In this section we'll cover what's different about being self employed, and what you need to know to manage your taxes. If you're both a new digital nomad, as well as a new Freelancer or entrepreneur. When you're self employed, you'll see a number of changes to your tax return, but some things will remain the same. In this section, you'll learn a quick rule of thumb for how to budget for your self employment taxes. We'll talk about what's deductible as a business expense, and what the best business structure is when you're just starting out. First, let's define who's an employee and who's self employed.

In general, if you're not on an employment contract, and your employer doesn't withhold taxes at source, then you're probably considered self employed. If you're As an independent contractor, if your income is reported on a 1099 instead of a W two, and if you work for multiple clients, then you're considered self employed. And one note is, even if you have income from an employer, you may still have self employment income as well. For example, if you have a side hustle. So digital nomads who primarily work for an employer, but also have an independent income stream on the side, should also pay attention here because the concept of self employment tax will apply to their self employment income. So what differs from a tax perspective?

Well, most of us will be familiar with the traditional w two scenario. Your taxes are withheld throughout the year. And you just report the total taxable income from your W On your 1040 you generally don't deduct any business expenses because the idea is your employer covers those for you. When you're an employee and expat or digital nomad, then the Foreign Earned Income Exclusion just applies on your total salary up to the max. And again, you don't pay any self employment tax on your W two income. When you're self employed, you do deduct your business expenses from your top line revenue.

And then you're subject to tax on your net income after expenses when it comes to the foreign earned income exclusion, while you can claim it on both employment income and self employment income, there are a few limitations when it comes to claiming the Foreign Earned Income Exclusion on self employment income. First, the so called scale back rule means you can't claim an exclusion for gross income that's already been reduced by deducting business expenses. So this is factored in on your tax return. When you're claiming the foreign income exclusion, you don't need to do the math yourself on it. But you do need to understand that it's not a straight line deduction the way that it is for employment income. There's also a rule that states that your foreign earned income exclusion is limited when your business is such that capital is a material income producing factor in your business.

For example, businesses that sell physical inventory, or otherwise require significant capital investment to get started. This is called the so called 30% rule. And it probably doesn't apply to freelancers whose business is just selling their services. But it's worth noting nonetheless. Finally, when comparing employees to freelancers or entrepreneurs, we should be clear and compare apples to apples when it comes to the self employment tax. In other words, what that 15% really represents is both the employee and employer portions of Social Security and Medicare.

So if you work for a US employer, those apply even if you qualify for the foreign income exclusion, they're just withheld from your pay at source. So it's not as though the employee gets off completely scot free here. They just want me to make the quarterly payments because the withholding is done at source throughout the year. Whereas the self employed individual has to pay it themselves on a quarterly basis. And just for Clarity sake, let's also confirm what doesn't change when you're self employed. For example, you still get to choose the higher of either the standard deduction or your total itemized deductions, which I just note to confirm that those are separate from your business expenses.

And your income from other sources is treated exactly the same. The business income in your schedule C exists in its own silo, and investment income flows through to your 1040 from the other forms, for example, Schedule B for interest in dividends, Schedule D for capital gains, etc. So we can think about accounting for your business income and expect expenses totally separately, and then everything else on the tax return is done the same as it would be for an employee. And then finally, if you're married, of course, you can still file jointly if you're otherwise eligible to do so. So, one or both spouses can be self employed, and the other spouse can be an employee or not working outside the home. So that all stays exactly the same.

The self employment tax would only be on the income from the spouse that had the self employment activity. And of course, both spouses are still able to claim the foreign income exclusion if they're eligible as well. So what are deductible business expenses? Well, generally there are expenses that are both ordinary and necessary to conduct your business. So that would include all of the typical expenses that you might expect, such as inventory if you're selling physical products. If you're hiring any independent contractors, obviously, the amount that you pay them is a business expense.

But sometimes digital nomads might have other expenses that they're not sure if they business expenses are not. So I thought I'd discuss some of those here. For example, well your personal travel and housing expenses while you're traveling around the world. If they're not specifically related to conducting your business, then they're not a business expense and they shouldn't be deducted as such. However, if your travel is related to client work, or if it's for a conference that's business related, then that is a business expense. So you should differentiate those in your own record keeping.

Additionally, expenses that you have related to internet that you pay for if you need to work while you're traveling around the world. If you visit co working spaces in the cities that you visit, for the purpose of conducting your business there, those fees are a business expense. Obviously any fees that you pay for, say your website, hosting any software Then finally, just to note that fees that you pay to professionals, including your trusty expat tax accountant, those are also business expenses as well. So when you're tracking your expenses, just keep note of those throughout the year. So we alluded to this earlier, but let's talk about what exactly is the self employment tax. It's a way of essentially collecting both employee and employer portion of FICA tax, which is the combination of Social Security and Medicare.

So instead of the 7.65%, combined withholding on your W two, self employed individuals pay around 15% for both the employee and employer contributions. So for what it's worth, you're still paying into social security and still accruing credits. So if you don't have at least a minute Have them number of credits to qualify for Social Security, which for your reference is 40 quarters, or 10 years worth of contributions, then perhaps you can interpret, continuing to pay into Social Security as a good thing because it's going to allow you to claim those benefits when you retire. And the same wage cap applies on Social Security tax as it does for employees. So it's up to a maximum amount of income per year. And then, you know, longer term there are other structures you can consider to alleviate some of the self employment tax.

But for most digital nomads, just starting out, this 15% self employment tax will just be a reality that they'll need to budget for. And then how to make those quarterly estimated payments Well, you should note these dates down for your planning purposes. And then ideally, just pay one quarter of your total estimated tax burden on each of those dates throughout the year. You pay online, there is the IRS direct pay website that you can pay directly from your Us Bank Account. And really, that's about it. It's not very complicated.

And as long as you remember to do it, then you should be fine. And one note in terms of the fact that you might not know exactly what the taxes due will be, that's okay as well. That's why it's called an estimate, you estimate the roughly 15% and then if you pay in a little bit too much, then you'll get that back as a refund or you can apply it to the following year. And if you don't pay in quite enough, then you can make that additional payment when you file your tax return. So you never usually going to get it correct down to the dollar but you try and aim for as close as possible. So, what are some best practices when you're newly self employed?

Well, I think a good step for most people would be to open an LLC in a low fee state. Even if you're just operating on your own as a freelancer, it's generally a good idea to run your business through a single member LLC. And because it's a disregarded entity for tax purposes, tax wise, nothing changes. You'll still file a Schedule C, and you'll still pay self employment tax, but you will gain the protection of limited liability by separating your business assets from your personal assets. If you set up an LLC, you can then obtain an Ei n, which is an employer identification number. This can be a confusing term for people because you don't have to be an employer to get this Ei n it's just the tax ID for the LLC.

And once you have it, then you can set up a business bank account in the LLC name that will allow you to issue invoices in your business's name, and pay for business expenses with your LLC account. It's not difficult to operate your business this way. It doesn't complicate your taxes at all. And it just gives you that layer of separation so that your personal assets won't be at risk. Just note that I'm not a lawyer. This isn't legal advice at all.

But these are just some general ideas that you might want to consider. One note about setting up a business bank account is when you're noting on your checklist. If you are going to consider this. Remember that you'll need to do it while you're still physically in the US or if you're back on a visit. Because most banks won't allow you to set up an account remotely. They want to see you in person.

So that's just something to consider from a practical standpoint. And then In terms of choosing the state for your LLC, one question that I sometimes get is which state should I choose? Does it have to be the state that I was from? Does it have to be a state that I have some ties to? No, it certainly doesn't actually just choose any state that has low fees and isn't going to tax your LLC income. So a lot of my clients would choose Wyoming or Nevada, they both have a very low fee structure and are pretty easy to operate in.

And then your business bank account can be anywhere and with any bank that you choose, so it doesn't need to be in the state your LLC is registered in and you don't need to physically visit that state. So to summarize your action items as a newly self employed Freelancer or entrepreneur. Number one, decide on your preferred structure, but a single member LLC is oftentimes a good first step. If you are going to open up an LLC, choose a low fee, no tax state, Wyoming and Nevada tend to be good ones, and then choose a Registered Agent and pick a name for your LLC. Number three, obtain an Ei n from the IRS. You can get that online and it's a pretty easy process.

Number four, open a business bank account. And again, do this while you're going to physically be in the US. And after you've obtained your Ei n. Number five, track your business expenses throughout the year. Number six, set yourself a calendar reminder to renew your LLC each year and pay the required fees and then set yourself reminders as well to make your quarterly estimated payments. And that's it. It's no more complicated than that.

Once you have the structure set up and the dates all in mind, then you run your business as though nothing changes really. So again, whether you choose to go for a single member LLC, or you just operate in your own name, all of your accounting and bookkeeping can stay the same. So as you can see, as a new business owner, even if your business is just offering your own services, you do have a number of additional things to consider and decisions to make. But this list and the accompanying checklist should help you tackle them one by one. Finally, our next section will just round out our tax concepts by highlighting the difference between expats and digital nomads. So stick around for that