I am a consultant for a nonprofit located in Europe, which pays me by transferring funds to my bank account here. I'd like to ask for some clarification on this: the IRS states about business expense deductions related to this that "You may not claim deductions for expenses on Schedule C," but then in the following paragraph says, "You may also claim deductions for unreimbursed employee business expenses arising from your employment on Form 2106, Employee Business Expenses."
So can I deduct the expenses on 2106 but not on Schedule C?
I'm not sure where you are reading about your business expenses. If you are filing a Schedule C for self-employment, you deduct your expenses just like you would for any other income. It does not matter if your client is a nonprofit or an overseas organization. It's not foreign earned income if you are a US citizen and resident and perform the work here.
If you receive a W-2 from this client then you would claim expenses on the 2106.
Here is the full context from the IRS web site and why O asked the question: "U.S. citizens working in the U.S. must pay self-employment tax because the foreign government or organization is not liable for the employer’s portion of the contribution to the U.S. system. However, you are not “self-employed” for any other federal tax purposes. You may not claim deductions for expenses on Schedule C and are not qualified to establish a Simplified Employee Pension (SEP) Plan and there is no allowable deduction on line 28 of Form 1040 for contributions to any such plan. Rules of contributing to SEP/IRA plans are explained in IRS Publication 60. and Revenue Ruling 73-384 for additional information.
You may also claim deductions for unreimbursed employee business expenses arising from your employment on Form 2106, Employee Business Expenses. The deduction is claimed on line 21 of Schedule A, Itemized Deductions, on the Form 1040. These expenses are miscellaneous itemized deductions subject to the 2 percent of adjusted gross income limitation."
The rules you cite are for US citizens working in the US for a foreign organization or government located in the US, as an employee. For example, employees of foreign embassies in Washington, or the World Bank located in Washington. Those employees receive a W-2 for their wages but no social security or medicare is collected from their paychecks.
That situation does not apply to you because the client for whom you work is not located here in the US and it does not sound like you receive a W-2 from them