Talking Expat Taxes #18

Welcome back to another episode of Talking Expat Taxes, where we take complex international tax situations, talk to real humans, real people out there going through these things, and try to break it down in a way that, that helps you understand what's going on, with these rules and how to apply them.

Today we have a call-in. We'll walk through this individual's situation with moving abroad and earning income abroad and how to structure it in a way that, is tax efficient and also balances simplicity with complexity, um, which is always, always the balance we're striving for.

We want, there to be value behind complexity that you create with tax planning. So I'll let you introduce yourself today, caller. If you could, introduce yourself , and your situation, we'll jump into it and see how we can help.

Yeah.

Yeah. No, that makes sense. And I , yeah, so just to recap, you're in Chile and working for a US company, so still on a W-2 getting US payroll, withholding taxes in the US. You're soon to be a permanent resident in Chile, but you're already a tax resident there most likely. Or can you remind me what you said there as far as your residency status in Chile?

Yeah, Chile, you know, I work with a lot of people in Latin America in general, and Chile is definitely the outlier when it comes to Latin America in that it actually has a tax treaty with the US. , It has what's called a totalization agreement with the US which

i'll explain how that factors into this situation as well. At the end of the day, like the basic level of international tax planning in this scenario is, for one, making sure that we're filing the right forms that are necessary at the right time, as well as, the initial planning is really like your setup, right?

What is the most tax efficient set up for your scenario? And then, planning like, actually reducing your tax rate and saving for retirement, which is a big one in these scenarios. It's kind of a big like whale of things to look at in a way.

But the way I wanna break it down is kind of into what I see as your options, right? So you live in Chile, and what I see as your options, let me know if, these are like, are valid for your situation and worth talking through. But for one, you can remain potentially a employee of the US company.

The other one is you could be an employee on the employee of record, which is, you know, an employee of a Chilean company, and so the US company basically contracts that Chilean company to outsource the payroll to them. And then another option is for you to be a contractor. And I'll just say like more generally, those are the options on the table for, people moving abroad and having a more flexible employment job.

And maybe the employee of the US company is not an option for like your specific scenario.

I definitely have an overall suggestion for this. I'm gonna save that till the end and so we can walk through the reason we get there. But the employer of record, the reason that can make sense, just from an employment standpoint, there's

Like, a US company can and still does, in a lot of cases, employ people that live outside the US. So you can still have US employment with a US company, even if you live in Chile. The problem is that the local country rules are gonna be different for every country, but a general rule, and I believe this is Chile's technical rule, is if you're a resident there working as an employee of the US company, US company technically needs to have payroll on the ground there.

And of course, that would be a huge pain for the US company to,

Register itself in Chile and have you as a, employee and go through all that. So that's the reason the employer of record service exists. I personally don't see that very often with a single employee because it can be expensive , and companies like Deel have made it more, possible over the last few years to do it on a smaller scale.

Usually, the employer of records I see more people are opening up an office in Chile and hiring 30 people, and so they do the employer of record as opposed to setting up the company. Just because they can be a little bit expensive on the fees that they charge. But another reason I don't really see them as much, not because it's not required for US companies to have a local payroll presence, it's just extremely hard just realistically there's the rule and there's what people do sometimes, and that's just

a reality of the situation.

And It's very hard for the Chilean government or any government, including the US. I see it all the time the other way, where a foreign person comes to work in the US. Technically, foreign company needs to run US payroll, but it'd be very hard for the US government or any other government to actually, like, monitor that and enforce it.

So most of the time it's people just kind of flying under the radar and your company in particular, I mean, you've done the research or they've done the research, and flying under the radar is not really, the best approach necessarily for an employment situation. But like you mentioned, so if you go the employer of record route Downside is you lose your ability to contribute to a 401k,

with the company.

You still keep your 401k. It doesn't go anywhere. That's yours, but you can't contribute to it anymore because you're not an employee of the US company anymore. So it's gonna come through Chilean payroll. You're gonna have Chilean payroll taxes withheld, and then on your US personal tax return, we can take one of two things, the foreign earned income exclusion or the foreign tax credit, to ensure that you're not paying tax twice, on the same income.

So the foreign earned income exclusion for 2025, it's $130,000 of earned income. So as long as you're performing the services outside of the US and you meet the physical presence test or the bona fide residence test, which I'm not gonna go into all the details of that. You live there, are married to a Chilean resident, so clearly in your case, you're gonna meet the bona fide residence test really.

So, You'd be eligible for the foreign earned income exclusion or the foreign tax credit. And in that case, it's an optimization that we run to see which is a better option for you, as far as not paying taxes there. Do you have any questions on that so far?

Yeah, so it is earned income that you can contribute to a regular IRA or a Roth IRA, depending on your, income, how much income you earn. But the only thing, the thing that's gonna keep you from being able to contribute to a regular IRA, and so that's, I think it's $7,000 for 2025 to contribute.

The only thing that's gonna keep you from doing that is if you take the foreign earned income exclusion and it reduces your income all the way out. So if you earn $100,000 and you run it through the employer of record or however you earn it, and we take an exclusion so you have no earned income, you can't contribute to an IRA.

what I typically do in that scenario is if you spend any time in the US throughout the year, we call those US days, and in our world that we live in, almost everyone is working regardless of where you are, right? You're working when you have your laptop in front of you or even your phone.

So we make a case for some US sourced income based on days you're spending in the US and working there. And so as long as you have at least $7,000 of US sourced income that's not eligible for the foreign earned income exclusion, then you can contribute $7,000 to the IRA

And let's say, and in your case, so your standard deduction, let's say it's $12,000.

You make $100,000, we exclude 93,000 of it, and we leave 7,000 as US sourced. That's gonna be wiped out by the standard, by the standard deduction. So you still end up with no income tax and you got your, contribution. In which case, the Roth IRA would make more sense, right? Because you don't need that deduction from the traditional IRA.

you're getting like a free contribution to a Roth IRA in that scenario. So that's a pretty good deal.

So that, that would be the way I would go about it from an employment perspective. The other side of that coin is a contractor. So if you get off of employment and you become a contractor, then there's no need for the employer of record.

You're not an employee of anyone. Instead, you're gonna receive the gross amount of income. There's gonna be no payroll taxes in the US or in Chile, and you still have the same options available to you as far as wiping out your income tax. So foreign tax credit, foreign earned income exclusion.

Now, you will be responsible for the Chilean tax personally, and that's kind of a different question is how does the local country, Chile in this case, treat self-employment income versus earned income through an employer in the local country?

In my experience, in most Latin American countries, it can be a better deal to be self-employed with the way that you report your income, but that's something we'd need to get like a Chilean tax person to tell us that answer. I don't know. Is that something you've looked into yet, like how that would be taxed in Chile?

Because I don't know off the top of my head.

Oh, really? And just a quick plug, I would love to be introduced to those people, by the way. If you're, if you liked them and they sounded knowledgeable.

Yeah, it's, it's confusing. I mean, the basic idea is like if you're living in a country, the country you're living in, their rules apply first, and then the US adds their layer of complexity to say, "You're still a US citizen, so we need to apply our rules too." And so the starting point is usually local country, like what is their tax scenario?

I say the starting point, it's the starting point just in the sense of who has the first right at tax. But a lot of the planning is more geared towards the US just because it can be more complicated, and you certainly wanna avoid double tax. So in that scenario, as self-employed, you have the same options with foreign earned income exclusion, foreign tax credit.

Most likely in Chile, the tax rate's actually higher in there than it is in the US. That'd be something we'd need to figure out for sure. But if it's higher, my suggestion is always to take the foreign tax credit. First of all, I think the IRS is less prone to question foreign tax credit claims than they are foreign earned income exclusion claims.

And you don't have the retirement account problem at all because, we're not excluding any of your earned income. So if you earn $100,000, you'd more or less be in like the 22% tax bracket in the US, but your effective rate would be more like, I'm just kind of guessing, but 12% to 13%.

And in Chile, if it's higher than that, then you're not gonna pay any tax in the US. We'd get a full credit in the US and you'd only pay to Chile. And in that case, as a self-employed person, you actually, you have more options from a retirement standpoint.

You have the same option as we talked about before with Roth IRA or regular IRA conversions, the $7,000 contribution. But then you have bigger options like the self-employed pension, the SEP, and then there's solo 401Ks, where you can put a lot more money in. So

SEP allows you to put 25% of your net business income in.

the solo 401K is a little bit more. So, so the SEP is 25% of your self-employed income up to, I think it's like $70,000 or something. And it's a deductible expense. The way that that works like practically with your tax return is you can set up the pension account with whoever, Charles Schwab, Fidelity, whatever you, wherever you want to set it up.

And then for example, for '26, if we wanted to implement that, let's say you were a contractor in '26. We'd need to set up the self-employed pension plan, and then when we do your 2026 tax return next year in 2027, we would come up with your net income from the business, and then you can make the contribution by the extended due date of your 2026 tax return.

So you don't have to make it in 2026. You'd make it next year in 2027 when we know what your net income is. And so that, that can give you a much bigger, bang for your buck than the 7,000. And then the solo 401k is another option that you can contribute as the employer as well.

It's still capped at the 70,000 number, but you can get the 25% plus 23,000 more or less. Anyway, there's just bigger options as self-employed as far as retirement planning contributions.

Yeah. No, that's a good

Yeah, I mean, it's a coordination event at the end of the day, at least in like a taxable jurisdiction, a foreign taxable jurisdiction. Like From the financial planner perspective, I would say if they're not coordinating with the person doing your taxes, they're not the right financial planner or tax person.

Because they go hand in hand. And, and I think that... Well, one other thing I wanted to mention with the foreign side is as a general rule, as you mentioned before, you could be, eligible for Chilean pensions and things like that. As a US person, pensions are one thing and we need to be a little careful, like, how you contribute to those pensions.

But investing outside the US, I would say nine times out of 10, I guess let me clarify that. In like a brokerage perspective. Like buying a financial instrument outside of the US is usually a bad idea because it complicates your US tax returns.

What I mean is if there's some IRA version of, in Chile or some type of, financial instrument in Chile that makes sense in the local country because it offers like tax deferral or something like that, the US likely isn't going to respect that. So it takes away the whole benefit of it, and then there's added US complexity.

So my general suggestion is from a financial savings and investment standpoint is investing in like US brokerages. Now, it's a whole different discussion if you're trying to like diversify your investments outside the US. I have a lot of clients that invest in, non-US real estate and non-US company projects and things like that.

That's, a different thing. I guess what I mean is like financial instruments, brokerages and things like that. Don't do that outside the US. Do that in the US. But from a financial planner perspective, yeah, it's a coordination. I think one thing that gets confusing is what the role of the financial planner is, you know, versus the tax person.

If you need retirement accounts set up and someone that can help you, with budgeting, cash flow, setting up the right retirement accounts and contributing the right amounts and to which account, that's something that needs to be coordinated by the tax person and the financial planner, or in a lot of cases just the tax person.

Like that's something that I do, like as a tax person. I can help people set up retirement accounts and with budgeting, cash flow and that sort of thing. But if you're looking for someone to actually manage investments, you know, like actually picking stocks and investments and buying and selling things more like a brokerage, as well as the financial planning, that's something different.

But it is all coordinated because, there needs to be some level of interaction. What I like to do is have an initial call with the financial planner and myself, especially with the retirement accounts, because they're gonna need me or your tax person to calculate how much you're eligible to, contribute to the retirement accounts.

And so that's a coordination that needs to happen as far as that goes. And then the financial planner's role is going to be either, managing the investment itself, like what's going into the investment, or they're going to be looking, from a cash flow and budgeting perspective and helping with those decisions.

In which case taxes are a piece of that, right? So don't know. Does that answer your question? Like, it's unavoidably linked, I guess is the question. So, if you talk to people that, that seem put off by the fact that there's a tax component to the financial planning or that's not part of the conversation, to me that's a bit of a red flag.

For

To me that's a, red flag unless they misunderstood the question somehow and like they thought you were asking if they did tax planning or something. I don't know. But yeah,

Uh, but yeah, so I mean, I think that's definitely part of it. And, I guess back to the general fact pattern, as far as your income tax goes, what we've laid out so far is there's not a difference in the US from the employer of record versus self-employed. You can get to the same place. We're gonna wipe out your US income tax either way. So then the question is, you have more options as a contractor from a retirement planning perspective than you do with the employer of record, because your only option is the $7,000 IRA contribution, which may be good.

That's not a bad option. So then the other wrinkle is local country tax. You know, how, what is the difference between contractor and not?

in that scenario, I think the cost from an employer's perspective of the employer of record, whatever that is.

Um, so, the other side we haven't talked about yet is Social Security tax, so FICA and Medicare. FICA and Medicare, when you're self-employed, it's called self-employment tax. When you're employed for a US company,

it's FICA and Medicare, but it's just not called self-employment tax anymore. So if you're employed by a non-US company and doing your work outside the US, the US Social Security system can't get involved. So in the employer of record scenario, there's of course no US Social Security tax on the payment to you because you're an employer of a foreign company doing work outside the US.

You're gonna pay the Chilean version of Social Security,

it's a similar... Well, when you're self-employed, it's different because it's similar in, in the local country because you're still gonna be taxable there just in a different way because you're gonna be personally responsible for it, whereas they're being withholding in the employer of record scenario.

But the US now gets their hands in for Social Security and Medicare if you're self-employed. The benefit though, in your case, is that you're in Chile, which has what's called a totalization agreement between Chile and the US. The totalization agreement, essentially the main part of it is that it says you don't have to pay social taxes on the same income in both countries.

It says you're gonna pay social taxes in the country where you live, essentially. So

in this case, you live in Chile, so you're gonna pay social taxes there, and you get an exemption from the self-employment tax in the US. So you get to the same place as the employer of record. This is usually the game where I have a lot of trouble with people in Latin America is because Chile's the only one that has this.

So if you're in Mexico, Costa Rica, wherever, and you wanna be self-employed, even whether it's a US person paying you or a non-US person paying you, you're subject to self-employment tax in the US, which is up to 15%. Um,

into like an employer, not necessarily an employer of record, but a company set up that you own to pay yourself a salary.

That's where, you know, the gamesmanship can kind of start with some of this. In your case though, you don't have to do any of that as a contractor because with the totalization agreement, you can go in, and I can show you how to do this on the website, but you have to get a certificate of coverage from the Chilean government.

And even then, technically you need to include that certificate of coverage with your US tax return filing and then on the tax return, it literally says exempt on the self-employment tax line. I don't actually do that with the majority of my clients. I just include a statement that says you're eligible for the certificate of coverage, and if the IRS ever asks for it, then we can get it, just because it is kind of a pain to get.

But I usually what I say is, "Let's go ahead and start the process of trying to get it," because it can take a while because most countries aren't that responsive to the certificate of coverage scenario.

I guess at the end of the day, my suggestion or my thoughts are the contractor is a much simpler route that gets you to the same tax answer in the US with the US company, it's simpler for them too, and cheaper for them to pay you as a contractor than to set up the employer of record scenario. But you can get to the same place either way. The employer of record's not a bad way to go. It somewhat limits your eligibility for the retirement plans, and it's another cost to the employer.

And likely it's a little bit more expensive from a tax perspective in Chile as well to do it that way.

know- Mm-hmm ... I

Yeah.

No, I, I understand what you're saying. Yeah, it's, it definitely is a factor in the financial planning. Generally with my clients, I just assume people don't really know, but really, I don't know that it makes that big of a difference in your case.

I'm not advocating like financially for you to invest more locally in Chile either way. I think either way, your retirement accounts need to be in the US. I think the self-employed route, provides you a little more flexibility than the employer of record, because if you did end up moving, it would just be another hassle like to either find another employer of record or I don't know that it's that big a deal.

You just cancel it and move your employment to another place back to the US, whatever it is. As a self-employed person, you really have no responsibility to tell your employer anything about where you live. It's not their problem, so I think it allows more flexibility in that case.

The only thing we have to be careful of from a contractor perspective is that you are actually a contractor and not an employee. And, so that means like building in the right language into the contractor agreement. And I do have some-- I mean, I work with some people where they're just not contractors, you know.

Like the nature of what they do is an employment arrangement, and it usually, it kind of comes down to, what's the best way to put it? Like, uh, I'll keep on... I'm thinking control, even though that comes off that doesn't come off great, but it is kind of what it is like from a, from a employment standpoint, the way the IRS looks at it is like they're in more in control of your time, right?

Like you are maybe using their equipment, you're working at the hours that they provide, and you don't necessarily have the flexibility of doing other, like working for other people. Those are things that kind of sway the factors to employment. Whereas a contractor, maybe they're using their own equipment.

They're contracted for a job. Like you're contracted to do this job how you see fit with the things you need to do it. That's what a contractor's doing. Um, I mean, kind of like if you hire me to do your taxes, I'm gonna do your taxes the way I see fit with my stuff.

Whereas if you employed me to do your taxes, you'd give me the computer, you'd buy the software, and I'd do the work when you tell me to do it, um, and that's just to say, like, you probably are more of a, an employee, like in, in that sense based on like that definition. But we'd need to just be a little careful with the way we draft the contractor agreement to make sure that...

see if we can fit into the contractor-type scenario, like where you're not locked in as an employee from a definitional and US tax perspective.

a legal question. I'm not doing a great job of explaining like the difference between contractor and employee. I always have to like look it up and pull up the factors, and then basically we take all the factors and see how many we can put in the contractor camp and build a contractor agreement out of it.

And that would be something interesting to look at is like, what does your current employment agreement say that's different from your original contractor agreement?

for, the employee-related, benefits, you know?

I think that would kind of be the first step is looking at your agreements and seeing can we get to an actual legal argument that you are a contractor?

And if so, to me, that's the simplest route. It provides the most flexibility. We can get you to essentially zero tax in the US unless your tax rate's higher than a... I mean, your tax, sorry, your income's higher than 130,000, which is the foreign earned income exclusion limit, and the Chilean income tax is less than the US tax.

Does that make...

If the Chilean tax is more than the US tax, you're not gonna pay any US tax, either way. But, and then it's simply a, an annual tax filing that you need to have in the US to claim the foreign earned income exclusion or the credit, and then look into the retirement account options that make the most sense for you.

Like how, like how much money are you making? How much cash flow do you realistically need on an annual basis? And in your case, I, like the Roth IRA option for people like you, 'cause you don't need the deduction. So it's a great way and a great opportunity to get free money into a Roth IRA and have it grow tax-free and come out tax-free, you know,

20 years or so.

For sure.

Yeah

the self-employment option gives you more options. I mean, one thing you and I had talked about outside of this call was the, like side jobs, right? Can you get to the same place with a side job, like keeping the employer of record option and getting a side gig?

And the answer is yes, but it's still-- it's a 25% of your income, amount you can contribute, right? So I mean, you'd have to make, it'd have to be a pretty good side gig, I guess, to

make it worth it.

You start to sound kind of like a contractor for the other company, because now you have this side gig

it seem like that's more of a contractor relationship in a way that you have with the employer, you know?

In which case, why didn't we just call the other one a contractor in the first place? Um-

Exactly. And it also has to do with, like, your relationship with your employer, your relationship with them, how and how they operate, you know? Like, is it, I mean, some people are just very, like, the EOR, I guess, sounds like the most conservative route to go, in some cases.

But, I think explaining the consulting or the contractor route is worth doing, and I think that's probably the answer. And like in this case, like I'm happy to like even as- like assist with that and talk, your employer if it's helpful, like if they have questions around employer versus not, contractor versus not, just so we get to the right answer that makes the most sense for both people.

Oh, you do? So

You're not, the only employee outside the US?

Contract. Oh, okay. Oh,

I guess it depends. If we're going the foreign tax credit route, yeah, we're gonna need to know the foreign tax amount to file your US tax return. So yeah, the timing is we extend your US tax return, which is the reason why expats have an extra two months to file their taxes.

So expats have till June 15th, before they need an extension, and then there's additional extension from October to December as well. That has to get filed for separately. But just because some country, it's an extra effort and you have to wait on the foreign country to get the taxes. Now, if we do the foreign earned income exclusion, then we don't really need the taxes.

We, uh, just go ahead and file and we forget the taxes because they get reduced out anyway. Like if you can't take a credit and the exclusion on the same income, so if we did the exclusion, we would just kind of ignore the taxes. Or if you did the employer of record option, we'd already know the taxes because they're being withheld.

we don't, have to wait. But the situation where we do is self-employed and we're gonna take the foreign tax credit, we need to wait on the local country side to get those taxes.

うん。 Yeah

And then get them back.

Yeah, you just, yeah, I mean, it's pretty simple. You don't have to pay them at all because the estimated tax rule is 100 or 110%, depending on your income, of the prior year liability or 90, 90% of the current year liability. So if you're not gonna owe any taxes, like if you make $100,000 this year and we're gonna take the foreign earned income exclusion and there's no self-employment tax because we're doing the totalization agreement, then there's no tax, so you have no, no requirement to do estimated taxes either

So that's pretty simple. One thing that can be interesting, which isn't your scenario, but I'll throw it out there, is if you work for the US company and they continue to withhold US taxes, that can be a problem, right? Because if you're paying... Let's say you keep your W-2 job, 'cause a lot of people, like you're coming very transparently with your employer and working together with them to figure out the option in Chile.

A lot of my clients are like, "Hey, my employer doesn't actually know that I live in Panama now, but I'm wondering how I..." They don't, they don't care or whatever the situation is. But so their withholding is the same, but they're having to pay local country tax. So now they're out both taxes until we can get a refund in the US, which is a pretty bad deal.

So there is actually a way to, if you're taking the foreign earned income exclusion, to stop the withholding in the US. But that's not your scenario, so we don't really care about that. But just in case that option came up. But, yeah, otherwise, yeah, if you're not paying US taxes, you don't pay US estimated taxes either

Yeah, you're right. 'Cause I literally, I've been doing this for, close to 15 years, and it only came up as options for like big companies setting up offices in foreign jurisdictions. But

just in this year, I've had several people reaching out to me about that, and I think it's because companies like Deel are making it more affordable to set up these EOR options, and they're just marketing it better than they've done in the past, I think is part of it.

But I, I still don't know that it's, I don't know that the actual logistics of it have really changed in that sense other than it is more affordable to do than it was in the past, which is why nobody ever did it before, like on an individual level.

Yeah, it's kind of like this is a way to like to-- Yeah, to...

Right. Exactly. As opposed to my other clients that are just like using their parents' address in Pennsylvania and pretending that's where they live. But they, but they live in a foreign country. That's the other way to do it. But

Yeah, thanks so much for calling in and a quick plug on this next week, or if you're watching this, if you're currently searching for questions and things on Reddit and Facebook and not sure if you're getting the right answers,

You can check us out on our community. It's called the Expat Tax Coach, where basically it's a group of like-minded people, expats, where we can, where you can post your questions, your topic, chat amongst yourselves, and I'm on there as well to moderate, I post videos once a week on important topics.

I put news clips out there, and I can help you also get, get referred to local country professionals as well that make sense for you. So thanks so much for joining today and, we'll see you next time on the Expat Tax Podcast.