Warning. reading this post may be very taxing. Do not attempt if you suffer from heart disease or have any other health condition that requires a physicians (or accountant’s) care.
Q & A 25 Sep 2008 Do I Have To Pay taxes?
Question: I currently live and work outside the US so I don’t owe US federal or State income tax on my wages. If I start making money online, and come to live in the Philippines, do I have to pay US taxes, especially Self Employment taxes? What are some ways to minimize the US tax bite?
Answer: First of all, you have to really understand I am not an expert … and especially if you are setting up a business … which one hopes would be successful … you really need advice from a qualified professional. My answers are personal opinions, based on personal experience and may be injurious to your pocketbook if you don’t check and double check what you are doing. Setting up a business the wrong way and then changing it to fix errors made at the beginning may prove much more expensive that making the investment in sound professional advice at the start.
Issue 1: Do you have to report? Better to read what the IRS has to say than what I say:
While most people are aware they must include wages, salaries, interest, dividends, tips and commissions as income on their tax returns, many don’t realize that they must also report most other income, such as:
cash earned from side jobs, (my emphasis)
barter exchanges of goods or services,
awards, prizes, contest winnings and
gambling proceeds. ….Taxpayers must report all income from any source and any country (my emphasis) unless it is explicitly exempt under the U.S. tax code. There may be taxable income from certain transactions even if no money changes hands….
It is a common misconception that if a taxpayer does not receive a Form 1099-MISC or if the income is under $600 per payer, the income is not taxable. There is no minimum amount that a taxpayer may exclude from gross income.
All income earned through the taxpayer’s business, as an independent contractor or from informal side jobs is self-employment income, which is fully taxable and must be reported on Form 1040…
Much more explaining tax liabilities on the IRS website … it is likely better that you learn before you burn. In particular a lot of people seem to believe some fairy tale that money earned online isn’t taxable … or isn’t taxable if you live outside the US. Not so.
As a matter of fact, Google and other regular US corps routinely report all payments to others as the US tax law requires. eBay and PayPal,two other places people seem to think money can be hidden, always report when subpoenaed. I recently read of an eBay power seller who was failing to report thousands per year in income. Seemed like a great deal to him, saving all those taxes. He got caught when one of his buyers was involved in a phony credit card scam.
In response to the credit card scam investigation the seller’s income amounts just happened to come to the attention if the IRS. Ooops.
Issue 2: Self Employment Tax: Many people balk at the thought of paying (currently) 15.3% of their self employment earnings into the Federal kitty. Sorry, can’t help much there. The truth is every single tax payer pays thise taxes but wage earners normally have more than half paid by their employer so they don’t see such a whopping deduction. You pay it though, one way or another. Again, the IRS is pretty clear about this:
What is Self-Employment Tax?
Self-employment tax (SE tax) is a social security and Medicare tax primarily for individuals who work for themselves. It is similar to the social security and Medicare taxes withheld from the pay of most wage earners….
SE tax rate. The self-employment tax rate is 15.3%. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance)…
Again there is a lot of authoritative information that seems clear enough to me … even when I don’t like what it says … on the IRS’s own site. Many people I’ve talked to over the years seem to get their information from Yahoo Group discussions or bar room conversations. Probably not the best source. If you form a corporation, as just one example, you may be able to legally avoid some of the SE tax bite. Probably a wise thing to consider. You need better assistance than what I can offer on that, though.
Speaking from experience, when my wife and I had our own corporation in the US we essentially didn’t pay SE taxes. However, the overall cost of running the corporation and all the other taxes and reporting requirements I believe came up to more that our SE tax bite would have been. And we gained no earned income toward our Social Security retirement in those years either … once you have a zero year for Social Security, you have a zero year … there is no going back.
Some Conclusions: Well once again I seem to be creating an opus here. Time to wrap things up. My one last, perhaps most important pice of advice on these complex issues. When you seek professional assistance, remember this abut the professionals you are likely to encounter.
Accountants are trained in the practice of accountancy and such subjects of the procedures of how money flows in your business, the best methods to handle your banking and issues along these lines. All accounts have professional training in tax matters and some have a great deal of expertise, but I personally do not recommend you go to an accountant for advice in setting up the basic structure of your business … nor in answering questions about what is and isn’t reportable, what techniques you can use t legally exclude income and minimize taxes, etc.
Who do I recommend then? Simple. A tax attorney. First, a tax attorney is by definition and by professional accreditation an expert on the law. You must be sure you are complying with the law before you get into the intricacies of accounting procedures. Choose an attorney who specializes in tax law and who is enrolled to practice before the IRS.
Other individuals, including CPA’s may also become enrolled to practice before the IRS but there is an important difference. If you engage an attorney, communication between you and that attorney becomes privileged. It can not be disclosed to the IRS. Taxpayer-accountant relationships do not have that advantage of legal privilege. Why is this important?
Neither an attorney nor a lawyer can legally advise you to do something illegal … but you’ll never know if your ideas are legal unless you ask, now will you? If you ask about procedures which later turn out to be illegal, an accountant can be forced to testify about this in court. Your attorney can not. It’s only Dave’s opinion, of course, but I feel that if I am undertaking something which might land me in court later, I might as well protect myself properly from day one.
OK, what other questions do you folks need answers to? A couple came in today. I’ll try to keep this a regular weekly feature of PhilFAQS the source of information about moving to, living in or retiring in the Philippines.
Hahaha – Sorry Dave – but I have to laugh – not at your article but at your WARNING!
One more tip – do not make enemies! Most audits by the Internal Revenue Office are carried out from “anonymous tips”.
Hi Dave – CPAs are accredited to practive before the Tax Courts of the US without becoming enrolled agents. As a CPA and a retired corporate tax accountant for one of the Big-Four accounting firms (formerly Big-8, then Big-6, then Big-5, now hopefully the Final-4), I’ve spent considerable time undoing the “wonderful work” of some tax attorneys and time in court.
Additionally, there are privileged communications between a tax client and his CPA that is shielded by law from the IRS. Too, if a tax attorney’s paid advice is illegal, he can easily become a co-defendent and made to testify. Attorney-client privilege is not a defense for conspiracy (to commit fraud or some other illegal act), or some other breach of law.
States require the CPAs they license to complete at least 40 hours of continued professional education (CPE) each year, with a majority of those hours centering on CPA’s area of specialty (audit, tax, IT accounting, forensic accounting, etc.). If one doesn’t stay familiar with current statutes, regulations, statements, etc., one loses his/her license.
btw, Ellen is absolutely correct about anonymous tips and IRS audits.
@Ellen: Ha ha, thanks Ellen, that makes at least two of us here with the same warped sense of humor.
And yes, especially in the give and take n-line world, informants are a distinct source of worry if you are doing anything ‘shady’. I’ve seen lots of folks in formums and such bragging about the income they didn’t report. Not only are there people who sometimes get vindictive out of pure jealousy or nastiness, but the IRS even pays cash reqwards for whistle-blowers … so if you have a secret little scheme that seems foolproof, better make sure no other fool ever learns about it.
@Paul: Thanks Paul. As I clearly said CPA’s are highly trained professionals. But one thing they are _not_ is lawyers, and that was my point.
Thanks, Dave. I may have misunderstood your words a little bit.
As to the lawyer issue, yes in most cases (i.e., unless one is a DIY nut) one needs a lawyer to file incorporation and/or other papers to create a business entity in the eyes of the law. Anyone who is not a BAR member attempting to do this for a third party will be cited for practicing law without a license. Plenty of trouble.
CPAs are in a better position to advise on business operations and strategies, as well as providing auditing and tax counseling, planning and compliance services.
CPAs do team up with tax attorneys when preparing tax strategies for their clients. They engage a tax attorney to provide a professional third-party “opinion letter” stating the attorney’s opion on the legality of the strategy.
As for representation in front of the IRS (be it a desk audit, on-site audit, or in tax court), one’s CPA is in a better position to serve their client. Of course, their strength comes from preparation and planning that keeps any incident from rising to a level where interaction with the IRS occurs.
A smart business owner has both a business attorney and a CPA. The attorney helps create and keep the business legal, while the CPA helps keep the business solvent and a “going concern.”
I’m confused. If a U.S. citizen moves outside the U.S. and works outside the U.S., what claim does the IRS have on his income? Do i have to pay them no matter where i live, even on the moon? What the hell?
@pogidaga: Sorry guy, I don’t make the laws, I only live under them *sigh*. As I said, it’s a common misconception that a US citizen gets tax advantages by living overseas. As far as federal taxes go, it just isn’t the case (except for some provisions regarding salaries paid from outside the US … more than I want to get into here).
A lot of folks have concerns about somehow losing their US citizenship. One of the reasons that aside from criminal activity it’s very hard to lose your US citizenship is, Uncle Sam might lose his tax claims. By the way, permanent resident aliens (Green Card holders) have essentially the same liabilities ans well as non-resident ailens in some cases. The reach of the IRS is long, indeed.
@Paul: Got it Paul … thanks for the additional clarification. It is appreciated.
@Philly: Since the time I first responded to this message, I came across another blog here in the Philippines which is published by a guy with about as unimpeachable authority on this subject as one can have … a retired agent of the IRS … Rusty Ferguson http://rustyferguson.com/?p=310 Some may enjoy Randy’s views, it’s good to see some more expertise online and the world can always use another retired federal emoyee … but then again, I’m biased
Hi Dave, sigh, here we go again. I agree, that IRS and any country’s tax authorities, has far-reaching arms. Not sure of the US, but Canada has a catch all rule to close all loop-holes – it is called the GAAR (General TAx Avoidance Rule). If they don’t catch you under any of the other statutes, then more than likely, they can catch you under the GAAR. BUT you can be very creative in your business set-up, in going around these rules – by hiring a good tax lawyer PLUS a creative CPA.
Declaring “world income” is just that – ALL income irregardless of where you are, unless otherwise stated or specifically exempted in a TREATY agreement between the 2 countries.
If you are a small business, just keep-it-simple-stupid (KISS principle) and declare all your income and pay the taxes due, unless you have lots to spare to hire a good CPA and TAX attorney for advice. You can sleep better this way.
@Ellen: Yep, I knew this post would spark some discussion/interest. reporting income is not the same as having to pay taxes on it … what you have to pay is acompletely different issue than what you have to report. But I thought I would throw it out there just because so may US folks I have herad from have the idea that you don’t have to file, don’t have to declare, etc. While your comment was sitting here awaiting a response, our good friend Bob
http://liveinthephilippines.com/bobm/
sent me two links which I’ll republish here.
http://www.usexpatriate.blogspot.com/
http://www.taxmeless.com/index.html
seems to be a wealth of information there from a US-based CPA-Attorney … I know I will be spending some reading time there for sure. As always, thanks for commenting.
Consider the Secretary of the Treasury’s strategy:
http://finance.yahoo.com/news/Source-Geithner-failed-to-pay-apf-14050873.html
Note (1) the lack of penalties; (2) how he almost got away with not
paying SE taxes for two of the years he had self-employment income.
If Congress wants people to take their taxes seriously, they need to stop confirming crooks as IRS bosses.
Disclaimer: I have always voted Democrat for all members of the U.S. Congress and the U.S. Presidency.
Let’s try to keep US politics out of our discussions here, shall we, please? One of the reasons I live in the Philippines is that I don’t have to listen to the BS spouted by every candidate for years before election day comes around. It doesn’t make a difference which party they represent, they all promise chnage and then they all appoint law breakers, hacks, ner-do-wells and lobbyist-supported “axe grinders” to important posts. Raises my blood pressure and I don’t doubt it does the same for others.
My country suffered 16 years of mis-management by two “me first” presidents and while I am willing to give the new guy some slack, and wish him success, his appointees so far have been disappointing to say the least. Let’s just move on to important things about the Philippines if we could, please.
I’ve been involved in taxations for longer then I care to admit, both on the individualized side (all my working life history!!) and from a legal point of view since satisfying the bar and following tax law. I’ve rendered a lot of advice and rectified a lot of wrongs, and I must say that what you’ve put up makes perfect sense. Please continue the good work – the more individuals know the better they’ll be outfitted to cope with the tax man, and that’s what it’s all about.
Thanks. Also I note it looks like you are just starting up a new site devoted to tax information. A good niche, IMO. If you want a sub-niche, one where you can really rank some ketwords, think about advice directed specifically to US expats. There are a lot of us, therules are somewhat complex, and from my lay readings it seems the US IRS is not really clear in their own minds how they will handle many issues that are simple within the US.
In particular, most of the IRS’s guidance applies directly to folks who work at salaried jobs overseas. That particular niche isn’t all that more complex than a US resident. But folks like me who earn money online and have no salary? A different kettle of fish it seems. A wide open field I would say.
Just like Philly, I am not a CPA/Atty, so be sure to check your individual circumstances with a professional.
One thing I did not see in your well done article is the foreign income tax exclusion, which I very much take advantage of each year to minimize my tax liability to the good ol’ US of A. It turns out if you qualify as a resident of a foreign country (see IRS publication #54 & form 2555), then a large amount (changes each year, currently over $95,000) of your foreign earned income is essentially tax free.
You still have to pay the “nuisance” taxes like Medicare etc, but at least you dont have an income tax. And if you make over the 95K while living in the Philippines, I dont feel all that sorry for you
When my CPA told me about this, I actually didnt believe her, and got a second opinion. It really sounds like a free ride if you ask me.
Strongly suggest everyone reading this at least looks into this – its very cool
Hi Joe,
Actually my omission’ of the Foreign Earned Income exclusion was 100% intentional. I make good use of it myself, but I don’t write articles about it for several reasons:
1. US income tax articles are way far worse than articles about religion or politics. Arguements, anme calling, life-long grudges, etc., are al common. I say let someone else be the tax advisor, I am not one.
2. Many folks reading here are on US pensions or have a large percentage of their income from pensions and annuities. The foreign earned income credit doesn’t cover pensions .. these are not what the US classifies as ‘earned” income. Again, anger, confusion arguments and so forth. Not interested in that myself.
3. In order to take advantage of the foreign earned income exclusion, you actually have t make money and report it. Many people I come in contact with seem to be hiding out from taxes, perhaps don’t report some income, etc. Just a subject I don’t care to deal with.
very, very fertile ground for someone looking for blogging/online service ideas. In general, the subject of taxes for overseas residents and online entrepreneurs is severally “under-served.” More power to anyone who chooses to take it up.
I second Joe here. Point out that US does have tax treaties and provide a link for those who want to know what the rules are. There are many people living overseas and in US who are not aware of the tax breaks for aliens living in US and US citizens living overseas that are clearly outlined in IRS pamphlets.
A useful one for US citizens and Permanent Residents who have a non-resident spouse living outside US is that they can file a Join return claiming the non-resident spouse as a Resident Alien for tax purposes. A form W-7 may be required. (Check Pub 54 for details & to make sure this is still in effect in future)
No discussion of the cost/benefit of staying legal is needed. Just point those who ask to http://irs.gov where they can go to the forms & pubs page (exact link changes each time the site is redesigned, so just follow the menus) and read Pub 54 & Pub 519. These are starting points for those who want to know what the rules are for American Citizens, Resident Aliens and ALL aliens with US income or who have spent time in US during the last tax year (yes, just visiting US can subject you to IRS regulations. See Pub 54)
Discussion of anything more than where to look is of minimal use as the laws change every year according to the whims of Congress
No reason for anger or other emotion in reporting that overseas residents can (currently) claim a tax break based on residence and that the IRS has rules governing what it applies to. It is simply a statement that people living outside US should check to see how much they can legally save in taxes and a reminder for those who may not be aware of this and other unadvertised tax breaks that apply to a limited number of taxpayers.
Philippine exceptions are much simpler. See http://www.bir.gov.ph/taxinfo/tax_income.htm
)
Today the rules are (the Philippine Congress also likes to write new laws
Philippine citizens resident in Philippines report income earned from both Philippine & non-Philippine sources.
Aliens regardless of residence report income earned from a Philippine source.
Philippine citizens NOT resident in Philippines report income earned from a Philippine source.
So it is possible for a US citizen living in US to be required to file a Philippine tax return. This is fairly normal with any income reported to the local equivalent of the BIR/IRS generating the need to file a form reporting the income in accordance with local law.