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The Price of Being a Digital Nomad
By Mohitindervir Sandhu, JD, EA from H&R Block Expat Tax Services
Jack Ryan and Jason Bourne are not the only US taxpayers travelling the world for their job. With the start of the digital age, more and more taxpayers are working from their laptops from around the globe. However, even with all their globetrotting, they may still owe self-employment taxes to the US.
US Self-Employment Tax
If you are an employee, Social Security and Medicare taxes (FICA taxes) are already withheld from your paychecks. However, self-employed individuals pay self-employment tax (also referred to as SE tax) in lieu of FICA taxes at a 15.3% rate. Both FICA and SE taxes support the US Social Security and Medicare system.
For self-employed taxpayers, the first step in calculating SE tax is netting their income and expenses. If the net earnings are at least $400 USD, then SE tax will apply.
Another crucial difference between SE and FICA taxes occurs when a US taxpayer is working abroad. For US taxpayers working outside the US for a non-US employer, FICA taxes generally do not apply unless a totalization agreement is in effect (see below).
However, unless that totalization agreement states otherwise, a self-employed individual will be required to pay SE tax to the US if their net earnings hit the $400 threshold. US SE tax has a global reach, especially considering the US has signed only 26 totalization agreements and there are over 200 countries in the world.
So, if you are working for yourself in a country that does not have a totalization agreement, there is a totalization agreement and it requires paying SE tax to the US, or you are in international waters or Antarctica, then you will be subject to SE tax.
To address these complications, many nations have developed totalization agreements with the US. These agreements focus primarily on Social Security contributions and most of the agreements are with European nations. Essentially, these agreements:
• Encapsulate multiple cross-border scenarios and outline which nation the taxpayer should pay Social Security taxes to.
• Mandate that all covered workers acquire a certificate of coverage from one nation’s Social Security department to provide to the other nation’s department.
While totalization agreements do not cover every aspect of international taxation, they are designed to tackle the large problems of dual Social Security contributions and insufficient credits for cross-border workers.
If you are self-employed and expect to have net earnings exceeding $400, then consider making estimated payments to the US throughout the year to stop any penalties and interest from accruing.
Remember that if you are covered by a totalization agreement you will have to pay SE tax to either the nation you are living in or the US. If you are paying SE tax to your home nation, then obtain a certificate of coverage in case of a letter from the IRS.
Especially as a self-employed person, be sure to track and document all your income and expenses. Not only will this allow you to more accurately measure the success of your business but is also useful in the face of an IRS audit.
So, whether you are planning to telecommute from your boat, sailing along in international waters or in your modern hut out in Mongolia, be aware that you will likely have to pay SE tax when you file your US tax return.
H&R Block Expat Tax Services is a specialized team of tax attorneys, CPAs and enrolled agents whose singular focus is preparing taxes for Americans living abroad. Remember that US tax reporting for expats is complex and specific to each person’s situation. www.hrblock.com