To qualify for the Section 199A deduction, your business income must be effectively connected with the conduct of a trade or business within the United States.
The preamble to the proposed Section 199A regulations clarified that in almost all circumstances this means the income has to be United States–source income to qualify.
Under the tax law, you source your compensation for personal services based on where you perform the services. For example, you perform all services from your office in Norway. The services do not generate U.S.-source income.
You have two ways to reduce or eliminate the United States income tax on your foreign-source income:
- Foreign earned income exclusion
- Foreign tax credit
The only way you’ll know for sure is to calculate your return using both methods and pick the one with the better outcome.
If you file a Schedule C, you already know you need to pay self-employment tax on your net Schedule C income.
However, the U.S. has totalization agreements with certain countries to avoid double Social Security taxation. These agreements usually apply to self-employed individuals.
The IRS expects to see self-employment tax when there is a Schedule C on a tax return, so be sure to do the following:
- Get a Certificate of Coverage from the country where you reside to help prove to the IRS you are exempt from self-employment tax.
- File Form 8275, Disclosure Statement, with your tax return to disclose the position that you are exempt from self-employment tax due to the totalization agreement.
If you have an interest in or signature authority over foreign financial accounts or other foreign financial assets, you may have to file special forms in addition to your tax return.
If you don’t file the forms but had a filing requirement, the penalties could be severe: as high as $10,000 per form per year.