Discussion:Foreign self-employment income in the UK

I have a client that has been living in the UK for a couple of years now and for 2007 he has both, US (W2) and UK (self-empl) income. He qualifies for the exclusion, and there is a totalization agreement with the UK for SS tax.

My question is; provided that he paid SS and income tax in the UK, how do I report that in his US return? I know he will have the 2555 for the foreign self-employment income, but for the self-employment income, do I file sch C? How do I show that he is not subject to the self-employment tax? Do I have to attach anything to the return?

Thank you!

If you feel confident that the client is domiciled in the UK, then he can file the Schedule C without paying SE taxes and without disclosing the treaty position on Form 8833. However, I recommend including a disclosure on the Schedule C regarding the treaty exclusion.

Residence or ordinarily resides, when used in agreements, has the following meaning for the U.S. Residence or ordinarily resides in a country means that a person has established a home in that country intending to remain there permanently or for an indefinite period of time. Generally, a person will be considered to have established a home in a country if that person assumes certain economic burdens, such as the purchase of a dwelling or establishment of a business, and participates in the social and cultural activities of the community. If residence in a country is established, it may continue even though the person is temporarily absent from that country. Generally, an absence of six months or less will be considered temporary. If an absence is for more than six months, residence in the country will generally be considered to continue only if there is sufficient evidence to establish that the person intends to maintain the residence. Sufficient evidence would include the maintenance of a home or apartment in that country, the departure from the country with a reentry permit, or similar acts. The existence of business or family associations sufficient to warrant the person's return would also be considered.

Riley, he is not domiciled in the UK. He moved there about 2 years ago because his domestic partner got a temporary (3 years) job there. They are coming back next year. He ownes a house in the US and is paying mortgage, prop. taxes, and he is planning on coming back.

I have some minor disagreements with some of the terminology used above. "Domicile" is a legally defined term that doesn't necessarily coincide with the definition of residency defined above. I would instead state that a person is resident as defined under the particular provision. Also, totalization agreements do not rise to the status of treaties. Thus, Form 8833 would not be applicable. Instead, you should follow the instructions in the totalization agreement or official government summaries thereof.

Assuming that the US payor is Ordinarily Resident (as defined by HMRC) and does not maintain a Permanent Establishment (as defined under Article 5), then:

1) UK taxes full income in the UK, including NIC (UK SS equivalent tax). 2) US taxes self-employment on Sch C, and backs it out again on 2555 and/or backs out the tax on 1116. No Sch SE filed as he's exempt under the US/UK Totalization Agreement. 3) You need NOT attach the Certificate of Coverage. Instead, just a short note (in the margin on 1040 pg 2 is fine) saying that you are relying on the US/UK Totalization Agreement to not pay US SE tax. The taxpayer should obtain a Certificate of Coverage in case the IRS ever requests it. I've only had the IRS request it once in 9 years of international tax prep.

If he ownes a home in the US (he will be claiming mortgage, prop. tax...) is that considered Permanent Establishment?

My client gave me a letter from an accountant in London and the letter says that "according to the double tax agreement, the business profits of an enterprise of a contracting state shall be taxable only in that state, unless the enterprise carries on business in the other contracting state through a permanent stablishment situated herein. Based on this, your self-employed income in the UK will be taxed in the UK and there will not be any USA tax on this income".

It's not clear to me if he is referring only to income tax or income tax AND SS tax.

THANK YOU!

All that is required is ordinary residence in the UK. The words "ordinary residence" here do NOT mean the same as under domestic UK law. This is common and foolish mistake. Instead all they mean is their plain English meaning, it is the place where you normally live (there is certainly no "two year" test in the totalization agreement!).

In addition you MUST attach a certificate of coverage because the SSA say you must so a typical IRS auditor will assume you MUST (in fact this gloss is not in the totalization agreement, only in the SSA explanation, but this is splitting hairs and if you don't want to annoy the IRS then you MUST).

As far as Lalva's last comment, the tax treaty will be of little use here of course because of the saving clause. The true saving is US SET.

Residence or ordinarily resides in a country means that a person has established a home in that country intending to remain there permanently or for an indefinite period of time. Generally, a person will be considered to have established a home in a country if that person assumes certain economic burdens, such as the purchase of a dwelling or establishment of a business, and participates in the social and cultural activities of the community. If residence in a country is established, it may continue even though the person is temporarily absent from that country. Generally, an absence of six months or less will be considered temporary. If an absence is for more than six months, residence in the country will generally be considered to continue only if there is sufficient evidence to establish that the person intends to maintain the residence. Sufficient evidence would include the maintenance of a home or apartment in that country, the departure from the country with a reentry permit, or similar acts. The existence of business or family associations sufficient to warrant the person's return would also be considered.

I don't agree with Guya's statement that "Lizzit is . . . more right than some of the other contributors." I reviewed my and Riley's comments above, and I don't see any comments that should be changed. The majority of Lizzit's posting seems to revolve around the treaty. I don't see how the treaty would apply to any of Lalva's questions. Further, the instructions to Form 1040, Schedule SE state that the certificate of coverage should be attached to the return ("If your self-employment income is exempt from SE tax, you should get a statement from the appropriate agency of the foreign country verifying that your self-employment income is subject to social security coverage in that country. Do not complete Schedule SE. Instead, attach a copy of the statement to Form 1040 and enter “Exempt, see attached statement” on Form 1040, line 58.")

1) I've never filed the certification for my clients and the IRS has never asked. One US lawyer living in Chile told me it took her three months to find the office that issued the certificate and they told her she was the first person who had ever asked for it. So I conclude that this is widely non complied with and not vigorously enforced.

2) What happens if you don't file the certificate? Is there a penalty? Would the IRS make you pay the SE Tax? I have reason to doubt that, because several of my clients who had been paying the SE tax before the treaty was signed wanted to keep paying it (to increase their SS) and I was told by both IRS and SSA that they would not accept SE payments from a resident of a country with a totalization treaty.

3) In Chile the retirement system is privatized, so both SE and salaried people buy shares in an "AFP", which is essentially a restricted mutual fund. This means they need to file an FBAR and report the investment as a PFIC. This came as quite a shock to people who had been assuming that their AFPs were just like IRAs or 401Ks, and frankly I'm not sure how to handle clients who have multiple years of non-reported PFIC income. It's easy enough to mark to market if you catch the account the year it opens, but it looks to me like beginning to file mid-stream incurs a tax that is in effect confiscatory. And most of these people earn Chilean level salaries -- ie US$15-30K -- so can't afford a big tax hit, or even the fees for a complicated tax filing. Any suggestions?

5) I haven't run into this yet, but I assume that when my clients begin withdrawing their retirement funds they will be tax-free in the US, since they were paid with post-tax funds and (theoretically) any gains were taxed yearly. Correct?

6) How does this work in other countries? What (if any) are the US filing requirements for retirement plans? I know Canada has an exception for registered plans, and the treaty with France exempts retirement income. How do people in the UK or France (or non-treaty countries) have to report for either state-sponsored or private retirement accounts?

Thanks, David H.

It sounds like the IRS may not be too strict on requiring the certificates of coverage.

I have not looked at the Chilean retirement system, but what you have said above makes sense. If contributions are made by purchasing shares in the mutual fund, then I would expect that withdrawals would be sales of shares. If you have elected mark to market, then their basis in the shares sold would be roughly equal to the sales price and little or no U.S. tax should be due on withdrawals.