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Expat Taxes

Expats and Taxes, Freelancer Edition

by
Bret Willoughby
on
9/19/2016
Expats and Taxes, Freelancer Edition

If you are a freelancer, then taxes are probably already frustrating for you. People who are self-employed have special requirements and tax obligations that are different from W-2 employees. But if you think that filing as a freelancer based in the United States is difficult, then consider the additional headaches that come with being an expat freelancer who is working and being paid while abroad.

Just to Give You An Idea…

If you want a sense of how much more tax aggravation can be included in the life of an expat freelancer, consider the example of a teacher working in a foreign country, teaching English to students. You are being paid by your employer, the school, but a student’s parent may ask you to provide additional tutoring on the side. Any monies that you receive for providing these lessons outside of the workplace are subject to a 15% self-employment or Social Security tax. The only exception to this rule is where the U.S. and your country of residence have social security agreements (called totalization agreements) you only pay the Social Security tax to the country of residence thus avoiding double social security taxation.  Countries where the U.S. and the 26 countries have agreement are included on this list.

If you want to avoid having to pay these taxes while working abroad, your best bet is pretty simple - keep all payment arrangements flowing through your employer rather than directly to you. In other words, if you’re not viewed as self-employed, you don’t have to pay self-employment tax, but may be subject to FICA withholding. Of course, if the teacher in the example above had already been receiving payments directly from the parent, then they’re on the hook for the tax payments.

Figuring Out Whether You’re an Expat or Not

The first thing that needs to be addressed is who exactly needs to worry about paying taxes as an expat. An expat for tax purposes is someone who lives and works outside the U.S.  The Internal Revenue Service looks at where the employee is providing the service and NOT where the employer is located.

In order to receive the Internal Revenue Service’s favorable expat tax treatment, you must meet the requirements outlined in one of two tests: the bona fide resident test or the physical presence test. Each of these needs to be looked at to determine whether you have foreign tax status, and it is definitely worth reviewing because if you do qualify, you get the benefit of very attractive foreign earned income and housing exclusions. 

Likewise, if you wrongly assume that you qualify without actually checking to see whether you meet the test’s requirements, you could end up facing some unpleasant tax filing consequences.

  • The Physical Presence Test

The basic requirement of the physical presence test is that you have spent at least 330 days over the course of a 12-month period out of country. But those 330 days have to be normal living days – not vacation or travel days. You can’t take a year-long trip around the world on a cruise ship and say that you therefore qualify for foreign tax status.   

The physical presence test is almost always used the first and last years of foreign employment because individuals start work in the foreign country throughout the year and may not meet the 330-day requirement in the calendar year and may have to prorate their exclusions the first and last year after meeting the 330-day test over two calendar years.  Where the 330-day requirement has not been satisfied before the June 15 filing date for U.S. Citizens in foreign country an extension can be filed.

  • Bona Fide Resident Test

This second IRS test may sound straightforward at first glance, but in fact it is more complex than it seems. The rules require that the taxpayer lives in the foreign country “for an uninterrupted period that includes an entire tax year.” Though this sounds as if you could simply take up residence for a year and be deemed a bona fide resident, the agency does not interpret their own rules in that way. Instead, they look at whether the taxpayer is in the country with the intention of returning, or whether they are legitimately taking up residence.

This sounds like a highly subjective test, but the IRS has a series of factors that it considers in making its determination, including where an individual taxpayer’s financial connections are, where their children go to school, whether they continue to keep possessions in the United States, and more. The agency is trying to establish where the individual’s strongest connections are, and will look at a number of documents, including your passport, to help them in that decision. 

If you do not pass one of the two test above you may still qualify for an additional tax benefit, the Foreign Tax Credt

  • Foreign Tax Credit

If you cannot exclude all of your income using the foreign earned income exclusion and housing allowance, you may also qualify for the foreign tax credit. 

If You Do Qualify for Foreign Tax Status

If you are a freelancer and, after answering the questions on these two tests, you determine that you are in fact eligible for foreign tax status, then you qualify for several tax advantages, including automatically qualifying for a tax extension to June 15th and not having to worry about the tax imposed by the Affordable Care Act. More importantly, you qualify for an income tax exclusion on your first $101,300 of income in 2016 on income that you earn while out of the country, regardless of whether the income is earned from a company that’s based abroad or a company base in the United States. Caution: The exclusion is prorated for the first and last years based on the number of days in the foreign country. The question is where you are when you earn the money, not what the source of the income is.  If you are married, and your spouse also works and qualifies for the exclusion you each qualify for the $101,300 exclusion. 

Freelancers who are living abroad and who qualify for foreign tax status can take advantage of the foreign housing exclusion. This exclusion, allows you to deduct the costs of some of the largest expenses that you have while living abroad – rent and utilities.  

One More Thing…

Unfortunately, the fact that you are paying U.S. taxes as a citizen abroad does not mean that you are not obligated to also pay any taxes required by the country where you are residing. Some countries have signed treaties with the United States to try to preclude American citizens from being doubly taxed, but even where this is the case the treaties generally do not make allowances for freelancers. 

Finally, it is important for expat freelancers to understand that they are required to submit documentation to the IRS regarding their foreign bank accounts, and that failure to do so can result in significant penalties. The accounts are to be reported on the FBAR forms, formally known as the Report of Foreign Bank and Financial Accounts form. The rules indicate that if you have any foreign bank accounts that on any single day total more than $10,000, they need to be reported, and failure to do so can result in between $10,000 and $100,000 in penalties.

There are a lot of obvious advantages to living abroad, and if you’re an expat freelancer who is enjoying the benefits of living in a foreign country and working for yourself, then dealing with a complicated tax process is probably worth the trouble. A solid understanding of the basic information provided here should give you a head start to keeping yourself out of trouble, but if you need additional assistance, we are here to help. You can reach us at (913) 712-8539.

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Bret Willoughby

Bret Willoughby

Bret Willoughby is a practicing tax preparer for expats throughout the world. He created Providence Payroll to meet the needs of Churches, not-for-profit organizations and businesses with remote workers. His web-based payroll processing service benefits both employers and remote workers with an easy way to access payroll information. Clergy have unique payroll and tax-related issues, one that Providence Payroll is qualified to manage.

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