Hi! I would appreciate any advice on this question. I've searched online but haven't found a clear answer.

I am a long time overseas resident and US citizen. I file taxes every year and always claim the foreign earned income exclusion (FEIE). My income has always been less than the exclusion amount, so I pay zero.

In 2011 I did some work for some US agencies, who issues 1099s. It was about $20,000 total. I reported it, but claimed the exclusion and so paid nothing on it (my income including this amount and that I earned abroad was less than the exclusion). But I just got a letter from the IRS saying I "may" be liable for self employment tax on the 1099 income.

It was my understanding that all income earned abroad, even that earned from US companies, was counted under FEIE if you qualify as a foreign tax resident. Is this correct? The letter says "If you are not liable for self employment tax, please provide an explanation with your reply"... so can I somehow explain I am not liable?

Thank you!

“In 2011 I did some work for some US agencies, who issues 1099s. It was about $20,000 total. I reported it, but claimed the exclusion and so paid nothing on it (my income including this amount and that I earned abroad was less than the exclusion). But I just got a letter from the IRS saying I "may" be liable for self employment tax on the 1099 income.”--->Correct; as long as the amount on Sch SE line 4 is $400 or exceeds $400, then you must pay self employment tax to the IRS; the 2010 Tax Relief Act reduced the self-employment tax by 2% for self-employment income earned in calendar year 2011. The self-employment tax rate for self-employment income earned in calendar year 2011 is 13.3%, NOT 15.3%, (10.4% for Social Security and 2.9% for Medicare). The Temporary Payroll Tax Cut Continuation Act of 2011 extended the self-employment tax reduction of 2% for calendar year 2012 so the rates for 2011 remain in effect for 2012. For self-employment income earned in 2010, the self-employment tax rate is 15.3%. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).
“It was my understanding that all income earned abroad, even that earned from US companies, was counted under FEIE if you qualify as a foreign tax resident. Is this correct?”---->Correct. As a US citizen, you are subject to US taxes on your US source and world wide income, so as an IC, your self employment income ,regardless of its source, is subject to SECA taxes as long as the amount on Sch SE line 4 is $400 or exceeds $400 as mentioned above.You may claim the foreign earned income exclusion on foreign earned self-employment income. The excluded amount will reduce your regular income tax, but will not reduce your self-employment tax on sch SE.
The letter says "If you are not liable for self employment tax, please provide an explanation with your reply"... so can I somehow explain I am not liable?”---->I do not think so; as said, as an IC , a self employer,wherever you earn your self employment income, it is ALWAYS subject to SECA taxes in US UNLESS the amount on line 4 of Sch SE is LESS than $400. ALSO, certain taxpayers must maintain a state of domicile in the US, and there will be tax obligations to that state,too.