Self-Employment Tax: The Tax Burden on Self-Employed individuals with U.S. Citizenship.
Many self-employed people testify that the income tax takes a great portion out of their income. In some cases, this cut is so significant that they struggle to make ends meet. This is especially prevalent due to the fact that the tax rates that apply to the self-employed in Israel are particularly high.
In addition to this, self employed people in Israel are also required to make payments to the Israeli National Insurance Institute. However, the situation of self-employed people with dual U.S. citizenship is even more difficult – they are required to pay taxes and National Insurance fees in Israel and are also required to pay tax for self-employment in the United States.
In the article here we will explain what is the self-employment tax, who is required to pay it, and address whether it is possible that you will be required to pay double taxation for self-employment in both Israel and the United States.
The U.S. Self-Employment Tax
The self-employment tax is a tax imposed on the self-employed in addition to the tax imposed on their income.
The 15.3% tax is the American equivalent of the Israeli Social Security insurance, which is collected for the purpose of providing social services by the state and for basic medical care.
As for employees working for a paycheck, the tax is also paid, but it is divided between the employer and the employee and is already deducted from the salary slip.
Since self-employed people are their own employers, they are required to pay the full tax rate for themselves both as employers and as employees.
Who is required to pay self-employment tax?
The tax laws in the United States are personal – it applies to American citizens, permanent residents and even foreigners with income originating in the United States.
With regard to the self-employment tax, their applicability applies to citizens and permanent residents, regardless of their actual place of residence.
This means that an Israeli citizen with dual U.S. citizenship who owns an independent business in Israel must pay American self-employment tax (as explained previously this comes in addition to paying income tax), even if he has never visited the United States.
In the United States, the obligation to report tax and the obligation to pay tax depends on the threshold of annual income.
While for employees there are different income thresholds depending on the personal situation of the taxpayer, as far as self-employed people are concerned, there is no such distinction, and every self-employed person with an annual income above $ 400 must report and pay tax.
If so, any U.S. citizen or permanent resident of the United States (such as a green card holder) who is self-employed with an annual income that exceeds $400 must pay the U.S. self-employment tax, even if he does not live and earn a living in the United States.
Is it possible to be required to pay self-employment tax twice?
Simply put, the answer is yes.
All U.S. citizens, wherever they live, are required to file a tax return and pay tax to the U.S. Internal Revenue Service for their global income.
Note that even American citizens who do not live in the United States and source all their income in another country are liable to pay tax on the same income in the United States as well.
Double self-employment tax in practice
In practice, citizens with dual U.S. citizenship are taxed for the same income in both countries.
However, in order to prevent the situation of being taxed twice, Israel and the United States signed a treaty to prevent double taxation. Under the treaty, dual citizens will be taxed in both countries, with each type of income being taxed in the country where the tax rate is higher.
For example, if in Israel the income tax rate for a monthly salary is 25% of the salary and in the United States the income tax is 10%, then the higher tax will be paid to Israel (in practice, the taxpayer will pay the tax in Israel and receive a tax credit of on the tax he paid in the United States).
Things are different when it comes to self-employment tax.
As mentioned above, the self-income tax is the American equivalent of social security fees.
An Israeli citizen who is self-employed also pays fees to the Israeli National Insurance in addition to the income tax. If the same citizen has dual U.S. citizenship, he or she is obligated under U.S. tax laws and must also pay income tax and self-employment tax.
The double Income Tax treaty
According to the double taxation treaty, the income tax will not be paid twice. This raises the question about the self-employment tax, is it paid twice in both countries?
We would expect that here too the double tax treaty will prevent the double collection when it comes to self-employed people, but social insurance fees are not included in the double tax treaty.
This means that a dual national who is self-employed will pay both National Insurance fees in Israel and the self-employment tax in the United States (in addition to the income tax imposed on him in the country in which the tax is higher).
The United States has also signed a treaty with many countries that prevents double payments for social security, but Israel has not signed this particular petition. As a result, dual citizens who are self-employed will pay for social security in both countries.
Nevertheless, some upsides can be found since the double taxation treaty stipulates that if a taxpayer receives any benefits in one of the states, he will be exempt from paying tax on them.
The correct way to classify your income and plan your tax
Despite all that was mentioned above, it is sometimes possible through tax planning and proper classification of the income to prevent a situation of double taxation and to the minimum and to reduce your tax liability.
Therefore, we strongly recommend consulting a professional who can counsel and assist you in optimal tax planning. Of course, MasAmerica’s professional and skilled staff will be happy to assist, advise on this, and other issues.
