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How to report foreign income on US tax return?

Mar 14, 2017

Most of today's employees or businesses are looking forward to work internationally. When a person receives an international payment a question on how to pay income taxes will arise. Earnings shall be displayed in the US tax return, and we would like to draw your attention to some points of income reporting.

We will focus on two most common situations: when you earn money abroad while being in the US and when you earn money while being outside of the US. Foreign companies can pay employees in the US and in this case self-employment taxes are added to your income taxes. This need to be reported in the Profit or Loss from Business form (Schedule C).

Self-employment tax of 15% is added to your regular income tax. However, being an entrepreneur will also give you a couple of advantages. You will be able to deduct your traveling, capital goods, equipment and other expenses.

When you work abroad and do not qualify for Foreign Earned Income Exclusion(FEIX), all your earnings should be displayed in the Schedule C. If you are a resident of the US during the accounting period – you have self-employment income and need to display it in Schedule C. The same procedure will apply even if you worked outside of your residential country.

Let’s take a look at some examples of Foreign Earned Income Exclusion and how taxes are paid when not applying for it.

US citizen who works less than 330 days of a year in a foreign country cannot apply for the Foreign Earned Income Exclusion and is obliged to pay taxes in the US. It means that you work in another country but need to pay income tax and self-employment tax in the United States. In case of paying any taxes in the country you worked, you can use the Foreign Tax Credit and avoid double taxation with it.

Person who works abroad more than 330 days a year can apply for FEIX. First of all, you need to perform a physical presence test that will prove you have been in foreign country working for necessary amount of time. It applies to income that is less than $102,300 and you only need to fill the Foreign Earned Income Form 2555. After reporting your income and claiming the Foreign Earned Income Exclusion you will be free from income taxation in the US.

However, it works only when you are employed in a foreign company. You need to consider that if your income exceeds $102.300 and taxes in your employment country are lower than in the US, you will be obliged to pay the difference. For example, you paid 10% income tax to employment country, and afterwards you will need to cover the remaining difference of 20% in the US.

When self-employment tax is payed, Foreign Earned Income Exclusion can also be applied. This income also should be reported on Schedule C and Foreign Earned Income Form 2555.

If you are an independent contractor and have earned less than $102,300, FEIE will let you pay zero income tax but self-employment tax of 15% will remain. There is a way to eliminate self-employment payments, but in this case an offshore company need to be formed. In this case your income will count as a salary, not a self-employment earnings. All income will be displayed in Form 2555 and Schedule C should not be filled. Which means self-employment tax would not be applied.

Also, forming an offshore company will let you defer your earnings and reduce income tax as well. Your earnings can be reported in amount of $100,000 and there will be no need to pay income tax in the US. Basically, any job abroad can be organized to avoid unnecessary payments. OffshoreLicense Ltd will be glad to assist you with any taxation advice or help you form a personal plan for working abroad and lowering tax payments.

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