For many of us, October 7 has changed the way we manage our daily lives and this also affects our businesses. The economy has slowed down due to the war and the planning horizon for many freelancers has narrowed down to the next 2-3 weeks instead of long-term planning. As you struggle to deal with loss of certain clients and try to cut expenses, one the most overlooked expenses that US citizens living in Israel often ignore is the social security tax on their business income.
Due to the fact that the US and Israel have never signed a totalization agreement preventing the double taxation of US social security taxes and Israeli bituach leumi taxes, Americans living in Israel are stuck having to pay both taxes. Social Security and Medicare are taxed at 15.3 percent of the net business income, while bituach leumi is taxed at 5.97 percent on the first 7,122 NIS of your monthly business profit and any excess is taxed at 17.83 percent. This double taxation, coupled with Israeli income taxes, can create a potential tax burden of up to 60 percent of your hard-earned money.
Incorporating in Israel removes the US social security tax
So what are the alternatives to this draconian tax regime? While there are other options which we will discuss later, I usually recommend US citizens who are self-employed in Israel to set up an Israeli corporation and pay themselves a salary. This option not eliminates the social security tax completely but it also creates attractive tax planning opportunities by optimizing salaries and dividends.
The problem with the corporate option 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 1,505 NIS. Accounting fees also become higher when running a corporation. Israeli accountants often charge their corporate clients monthly fees starting at about 1,200-1,500 NIS per month. Your US tax accountant will also charge an additional fee in order to disclose this foreign corporation on your US return. 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
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 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 have about 12,000 NIS of additional expenses for the year. The added benefit of using a corporation is that you can deduct the 12,000 NIS additional expenses plus the employer portion of bituach leumi and further reduce your Israeli income tax and bituach leumi. So if you are self-employed in Israel and earn a minimal profit of 70,000 NIS, you would still benefit from using an Israeli corporation.
In addition, if you have not earned 40 quarters required for social security benefits, you have the option of leaving one of your business activities as self-employed and paying the minimal contributions to qualify for four quarters every year (this was $1,059 in 2023), while reporting the rest of your business as a corporation.
Another option (but be careful with it!): using a US LLC
For those of you who earn over 70,000 NIS as self-employed but not enough to benefit from sophisticated tax planning strategies offered by Israeli corporations, another option is to form an LLC in one of the 50 states and run your activity through it. This would eliminate completely the requirement to pay Israeli bituach leumi and it would not accrue many of the costs required by Israeli corporations. Before you even consider this tax-planning option, you will need to meet the following requirements:
- All of your clients must be non-Israeli residents. If you work with Israeli individuals or companies, you are required to bill them using an Israeli entity.
- In order to prevent your US LLC from being treated as an Israeli corporation, you will need to make sure that a substantial portion of the company management is done physically from the US. An full discussing of this matter is beyond the scope of this article, but you should seek advice from an Israeli accountant before putting a check mark on this requirement.
My personal recommendation to US citizens in Israel who are self-employed or consider becoming self-employed in the near future is to perform the required computations based on their estimated profits and applicable tax rates or to seek advice from an experienced accountant.
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.