Head Scratcher - Totalization Agreement - Self employment

Bit of a tough one here. This question regards exemption from US social security when self employed and resident in the Uk in the situation where your self employment is a side job and you are also employed.

Under the UK system you can claim a refund for Class 2 self employment national insurance contributions (about £130 a year) if your self employed earnings are below about £6,000.  This would also mean you would not gain a pension 'credit' for that year if that was your only job.  I expect it would also mean you were potentially liable for SS in the US as you are not covered by any system under the totalization agreement.

However, what about the situation where alongside your side self employment you gain a credit/qualifying year through your main employed earnings?  Therefore you are still getting a 'qualifying year' for your pension and you are covered by national insurance but you are not specifically paying self employed Class 2 contributions (because this was refunded), you are paying Class 1 through employment.  Under the UK system you gain a 'qualifying year' through employment so long as you earn more than approx £5,500 per year. This makes the Class 2s irrelevant.  

From reading the totalization agreement it appears that the countries are only concerned that you qualify under a particular system. The wording incudes definitions such as:
a.   "contribution period" means,
a period in respect of which contributions appropriate to the benefit in question are payable, have been paid or treated as paid;
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It appears that so long as under the law of the UK you are deemed to have paid the appropriate contributions for that year it shouldn't matter if these were self employment contributions or employed contributions.

My question is therefore, if a refund for self employed Class 2 payments in the UK was obtained would this matter so long as the appropriate national insurance coverage has been gained for that year through other means (such as employment earnings)?

Your opinions are as ever appreciated.

Social security does not work the same as income tax and you are trying to apply income tax principles (e.g. if you don't pay in one country it must mean you default to owing in the other).

The treaty is concerned with coverage - i.e. which country has the right to tax you or, said another way, which system you fall under.

The SSA has a lovely grid that tells you exactly where your contributions should lie.  http://www.ssa.gov/international/Agreement_Pamphlets/uk.html

If you are self-employed and residing in the UK, you pay to the UK.  The US does not get the right to impose SS in this scenario.  Equally, the US does not become your default system if you don't owe anything to the UK.  In this scenario, you are simply under the UK system - for better or worse. 

When you complete your US tax return, you will be led to add self-employment tax (i.e. SS).  The way I have seen this handled  is that you need just to zero this out and right a note (literally on the Sch SE form or leave out the form and add a statement) stating that under the terms of the US/UK totalisation agreement you are self employed, living in the UK and fall under the UK system. 

You can attach the certificate of coverage; the IRS asked for these frequently 5 or 6 years back but do not do so as often these days.

same topic different question...is it recommended then to apply for a certificate of coverage? from the Dept of WP?

The treaty is concerned with coverage - i.e. which country has the right to tax you or, said another way, which system you fall under.

The SSA has a lovely grid that tells you exactly where your contributions should lie.  http://www.ssa.gov/international/Agreement_Pamphlets/uk.html

US citizens in the UK don't get any choice as to where they make their SS payments and unless they work in the UK for a US company for 5 years or less they will fall under the UK system and not the US one.

The UK expat in the US has to follow similar rules and if they work for a US company will have to pay FICA, but they can also choose to make voluntary national insurance contributions to the UK while they are abroad and so have the potential to get full SS and UK state pensions at retirement.

Thank you all for your comments, this forum is very useful and you are all incredibly generous with your expertise.  Once we can afford to get a pro in it would definately be worth it. Anyhow.

Sarah - thanks for your explanation.  So to clarify, are you saying that so long as you are 'subject' to the NI system in the UK, what contributions you make and how you make them is irrelevant?  For example if you claimed a refund for all your self employment NI for a particular year (known as Class 2 NI) because the UK system allowed you to do so if you have low self employment earnings, this would not create a liability for self employment SS in the US?  In my example, the relevant contribution (to make that year 'qualifying' for pension credit) would be deemed made through the employed earnings threshold anyway (second job), but according to what you are saying it wouldn't seem to matter if a year became a 'qualifying year/credit' for NI purposes so long as you are purely 'subject' to the UK system?

The reason I ask is because the self employment earns next to nothing (it's a sideline) so to claim an NI refund on it albeit around £130 a year would add up.  The employed earnings on the other hand would be enough to ensure an NI pension credit is earned for that year.

This seems opposed to the tax system as you say. Where if there is no tax in the UK (say on an ISA account) the US wants you to pay tax on it even though the UK system allows untaxed savings under this ISA regime.

Many thanks.