You might think that consultants, independent contractors and other self-employed individuals (together referred to as self-employed) get a free ride because they do not pay payroll taxes. Not true! Here’s what you need to know if you are a self-employed US citizen living abroad.
As an employed U.S. person (not self-employed), you and your employer would pay payroll taxes at the tax rates (and on the relevant wage base) described in the table below. Your employer withholds the employee-funded portion of the payroll tax and remits them (together with the employer-funded portion of the payroll tax) to the IRS.
|Additional Medicare||0.90%||Over $200,000 for single; over $250,000 for joint filers||0.90%|
- The Social Security tax is only applied on the first $128,400 of wages but the Medicare tax is unlimited
- An additional 0.90% Medicare tax is applied on wages over $200,000. This only affects the employee (and the employer does not have to match this additional tax)
Self-employed individuals, however, must pay “self-employment” tax (SE tax for short). It requires self-employed individuals to pay the employer AND employee share of the payroll tax on their net earnings from self-employment.
Amount of Tax
An employee making $150,000 per year pays $10,111 of Social Security and Medicare taxes and her employer pays a like amount for a total of $20,222. By contrast, a self-employed individual pays SE tax of $20,222 (without an employer contributing to it).
If an individual has both wages from employment and self-employed income, the wage base ceiling is applied across all income (so as to not disadvantage them relative to others that have a single job).
Some Good News
Importantly, 50% of the SE tax (think of it as what would have been employer-funded) is deductible from gross income and can be claimed as a deduction regardless of whether the individual itemizes. This deduction saves the individual 50% of the SE tax times the individual’s marginal tax rate. It does not make an individual whole (relative to employees), but it does help.
Net Earnings from Self-Employment
The SE tax applies to net earnings from self-employment (but only if these are $400 or more). It does not matter whether these net earnings result from an independent contractor, a sole proprietorship, a general partnership and/or a limited liability company (LLC) member (with certain exceptions described below).
Net earnings is not a cash concept – that is, it does not turn on how much cash was distributed. In particular, you should look to the following lines on the following forms for your net earnings:
|Schedule C||Line 31 (net profit or loss)|
|Schedule F (Farmers)||Line 34 (net farm profit or loss)|
|Form 1065||Box 14, Code A|
You may offset negative earnings from one business against positive net earnings from another. Doing so will reduce your tax amount.
Special Consideration for Limited Partnerships and LLCs
Most advisors believe that limited partners are not subject to SE tax (though the general partner is) except to the extent they receive guaranteed payments for services rendered to or on behalf of their limited partnership.
LLC members are a more difficult question. The IRS has not provided definitive guidance on whether they are subject to SE tax. By analogy (depending on the extent of their involvement in the business), members could be treated like general partners (subject to SE tax) or as limited partners (likely exempt from SE tax). Therefore, most advisers believe that LLC members actively participating in their businesses are more like general partners (and thus should pay SE tax).
Quarterly Tax Payments
Employees are subject to withholding of income and payroll taxes. Self-employed individuals are not and, instead, make estimated tax payments usually quarterly throughout the year. If you are self-employed, when determining your estimated tax payments, remember to consider your SE tax, as well as your income taxes.
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