As an independent contractor or an employee, working abroad has both
advantages and disadvantages. A US expat living overseas might have
numerous financial and non-financial perks, especially when compared to
their domestic counterparts. However, your taxes will vary greatly depending
on whether you are an independent contractor or an employee. Read the
following case studies to see how both situations and your location might
impact how much you spend on expat taxes as a contractor or employee.
Definitions of Independent Contractor and Employee
A worker is considered an employee when an employer has the right to direct
or control the work performed by the person as well as the financial and
business aspects of the worker's job. Additionally, an employee is covered by
a number of federal and state employment and labour regulations, whereas a
contractor is not. Notably, an employee of a US corporation receives a W-2 for
salaries earned during the year, while a US-based contractor receives Form
1099-MISC to report commissions or fees.
Case Study of Paying Expat Taxes as a Contractor Abroad
US expats must comply with both the host country's income tax (if applicable)
and US income tax, as the United States taxes the worldwide income of all US
citizens and Green Card holders (legal permanent residents). Consider the
following example: A US expat who contracts overseas and earns $60,000 per
year in net self-employment income. The contractor resides in Dubai from
January 1 through July 31 of the tax year and in Singapore from August 1
through December 31. The contractor owes no income tax in Dubai on the
$35,000 (i.e., $60,000 multiplied by 7/12) earned while residing in Dubai. Since
the contractor resides in Singapore for less than 183 days per year, a 15% flat
non-resident tax rate applies on $25,000 ($60,000 x 5/12) earned in
Singapore. Therefore, the amount of tax payable in the nation of residence,
Singapore, will be $3,750.
Under Foreign Earned Income Exclusion (FEIE) under Section 911 of the
Internal Revenue Code, an expat who has lived abroad for more than 330 days
in any 365-day period may exclude the entire $60,000 of net self-employment
income on their US tax return. However, 15.3% of ($60,000 x 92.35%) = $8,478
of the contractor's net income from self-employment is subject to self-
employment tax. Regardless of the fact that the contractor was able to totally
exempt their income from income tax by claiming the FEIE, this is the case. On
$60,000 of net self-employment income, the contractor's total tax due for the
year would be $12,228 ($3,750 of Singapore tax plus $8,478 of US self-
employment tax).
A Case Study on Paying Expat Taxes as an Employee
Consider the identical scenario for an individual who is employed by a foreign
employer. The $60,000 wage earned abroad would not be subject to US social
security and Medicare taxes, and the $60,000 foreign earned income would be
entirely excludable by claiming the FEIE. Consequently, the sole tax payable
during the year would be tax in the nation of residency, namely the $3,750
Singaporean tax.
Doubling of Taxes for Independent Contractors
Based on this comparison of contractor versus employee taxes, working as an
independent contractor versus being employed overseas is evidently distinct.
While worked abroad by a foreign employer, wages are generally exempt from
social security and Medicare taxes. In contrast, income received as an
independent contractor, whether in the United States or abroad, is considered
self-employment income and is subject to self-employment taxes, i.e., social
security and Medicare taxes on both the employer's and employee's half. Self-
employed individuals and independent contractors would be subject to double
taxation on their social security and Medicare earnings. In contrast, an
employee would normally only be subject to this tax if employed by a U.S.
company who reports pay on Form W-2.
There is a notable exception to this rule. The totalization agreement also
applies to an employee working for a US employer for more than five years in
a foreign country with which the United States has signed a totalization
agreement, where social security tax is only required to be paid in the foreign
country and not to the United States, even though wages are reported on Form
W-2.
There is a relief for one-half of the self-employment tax that can be claimed as
an adjustment to taxes (an above-the-line deduction) by independent
contractors to arrive at their adjusted gross income (AGI). However, this
adjustment only reduces the tax on the net income from self-employment. The
self-employment tax does not change.
The Effect of Totalization Contracts
Continuing with the preceding illustration, consider a South Korean contractor.
In South Korea, an annual net income from self-employment of $60,000 is
taxed at an effective rate of around 15.5%, resulting in an income tax of
$9,300. The FEIE allows the entire $60,000 of self-employment income to be
exempt from taxation on the contractor's US tax return. Importantly, the
contractor's net self-employment income in the United States will not be
subject to self-employment tax as a result of the Totalization Agreement
between the United States and South Korea.
If they are considered self-employed (i.e., independent contractors) and intend
to live in South Korea for an extended period of time, they can get a
"certificate of coverage" in South Korea that exempts them from paying self-
employment tax to the United States. Each year, they must include a copy of
their "certificate of coverage" with their tax return. However, they will still be
subject to South Korean social security tax on their net self-employment
earnings. However, if they had a certificate of coverage, they might avoid
paying social security tax in two tax areas.
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Contractor or an Employee
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