U.S. Self Employment Tax and Social Security

If you are a bonafide employee of a foreign employer  and have that country’s taxes and social security numbers withheld from your pay, you do not have to pay U.S. social security or self employment tax. The U.S. has social security treaties with only a small number of countries, however.  If you actually own your own business abroad or are an independent contractor, you may owe U.S. self employment tax on your earnings, even though those earnings are not subject to U.S. taxes due to the foreign earned income exclusion previously mentioned. The self employment tax rate is 15.3% of your net income from self employment.

Forms Which Must be Filed With IRS to Avoid Severe Penalties

If  you own more than a 5% ownership interest in a foreign (non-US) corporation you are required to file  a special form with the IRS reporting that interest.  In many cases, if that foreign corporation is making profits, it will be a “controlled foreign corporation” and you may also owe U.S. tax on its earnings.  If you are the beneficiary or trustee of a foreign trust  you must file  a special form with the  IRS.  Another a form is required to be filed with the U.S. Treasury  if you have ownership or signature authority over a  foreign bank account which anytime during the year has a balance of more than $10,000 US or more.  If you fail to file any of these forms as required by law, you will be subject to penalties up to $10,000 or more.  These penalties might be assessed many years from now  when the U.S. IRS and the Mexican Hacienda finally start sharing information on a regular basis.  If you do not file these forms when required, it will be very difficult to later avoid those penalties.

Due Date of Tax Return

If you have your personal permanent residence abroad on April 15th of any year, you get an automatic extension to file your tax return for the previous calendar year until June 15th.  If you need more time, you can file several further extension requests which can extend the due date of your tax return until October 15th.  If you owe taxes, and fail to pay the estimated taxes in by April 15th,  you will be subject to interest and penalties for that  underpayment.  However, those penalties are not as severe as those imposed for failing to file your tax return in a timely manner. It is therefore wise to always file an extension if you are going to file your return later than April 15th, even though you do not have the money to pay your estimated taxes at that time.

Avoiding  U.S. State Taxes

If you have no income or maintain a permanent residence in a state in the U.S., you  do not have to file any state income tax return in your previous residence state.  Some of the criteria that a state looks at to determine if you are a resident for state income tax purposes includes your driver license, if you register to vote there,  if you maintain an address there, the location of your bank accounts, if you own or rent real property there, the license plates on your cars, and if you still receive utility bills in that state.  There are many other factors used by state taxing agencies to determine if you are a resident, but they are too numerous to mention here. You must be careful to reduce or eliminate all indices of residency or your previous state of residency in the U.S. will come after you for state income taxes. California is especially active in attempting to tax individuals who have left to live overseas, by initiating a claim that they are still actually California residents because they intend to return to California after their stay abroad terminates. You must carefully review and structure you factual situation in order to avoid California’s tentacles if you were previously a resident there.

You do have to pay taxes in a state if you receive rental income there or receive income from a trade or business located there, even if you are no longer a resident.  Investment income such as from stock sales, dividends, and interest are not subject to state tax unless you live there.  Pensions are no longer taxable in the state in which you earned the pension if  you permanently leave that state.

Offers in Compromises and Payment Plans

If one of the reasons you are living abroad  is that you owe substantial amounts to  the IRS or state taxing agencies, Offer in Compromise programs may allow you to settle the balance owed for pennies on the dollar.   When you do owe back taxes, the amount owed increases at a fast pace due to interest and penalties and therefore can get very large compared with the original amount of tax owed. In order to make an offer in compromise you must file tax returns for all of your past tax years and cannot just rely on amounts assessed by the IRS.

Many delinquent taxpayers have used the “Offer in Compromise” programs to settle with the IRS for  payments of anywhere from 10% to 50% of the total amount owed.  The IRS statistics show that in the past 25 percent of the Offers in Compromise have been accepted and that the average compromise was 18 percent of the total amount due.  The entire process usually takes three to six months and requires filing financial current information with the IRS as well as the  required forms. You can make an offer which allows you to pay off the amount agreed over a period of time.  The IRS very recently released new regulations which will increase the number of offers in compromise its accepts and allows taxpayers to claim “hardship” as a reason for the Offer.  These Offers in Compromise can be made by a representative in the U.S. and do not require the presence of the taxpayer in the U.S.

Don D. Nelson is an Attorney and CPA with offices in California. He has tax clients located throughout the world and regularly prepares expatriate tax returns, and handles other U.S. and state tax matters.  He has worked with U.S. Citizens living overseas in connection with their U.S. tax and legal concerns for over 20 years. He also is an expert in Offshore and U.S. corporations and Limited Liability Companies. Since he is an attorney, all communications between Mr. Nelson and his clients are privileged and cannot be disclosed to anyone.  He regularly prepares 5 to 10 years in returns for clients who wish to become current with their U.S. taxation to pave the way for their return to the U.S. problem free. He is a member of the Tax Section and International Law Section of the American Bar Association. He is also admitted to U.S. Tax Court.

Please check our Don’s website at www.taxmeless.com (which is directed towards his many clients in Mexico). He can be reached by phone at Phone: (949) 481 4094 - Fax (949) 218-6483.