Self-employed in a U.S. territory? Prepare for IRS scrutiny

The Large Business and International (LB&I) division of the IRS recently announced a new compliance campaign targeting self-employed individuals in U.S. territories who underpay or fail to pay their self-employment taxes.

The self-employment tax is equal to the Social Security and Medicare taxes on net earnings from self-employment. For the 2019 tax year, the self-employment tax rate is 15.3% (12.4% for Social Security and 2.9% for Medicare). An individual must pay self-employment tax if his or her net earnings from self-employment are at least $400.

Citizens of the United States and resident aliens who reside in any of the U.S. territories must also pay self-employment tax on net earnings from self-employment of $400 or more. These territories include:

• Puerto Rico,
• Guam,
• American Samoa,
• The U.S. Virgin Islands, and
• The Commonwealth of the Northern Mariana Islands.

Residents of these territories must pay self-employment tax whether or not they must pay U.S. income tax or are otherwise required to file a U.S. income tax return. Those with net self-employment income of $400 or more also need to file:

• Form 1040-SS, “U.S. Self-Employment Tax Return (Including the Additional Child Tax Credit for Bona Fide Residents of Puerto Rico),” or
• Form 1040 (PR), “Self-Employment Tax Return — Puerto Rico.”

The purpose of these forms is to report net earnings from self-employment to the IRS (and, if necessary, to pay self-employment tax on that income).

Background on LB&I campaigns

In January 2017, the IRS announced a new audit strategy for LB&I known as “compliance campaigns.” With these new compliance campaigns, LB&I essentially shifted to examinations based on higher risk issues to improve return selection. The IRS initially selected 13 compliance issues when it rolled out the strategy. Since then, it has retired some campaigns and added many more active ones.

A new LB&I campaign addresses residents of the U.S. territories listed above who, as mentioned, either underpaid or failed to pay employment tax to the IRS. Territorial residents who understated their self-employment taxes should file an amended Form 1040-SS or Form 1040 (PR) (as applicable) to properly report and pay their self-employment taxes. The IRS will address continued noncompliance through a variety of treatment streams, including examinations.

We can help

Contact Elliott Davis for more information on these and other matters related to conducting business internationally.

The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.