Self-Employment Tax Abroad and Totalization Agreements: Paying Social Security to Only One Country

I hear this more than you would think: a freelance designer in Berlin or a consultant in Mexico City is shocked to learn that, even with the foreign earned income exclusion reducing her income tax to zero, she owes the IRS thousands in self-employment tax.

She is right to be shocked. She is also right that it can sometimes be fixed. The fix is not an income tax election. It is a treaty of a different kind.

Self-employment tax follows you abroad

Publication 54 says that if you are a self-employed U.S. citizen or resident, the rules for paying self-employment tax are generally the same whether you live in the United States or abroad. Self-employment tax is the Social Security and Medicare tax on net earnings from self-employment, and you must pay it if your net earnings from self-employment are at least $400.

The exclusion does not change that. The IRS's page on self-employment tax for businesses abroad gives the example directly: you must pay self-employment tax on all your net profit, even if you claimed the foreign earned income exclusion. The exclusion reduces income tax. It does not reduce the self-employment tax base.

The foreign tax credit does not help either. It is a credit against income tax, and self-employment tax is a separate tax.

What totalization agreements do

The United States has entered into agreements with some foreign countries to coordinate Social Security coverage and taxation. Publication 54 explains that these are commonly called totalization agreements, and that under them dual coverage and dual contributions for the same work are eliminated. The IRS describes their purpose as avoiding double taxation of income with respect to Social Security taxes.

The agreements generally make sure you pay Social Security taxes to only one country. The general rule, according to Publication 54, is that you are subject to Social Security taxes only in the country where you are working. There is a common exception: if you are temporarily sent to work in a foreign country and your pay would otherwise be subject to Social Security taxes in both countries, you can generally remain covered only by U.S. Social Security.

The agreements also do what the name suggests, coordinating benefit coverage between the two systems. For details on a specific agreement, the IRS and Publication 54 point to the Social Security Administration's international agreement pages.

The rule for the self-employed

Publication 54 states the general rule for self-employed people: self-employed persons who are subject to dual taxation will only be covered by the Social Security system of the country where they reside. Specific agreements can vary, so the actual agreement between the United States and your country controls.

So if you are a self-employed U.S. citizen living in a country that has a totalization agreement with the United States, and you are covered by and paying into that country's system, the agreement may exempt you from U.S. self-employment tax on those earnings.

If you live in a country without an agreement, there is no exemption. You may pay into both systems.

How to claim the exemption

The exemption is not automatic. The IRS's guidance for self-employed taxpayers abroad lays out the process:

• Request a certificate of coverage from the appropriate agency of the foreign country. That certificate establishes that your self-employment income is covered by the foreign system.
• If the foreign country will not issue one, request a statement from the U.S. Social Security Administration that your income is not covered by the U.S. Social Security system.
• Attach a photocopy of the certificate or statement to your Form 1040 for each year you claim the exemption.
• Write "Exempt, see attached statement" on the line for self-employment tax.

If your situation is the reverse, meaning your self-employment earnings should be exempt from the foreign Social Security tax and subject only to U.S. self-employment tax, Publication 54 says to request a certificate of coverage from the SSA's Office of Earnings and International Operations, which establishes your exemption from the foreign tax.

Employees abroad

Employees are handled through the employer. The IRS's totalization page explains that a person claiming exemption from U.S. Social Security and Medicare taxes must get a certificate of coverage from the Social Security agency of the home country and give it to the U.S. employer. Publication 54 notes that if your pay abroad is subject only to U.S. Social Security tax and exempt from foreign tax, your employer should get a certificate of coverage from the SSA.

The IRS also notes alternative procedures in Revenue Procedures 80-56 and 84-54 and Revenue Ruling 92-9 for people who cannot obtain a certificate of coverage.

Two examples

A freelancer in a treaty country. A U.S. citizen working as a self-employed translator lives in a country that has a totalization agreement with the United States and pays into that country's social insurance system on her self-employment income. Under the general self-employed rule in Publication 54, she is covered by the system of the country where she resides. She requests a certificate of coverage from the foreign agency, attaches a copy to her Form 1040 each year, and writes the exemption notation on the self-employment tax line. No U.S. self-employment tax.

A freelancer in a non-treaty country. Another U.S. citizen does the same work in a country without an agreement with the United States. He may exclude his income from U.S. income tax under the foreign earned income exclusion, but he still computes U.S. self-employment tax on Schedule SE on all of his net profit. If his country also imposes social contributions, he may pay into both systems, because there is no agreement to coordinate them.

Same work, same income, very different results. Where you live matters.

Agreements also change over time, and a new one can change the answer for future years. Check the current list each year rather than relying on what was true when you moved.

What happens if you just never paid

Self-employed Americans abroad who never filed U.S. returns often owe self-employment tax for every year, even if their income tax would have been zero. If you are in that position, the Streamlined Foreign Offshore Procedures can help with penalties for qualifying non-willful taxpayers, but the tax itself, including self-employment tax, still has to be paid with interest. For years in which you were covered by a foreign system under an agreement, the certificate of coverage may eliminate the U.S. self-employment tax, so get those certificates before you file.

A checklist for self-employed Americans abroad

Keep each year's certificate of coverage with that year's return. If the IRS questions the exemption, the certificate is the proof, and replacing a lost one from a foreign agency years later can be slow.

• Confirm whether your country of residence has a totalization agreement with the United States, using the SSA's agreement pages.
• If it does and you pay into the local system, request a certificate of coverage for each year.
• File Form 1040 with Schedule C and attach the certificate, or compute self-employment tax on Schedule SE if no exemption applies.
• Do not assume the foreign earned income exclusion or foreign tax credit touches self-employment tax. They do not.
• Keep FBAR and Form 8938 obligations on the list too. Business accounts abroad count. See who must file an FBAR.

Freelancers abroad are often the most surprised by their U.S. bills and the most helped by one piece of paper from the local Social Security agency. If you want to sort out which years are covered, let's talk.