# Self Employed US Expats - How do you avoid double taxation?



## USExpatsTaxes (Dec 16, 2020)

Are there any US expats here that are self employed? How do you avoid double taxation (i.e. paying social security taxes to both the US and the country where you live)? 

As a self employed US expat living in a country has no totalization agreement with the US, I believe I'm subject to paying social security taxes both the US and in the country where I live. Aside from renouncing citizenship, is there any creative way around this? It seems so unfair to have to pay local social security taxes, plus 15% of my earnings to the US!


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## Moulard (Feb 3, 2017)

Unfortunately there is no way to legally avoid SE taxes if you are working in a country without a totalization agreement in place if you are truly self employed.

From a creativity perspective it may depend in part in terms on how you gain your work and how many clients you have and the nature and relationship between you and your customer(s)

Ultimately it boils down to which party has behavioural and.or financial control and the nature of the relationship between the parties?

The 20 factor test helps to define the relationship and sense whether sufficient control is present to establish an employer-employee relationship even if you are a contractor.

Found this summary for you... 



https://www.michigan.gov/documents/uia/IRSFactorTest_503194_7.pdf



There once was a time where I contracted through a intermediary company but their client had control using the 20 factor test... so I was not an employee of the company who paid me, but I could argue that I was an employee of their client. As I worked in their building, using their facilities on projects that they defined and so on..

Stuff for you to consider at least.


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## NickZ (Jun 26, 2009)

USExpatsTaxes said:


> Are there any US expats here that are self employed? How do you avoid double taxation (i.e. paying social security taxes to both the US and the country where you live)?


Things like social security isn't covered by the double taxation treaties. It's normally covered by the social treaties.


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## Jca1 (Aug 7, 2019)

I think the usual suggestion is to create a local company that you work through as an employee. You and the company then pay local social security taxes but not US. However, I don't know much about the control issues that Moulard mentioned, and this also creates a new problem of US tax reporting for a foreign company, which can come with big penalties if you get something wrong, sometimes even if it's something seemingly trivial or not really even wrong. This might also still require a totalization agreement.


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## Moulard (Feb 3, 2017)

No the control issue I was referring to is around defining the relationship between the two (or sometimes more) parties to the contract.

The 20 Factor test can be used to help determine if the nature of the relationship is that of an employee or an independent contractor - and that is a key to whether you would report as self employed or just an employee. The point I was trying to highlight is that it is quite possible for one to have a contract that stipulates you are an independent contractor but the nature of the relationship is that of employer-employee. In the US the IRS will get involved to help resolve this, but given the foreign business won't get involved, the OP can make that assessment and file accordingly, and there will not be a counterclaim by the foreign employer... 

Creating a local company doesn't really help... or at worst is jumping out of the fireplace and into the fire.

Its either treated as a passthrough company, in which it is invisible, and they are still considered self-employed, or the choose to treat it as a corporation, and then you have CFC (the control issue you were mentioning) and other corporate reporting requirements - save on SE taxes, but at the cost of far more complex filing requirements.


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## Jca1 (Aug 7, 2019)

Moulard said:


> No the control issue I was referring to is around defining the relationship between the two (or sometimes more) parties to the contract.
> 
> The 20 Factor test can be used to help determine if the nature of the relationship is that of an employee or an independent contractor - and that is a key to whether you would report as self employed or just an employee. The point I was trying to highlight is that it is quite possible for one to have a contract that stipulates you are an independent contractor but the nature of the relationship is that of employer-employee. In the US the IRS will get involved to help resolve this, but given the foreign business won't get involved, the OP can make that assessment and file accordingly, and there will not be a counterclaim by the foreign employer...
> 
> ...


I see. Yeah, you'd need to be making a lot of money to make the overhead and risk of foreign corporation tax reporting worthwhile, and you'd have to avoid pass-through treatment. As Treasury has said, Americans don't form small businesses outside of the US because it is not efficient.

Taking the position that your contract fails a control test and therefore you aren't self-employed is an interesting idea that I hadn't heard of before.


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## Moulard (Feb 3, 2017)

Yeah.. you are basically using the IRS rules that are designed to resolve disputes where employer says person is a contractor and person says that they are an employee to your advantage.

To protect yourself against an adverse determination in the event of an audit you would want to document evidence related to the 20 Factor Test and store it along with your return.

If you are self employed as say an electrician taking jobs from lots of clients its probably not going to fly... nor would it if you had a small business selling widgets.

But say, if you are an IT contractor, working through an agency for their client, and contract terms don't allow you to work for anyone else, you work on their clients property, using client equipment etc then you could quite possibly be considered an employee of the client.

Its not a silver bullet in all situations, but for information workers it has some merit, AND it is a specific IRS example where the determination may not be clear cut.


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## USExpatsTaxes (Dec 16, 2020)

Moulard said:


> Yeah.. you are basically using the IRS rules that are designed to resolve disputes where employer says person is a contractor and person says that they are an employee to your advantage.
> 
> To protect yourself against an adverse determination in the event of an audit you would want to document evidence related to the 20 Factor Test and store it along with your return.
> 
> ...


Thanks for the replies! Moulard, using the 20 factor test is an appealing idea. However, it seems like the IRS didn't intend for expats to use this 20 factor test, so I'm not if they would consider it a valid justification for reporting income as wages instead of self employment. Do you know of any instances where an expat has successfully used the 20 factor test to justify reporting income as wages, in the fact of an IRS audit?


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## Bevdeforges (Nov 16, 2007)

To be honest, it's very unlikely you would be audited from overseas. What many folks do is just claim their business as their employer and then just not bother trying to "prove" that they don't owe the "self-employment tax." Unless you have something suspicious on your return, it's very unlikely they'll bother to look any further.


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## Moulard (Feb 3, 2017)

USExpatsTaxes said:


> Thanks for the replies! Moulard, using the 20 factor test is an appealing idea. However, it seems like the IRS didn't intend for expats to use this 20 factor test, so I'm not if they would consider it a valid justification for reporting income as wages instead of self employment.


Perhaps you read too much into what I wrote, 20 factor test looks at common law factors. I couldn't find it at the time, but the actual source is Rev. Rul. 87-41, 1987-1 CB 296.

"This ruling provides guidance concerning the factors that are used to determine whether an employment relationship exists between the Individual and the Firm for federal employment tax purposes".

As far as I can tell there is no caveat so say that these common law principles only apply in the US. Now if you had said Rev. Rul. 87-41 was out of date and surpassed, then on that I would have to agree -- which is kind of why I hinted at the following...

IRS Pub 15-A - Employer’s Supplemental Tax Guide (2020) announced new or changed standards to be used by the IRS from the 2020 tax year onwards. Pub. 15-A announced a policy to focus on three “areas” of criteria in applying the preexisting “control test.”

Control of

Behaviour
Finances
Relationships
Do bear in mind that the fundamental “control test” and its prior explication set out by the IRS in Rev. Rul. 87-41 still remains valid.



https://www.irs.gov/pub/irs-pdf/p15a.pdf



You wanted a "creative" way... I have provided you with a legally open window by which you can assess your business relationship and come to a decision on whether or not under common law you are actually an employee and thus able to avoid SE Taxes. Whether or not you can fit through that window is a matter of your analysis and examination based on your personal facts.



> Do you know of any instances where an expat has successfully used the 20 factor test to justify reporting income as wages, in the fact of an IRS audit?


No.

Audits are not made public and this is not something I care enough about to troll through Tax Court and/or Private Letter Rulings over... but by all means you can if you need to satisfy yourself. These are public documents.

But if it eases your fears, a while back I did an detailed analysis of IRS published tax statistics in 2018 .

Globally (ie including US resident returns), the IRS examined 0.6% of individual returns.
Yes, 3.4% of international returns were audited which makes it sounds 7 times more likely for an international return to be audited until you take into account

This is a total of just shy of 6000 returns
That number includes 1040-PR AND 1040-SS returns (self employment returns from certain US Territories)
The IRS has no international presence outside specific major investigations
This means only the examinations by correspondence are relevant for a non-resident US taxpayer ... which leaves a grand total of...
157 tax returns examined.
To preemptively answer your question on the 1040-PR and 1040-SS returns, Territorial tax returns are complicated by the fact that a territorial tax resident typically pays no federal income tax (if they have no US sourced income) but does pay FICA taxes. It would not surprise me if the bulk those returns were for example somefile filing them with a mainland US address, or some other indicator that they were not in fact a tax resident of the territory and thus should have been paying federal income tax.

Practically speaking if you live overseas and are an "ordinary" taxpayer with an "ordinary" income the change of an examination is extremely small. The IRS budget works out to something like $50 a tax return, and far less than that if you look at only their operating budget (I think it is something like $17 a return)

I know international tax preparers who have told me that they have never had a customer of theirs audited in their entire careers.


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## USExpatsTaxes (Dec 16, 2020)

Bevdeforges said:


> To be honest, it's very unlikely you would be audited from overseas. What many folks do is just claim their business as their employer and then just not bother trying to "prove" that they don't owe the "self-employment tax." Unless you have something suspicious on your return, it's very unlikely they'll bother to look any further.


Interesting to know! Do you know if these people report their business as a CFC that they own? Because I'd imagine that if they report "employment income" from a business that they own, that would seem suspicious to the IRS - or maybe I'm overlooking something?


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## Moulard (Feb 3, 2017)

Personally I would suggest that the cost of compliance (either it terms of opportunity lost if you chose to do it yourself, or your hard earned ฿ if you chose to pay someone to do it for you) would mean making an entity election to be treated as a corporation, and then deal with CFC issues would not be worth it unless your business is making a lot of money. In which case you probably would be paying someone for advice rather than seeking it online.

USExpats.. apologies my Thai is extremely rusty... but this should give you my thoughts on you going down the Corporation and CFC route to avoid FICA taxes..

ถ้าคุณไปทางนั้นเป็นคนบาตรไม่เต็ม

Apologies, for the Thai for everyone else, I am idiomatically saying that he would be crazy to go down that particular path.

While you are trying to avoid SE taxes, the one (albeit minor) advantage of SE taxes and no totalisation agreement is that you won't be subject to things like WEP when you are of an age to receive social security payments.


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## USExpatsTaxes (Dec 16, 2020)

Moulard said:


> Personally I would suggest that the cost of compliance (either it terms of opportunity lost if you chose to do it yourself, or your hard earned ฿ if you chose to pay someone to do it for you) would mean making an entity election to be treated as a corporation, and then deal with CFC issues would not be worth it unless your business is making a lot of money. In which case you probably would be paying someone for advice rather than seeking it online.
> 
> USExpats.. apologies my Thai is extremely rusty... but this should give you my thoughts on you going down the Corporation and CFC route to avoid FICA taxes..
> 
> ...


I actually wasn't suggesting going down the CFC route to avoid FICA taxes. I was referring to Bevdeforges comment, which was: 

"What many folks do is just claim their business as their employer and then just not bother trying to "prove" that they don't owe the "self-employment tax." "

The point I was trying to make was the following: if these people own a business, are they reporting it to the IRS? Or just non reporting it and hoping the IRS doesn't notice it? I'm guessing it's the latter.


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## Moulard (Feb 3, 2017)

Outside of an examination the IRS has no means to know or find out. Under the exchange of information clause in the tax treaty, they can ask for information, but the chance of that is slim, unless they have already started an examination.


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## Bevdeforges (Nov 16, 2007)

For many years, I reported my salary income from the business my husband and I ran from our home. Now, in my case, I was officially considered an "employee" of the company and fully registered in the local social insurance system. (Also, France has a social security treaty with the US.) During all this time, I reported my employer as being our company (using the name of the company) with its business address the same as the home address I was using to file my returns from. Did the same on my FBARs (since I had signature authority as the one in the company who paid the bills). In the early years I wondered if anyone would notice. But twenty years later, when we folded up the company for retirement, I had never heard a peep. 

Back when I worked for one of the big public accounting firms, they called that "taking an aggressive tax stance" - and generally speaking the accounting firm said that they would deal with the IRS when (and "if") they asked any questions.


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## Jca1 (Aug 7, 2019)

Moulard said:


> Personally I would suggest that the cost of compliance (either it terms of opportunity lost if you chose to do it yourself, or your hard earned ฿ if you chose to pay someone to do it for you) would mean making an entity election to be treated as a corporation, and then deal with CFC issues would not be worth it unless your business is making a lot of money. In which case you probably would be paying someone for advice rather than seeking it online.
> 
> USExpats.. apologies my Thai is extremely rusty... but this should give you my thoughts on you going down the Corporation and CFC route to avoid FICA taxes..
> 
> ...


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## Jca1 (Aug 7, 2019)

One other thing occurred to me: it might be worth considering whether it's worthwhile to be paying some amount of "voluntary payroll tax" in order to be eligible for Medicare, SS and SS disability. From what I can understand, generally the disability benefits require at least 20 credits in the last 10 years. It looks like you get a credit for paying payroll tax on each ~$1500 in income, up to a max of 4 credits a year.


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