in the host country.

As for whether the assumption about the effect of the foreign tax credit on self-employment tax is true or false, I've found many sources making opposing claims on this, so it's not yet clear to me which it is.

And I suppose it doesn't matter which way it is, as long as I can expect the foreign tax credit to cover what the foreign income exclusion doesn't, effectively ensuring that I'm not doubly taxed, then I have no reason to find self-employment to be more costly.

If you are actually paying into a type of self employment tax in the host country, you may be able to take credit for that tax, but that would vary from country to country and would depend in part on individual tax treaties.

I'm not sure if the host country actually labels the tax as "self-employment tax." The foreign tax regime first takes social security (~13% for employees, and ~25% for self-employed). The remaining amount is taxable, and the same progressive income tax table is used regardless of whether the taxpayer is self-employed, or employed.

 

[davew128]

You may not agree with this assumption, but assume for a minute that I am correct in saying that the the foreign income exclusion doesn't affect self-employment tax.

It's not an assumption, it's written into the self employment tax law, and in fact I've cited that law on this forum in the very recent past.

Would you then agree in those circumstances that the foreign tax credit would apply?

Insufficient facts to determine that. Specific criteria must be met and a blanket statement cannot be made.

Certainly in that case the US self-employment tax would be applied to the same income that was already taxed in the host country.

Yes.

And I suppose it doesn't matter which way it is, as long as I can expect the foreign tax credit to cover what the foreign income exclusion doesn't, effectively ensuring that I'm not doubly taxed, then I have no reason to find self-employment to be more costly.

Unless the foreign tax is greater than the US SE tax.

I'm not sure if the host country actually labels the tax as "self-employment tax." The foreign tax regime first takes social security (~13% for employees, and ~25% for self-employed). The remaining amount is taxable, and the same progressive income tax table is used regardless of whether the taxpayer is self-employed, or employed.

Did you bother to check if the country in question has a Social Security totalization agreement with the US as many close trading partners do? Sort of solves the problem.....