Is Foreign Income Subject to Self-Employment Tax?

Earning income from outside the U.S. can complicate tax obligations, especially for the self-employed. Unlike traditional employees whose taxes are withheld automatically, self-employed individuals must calculate and pay their own taxes, including self-employment tax. This raises an important question: does foreign-earned income fall under this requirement?

Understanding how self-employment tax applies to foreign income is essential to avoid unexpected liabilities. Various factors, such as exclusions, tax treaties, and reporting rules, can impact what you owe.

Criteria for Self-Employment Tax

Self-employment tax applies to individuals who work for themselves and earn above a certain threshold. This tax covers Social Security and Medicare contributions, similar to payroll taxes for employees. When income is earned abroad, whether it is subject to this tax depends on the nature of the work and how the income is classified.

Service-Based Earnings

Income from providing personal services—such as consulting, coaching, or professional advice—is generally subject to self-employment tax, regardless of where the work is performed. The IRS requires self-employed individuals to pay both the employer and employee portions of Social Security and Medicare taxes, totaling 15.3%, if net earnings exceed $400 in a tax year.

For example, a U.S.-based marketing consultant working remotely for international clients is still liable for self-employment tax. Even if they never physically enter the U.S. while performing the work, the IRS treats these earnings the same as domestic income. The determining factor is not the client’s location but the taxpayer’s self-employed status under U.S. tax rules.

Freelancer Income

Freelancers—such as writers, graphic designers, and software developers—often work with clients worldwide. The IRS does not differentiate between income from U.S. and foreign clients when assessing self-employment tax. As long as the work is performed as an independent contractor and net earnings exceed $400, the tax applies.

For instance, a freelance writer invoicing clients in Canada, the United Kingdom, and Australia must report all earnings to the IRS and pay self-employment tax. Receiving payments through foreign bank accounts or digital platforms does not change this obligation. The only exception is if the income qualifies for an exclusion or exemption under IRS rules, which is discussed later.

Digital Commerce

Individuals earning income through digital means—such as selling online courses, e-books, or running subscription-based platforms—are subject to self-employment tax if they operate as sole proprietors or independent business owners. Even though digital commerce can involve passive income elements, the IRS classifies it as self-employment income if the business is actively managed.

For example, someone selling graphic design templates on platforms like Etsy or Gumroad must pay self-employment tax, even if all customers are outside the U.S. If they regularly market products, provide customer support, or update materials, the IRS considers these activities self-employment rather than passive investment income.

Foreign Earned Income Exclusion

The Foreign Earned Income Exclusion (FEIE) can reduce taxable income but does not exempt self-employed individuals from self-employment tax. Under Section 911 of the Internal Revenue Code, the FEIE allows U.S. taxpayers to exclude a portion of their foreign-earned income from federal income tax if they meet residency requirements. In 2024, the exclusion limit is $126,500. However, this exclusion applies only to income tax, not Social Security and Medicare taxes.

To qualify, individuals must meet either the Physical Presence Test or the Bona Fide Residence Test. The Physical Presence Test requires being in a foreign country for at least 330 full days within a 12-month period. The Bona Fide Residence Test requires establishing a permanent residence in a foreign country for an entire tax year. Meeting either test allows exclusion of foreign-earned income from federal income tax, but self-employment tax remains due unless an exemption applies under a totalization agreement.

Passive income, such as dividends, rental income, and capital gains, does not qualify for the FEIE. Additionally, income paid by the U.S. government or its agencies is ineligible. Self-employed individuals earning foreign income must report it on Schedule C of Form 1040 and calculate self-employment tax using Schedule SE. Even if the FEIE reduces taxable income to zero for federal income tax purposes, self-employment tax is still required unless an exemption applies.

Tax Treaties

The U.S. has tax treaties with many countries to prevent double taxation, but these agreements primarily address income tax, not self-employment tax. Most tax treaties do not exempt self-employed individuals from Social Security and Medicare taxes, which are governed separately under totalization agreements.

Totalization agreements determine which country’s social security system applies to a worker. These agreements help prevent dual contributions to both U.S. Social Security and a foreign country’s equivalent program. For example, a U.S. citizen working in Germany may be covered under Germany’s social security system instead of paying U.S. self-employment tax, provided they meet the criteria in the U.S.-Germany totalization agreement. Each agreement has different rules, so reviewing the specific terms is necessary.

To claim an exemption under a totalization agreement, individuals typically need a Certificate of Coverage from the foreign country’s social security administration. This document proves they are making contributions abroad and are not required to pay into the U.S. system. Without this certification, the IRS assumes self-employment tax applies, regardless of where the work is performed.

Reporting Requirements

Self-employed individuals earning income abroad must comply with U.S. tax reporting obligations. All worldwide income must be reported on Form 1040. Sole proprietors and independent contractors must also complete Schedule C to detail business income and expenses. If net earnings exceed $400, Schedule SE must be filed to calculate self-employment tax.

For those using foreign financial institutions, additional reporting may be required. The Foreign Bank Account Report (FBAR), filed using FinCEN Form 114, is necessary if foreign account balances exceed $10,000 at any point during the year. Failure to disclose qualifying accounts can result in steep penalties, even if no tax is owed. Individuals with foreign businesses or ownership interests may also need to file Form 5471 or Form 8865, depending on the structure of their foreign entity.

Penalties for Noncompliance

Failing to report and pay self-employment tax on foreign-earned income can lead to financial consequences. The IRS imposes penalties for underpayment and failure to file, which can accumulate over time. If self-employment tax is not paid through estimated tax payments, the IRS may assess an underpayment penalty based on the amount owed and the duration of the delay. Interest accrues on unpaid balances.

More severe penalties apply when taxpayers fail to report income or foreign financial accounts. If a taxpayer neglects to file Schedule SE or misreports self-employment earnings, the IRS can impose accuracy-related penalties of up to 20% of the underpaid tax. Willful failure to disclose foreign accounts on an FBAR can result in penalties of $100,000 or 50% of the account balance, whichever is greater. Repeated noncompliance or intentional tax evasion can lead to criminal charges, including fines and potential imprisonment. The IRS has increased enforcement efforts in recent years, particularly targeting unreported foreign income, making compliance essential for self-employed individuals earning abroad.