Since different income types have different tax rules, US Expats must correctly categorize their income from overseas. Here’s a simple guide.
Disclaimer: Taxes for expats living abroad are extremely complex. We insist that your best bet is to hire a tax professional who specializes in these tax returns. There are so many unique situations that can lead to penalties and more taxes. This guide is very general and does not replace the IRS publications on how to stay compliant with your taxes.
US Expat taxes – introduction to foreign wages and how they are taxed
Wages are generally the salaries, fees, hourly rates, and bonuses paid as compensation by an employer for services. If you work for an individual or a business, you are generally considered an employee.
Note that the IRS does not care how your employment is classified or defined in your offshore country of residence. The IRS will go by it’s own rules regardless of what the foreign country considered to be employment. This goes for defining income from self employment and dividends as well.
Wages earned overseas can be offset by the foreign tax credit, and/or the foreign earned income exclusion. Expats earning wages of less than $110,000 or so that qualify for the foreign earned income exclusion can expect to have no US Tax liability on that income.
Even if an expat does not qualify for the foreign earned income exclusion, if they pay income taxes to another country at a greater tax rate than the US Tax rate, then they will likely qualify for the foreign tax credit. This will generally offset a US Tax liability in this situation.
US Expat Taxes and income from self employment
According to the IRS, self employment income is income that you receive when you carry on a a sole proprietor or independent contractor.
You are also considered self employed if you are a member of a partnership that carries on a business.
Generally speaking, you are self employed if you are earning money but you are not an employee working for an employer.
For US Expats, being self employed can trigger a self employment tax balance. Self employment tax covers employment taxes such as social security and medicare.
The foreign earned income exclusion and the foreign tax credit do NOT exclude self employed expats from self employment tax. These provisions can only offset “income” taxes.
Many countries have a treaty with the US that says if a US Expat is paying these social-type taxes abroad, that they will be exempt from paying self employment taxes in the US.
Expats living outside of these treaty countries generally can expect to owe self employment tax to the US . Self employment tax is about 15% of net (after deductible expenses) profit from self employment.
US Expat taxes and dividends
Dividends are generally passive income that are received as a shareholder of a corporation (or similar entity).
Some expats living overseas own a business in where they draw both a salary and take a distribution from their own company. If this company resembles a corporation or similar entity in which the shareholder does not have any personal liability, then the distributions are generally considered dividends for tax purposes.
Note that sole proprietors (with no incorporated entity) that take a draw on their net profit do NOT generally have dividend income. These draws would likely be considered to be earned income from self employment.
Income taxes on dividends may not be excluded under the foreign earned income exclusion.
The foreign tax credit may offset your US tax liability on dividends if foreign income taxes are paid specifically on those dividends.