One of the main difficulties faced by American olim trying to become self-employed in Israel is the double social security/bituach leumi tax. In addition to income taxes, self-employed Americans working in Israel face US social security and Medicare taxes at the rate of 15.3% plus Israeli bituach leumi at the rate of 5.97% or 17.83% (depending on the income). When Israeli income tax is added, the effective tax rate can sometimes exceed 50%.
This double tax is due to the fact that Israel does not have a totalization agreement with the U.S. on matters of social security.
A way to legally avoid this double tax is to set up an Israeli corporation and pay yourself a salary. Salaries received by Americans residing in Israel are exempt from US social security and are only subject to Israeli income tax and bituach leumi. The problem with this approach is that there are many significant additional expenses associated with creating and maintaining an Israeli corporation. The fee for setting up an Israeli corporation is 2,614 NIS (plus the lawyer’s fee) and the annual renewal cost is 1,484 NIS. Accounting fees also become higher when using a corporation. Israeli accountants often charge their corporate clients monthly fees starting at 1,000 NIS per month. This fee can be much higher depending on the size of the company. Your US tax accountant will also charge an additional fee in order to disclose this foreign corporation on your US return. On top of that, your bank charges will be increased, as you will need to set up a separate corporate account.
The following table compares the minimal expenses of an Israeli self-employed individual vs. a small Israeli corporation (based on our estimates in NIS):
|Corporate annual report||N/A||1,484|
|Deductible bank fees||N/A||600|
The bottom-line question is whether it is worth to invest in this more expensive structure. This will depend on your level of profits from the self-employed activity. For example, if you normally earn 70,000 NIS per year after expenses, your US social security and Medicare tax in shekels will be 9,891 NIS. On the other hand, if you decide to bill your clients through an Israeli corporation, you would be exempt from US social security and Medicare taxes but would incur about 10,000 NIS of additional expenses for the year. The added benefit of using a corporation is that you can deduct the 10,000 NIS additional expenses plus the employer portion of bituach leumi and further reduce your Israeli income tax and bituach leumi.
The above discussion is only relevant for individuals who have already earned 40 quarters and are therefore entitled to US social security or are simply not interested in these benefits. If you would like to contribute to social security and earn enough credits to qualify for benefits, you can maintain one of your freelance activities and pay the 15.3% tax on it.
My personal recommendation to US citizens in Israel who are self-employed or consider becoming self-employed in the near future is to perform this computation based on their estimated profits and applicable tax rates or to seek advice from an experienced accountant.
Here are a few additional tips that will help you reduce your expenses when using an Israeli corporation:
- Consider doing your own bookkeeping: If you are financially-inclined, learning how to do basic Israeli bookkeeping should not be too difficult. For this purpose, you will need special pre-approved software. This could cut your Israeli accounting expenses in half.
- Try to save on lawyer’s fees: Setting up an Israeli corporation with a single shareholder can easily be done using a standard template. Businesses with two or more partners who wish to incorporate are advised to hire a lawyer in order to draft the bylaws and related documents.
- Beware of auto expenses: If you decide to work as a corporation, you can still deduct your auto expenses in Israel, but you will be taxed at the personal level for the benefit of using the car during off hours. You should discuss the matter with your Israeli accountant in advance, as the cost may exceed the benefit.
- Beware of the US tax implications: While running an Israeli corporation may be beneficial, in order to fully enjoy the benefits of this structure, you will need to work with a US CPA who is proficient with all the relevant laws affecting US-owned foreign entities. This article discusses the matter in detail.
The content of this article is intended to provide general information on the subject and does not constitute legal or tax advice. You should consult with a tax professional where appropriate.