Being a digital nomad absolutely has its benefits, but it’s important to understand the tax implications and obligations as a US expat.
December 12, 2022
By: Bobby Casey, Managing Director GWP
Humans were nomads once out of necessity: we, like many other animals, followed the resources and shifted with the weather. They traveled in tribes or clans to keep their network of trusted people close.
Then people found a way to have resources come to them through elaborate supply chains, and they became stationary. Their lives took root in a house and an office or factory. Family members didn’t stray too far from that base.
With supply chains being more advanced and technology making our networks accessible on our devices, now people can stay or go based on desire rather than strict need, which is great! Being nomadic isn’t novel, but being an individual digital nomad was considered eccentric not that long ago.
More and more businesses and jurisdictions are accommodating this lifestyle, if not outright catering to it. People, businesses, and governments are all adjusting to this way of life, and that is good for everyone.
Understanding Digital Nomad Taxes
Nomads have their ups and downs like any other lifestyle has. Depending on where you are coming from, one of the “ups” is being able to live tax-free.
If you’re an American, however, you take this yoke with you. As an American myself, I can confirm that you can live a much freer life abroad, without question. You can live much cheaper in many cases abroad than you can in the US. But the albatross of US tax laws and FATCA follows you.
It’s a ridiculous reality where Americans live in a country that is more tax-friendly to foreigners than its own people. There is a silver lining, but you need to be aware of how that lining works for it to be silver.
Tax Obligations Based on Different Criteria
There are three different criteria by which individuals could be obligated to pay taxes:
1. Citizenship-Based Taxation
This is where a country taxes its citizens’ income no matter where they are. Examples include the United States and Eritrea.
In the case of the US, it extends further than citizenship. It technically extends to all American persons (think residents with green cards). This means it doesn’t matter if you live outside the US, your business has nothing to do with the US, you don’t even visit the US, and all of your assets are outside of the US.
If you are a US person or citizen, you need to tend to your tax situation.
2. Residence-Based Taxation
This is the most common, with 130 countries participating in this tax structure. You pay taxes based on your country of residence’s tax laws, not your country of citizenship. Examples include most of the EU, Mexico, Japan, and Australia.
This could be problematic in some cases for high-earning Americans because of the potential for double taxation.
3. Territorial Taxation
This is where you are only taxed if you earn income from within your country of residence. Examples include Singapore, Thailand, Paraguay, Panama, and Costa Rica.
Most digital nomad visas require that you earn from outside the country because they want to keep jobs for their citizens.
State Income Taxes for Digital Nomads
Beyond federal taxes, Americans could be on the hook for state income taxes if they are domiciled in states such as California, New Mexico, South Carolina, and Virginia. California and Virginia are notoriously stubborn about giving up their tax residents, so it’s best to set up your domicile in a different state, just in case.
States That Cling to Tax Residents
Any of the following things could flag you as still being domiciled in the state:
- They issued your current driver’s license or ID card.
- Your spouse and/or children live there.
- Your vehicle is registered there.
- You’re registered to vote there.
- You have a bank account open there.
- You own property there.
- You maintain a mailing address there (even if you’re using a friend or relative’s address).
Establishing Residency in Tax-Friendly States
If you are leaving the US anyway, your best bet is to set up residency in a state without state income taxes. A place like South Dakota doesn’t even require you to be there or go there except to renew your driver’s license and has no state income tax. That’s some low-maintenance residency!
Other states like Texas, Florida, and Wyoming also have no state income taxes but have more rules to become residents there.
FICA Taxes for Self-Employed Digital Nomads
The US is notorious for balkanizing its tax regime, so income taxes aren’t the same as FICA taxes.
What is FICA?
FICA is defined by the Internal Revenue Service (IRS) as:
“Taxes under the Federal Insurance Contributions Act (FICA) are composed of the old-age, survivors, and disability insurance taxes, also known as Social Security taxes, and the hospital insurance tax, also known as Medicare taxes. Different rates apply for these taxes.”
To that end, self-employed digital nomads still owe 12.4% of their income for Social Security and 2.9% for Medicare.
Totalization Agreements
There are exceptions to this as well. There are bilateral Social Security Agreements or “Totalization Agreements“ the US has with several countries that can offset this and are worth bringing up with your tax adviser.
Tax Benefits and Exclusions for Digital Nomads
Now for the silver lining and some of its terms and conditions.
Foreign Earned Income Exclusion (FEIE)
This exclusion is for the first $112,000 of earned income (for the 2022 tax year). 2023 is set to be $120,000. It does not apply to just any income. It is strictly for earned income, which is very particular.
So if it is part of your compensation from your business or labor such as salary or wages, bonuses and commissions, or any professional fees, that would be earned.
Non-earned income could be passive income or annuities such as interest and dividends, pensions, and capital gains.
Qualifying for FEIE
Not only must the type of income qualify, but you must individually meet one of two requirements: either the physical presence test or the bona fide residence test. (This is also required to qualify for the Foreign Housing Exclusion.)
- Physical Presence Test: Requires you spend more than 330 full days outside of the US during any 12-month period in one or many countries.
- Bona Fide Residence Test: You are a US person (citizen or resident alien) who has maintained a residence in a foreign country, lived there for an entire year with no plans to return to the US in the foreseeable future.
The thing about not being in the US for 330 days is staying somewhere else long enough to owe taxes there (often 180 days).
Foreign Housing Exclusion
This is in addition to the income exclusion. This is calculated based on what you spend on housing overseas, and it can be up to 14% of your FEIE claim. So if you claim $100,000 on the FEIE, then $14,000 would be your Housing Exclusion.
Qualifying Expenses
Self-employed individuals would need to file the Foreign Housing Deduction, as they would not qualify for the exclusion. These housing expenses must be paid with employer-paid income.
Qualifying expenses include:
- Rent
- Property or occupancy insurance
- Utilities
Expenses that do not qualify:
- Mortgages
- Airbnb or Vrbo stays
- Maintenance or labor for upkeep
Foreign Tax Credit (FTC)
The FTC is designed to prevent double taxation for expats and nomads. This claim can only be made on income beyond your FEIE. If you earned $110,000 in 2022, you would not have any further deductions to make in the US. If, however, you earned $135,000, the math could look like this:
- $112,000 FEIE (max deduction)
- $15,680 Foreign Housing Exclusion (max deduction based on max FEIE deduction)
- $7,320 is your tax obligation to the country in which you reside. You would be able to deduct this amount.
Tax Forms for Digital Nomads
There are multiple forms that will likely need to be filed, albeit your actual liability could be low or even zero.
Forms You May Need to File
- Form 1040: Individual Income Tax Return
- Form 2555: Foreign Earned Income
- Form 1116: Foreign Tax Credit (Individual, Estate, or Trust)
- FinCEN Report 114: Report of Foreign Bank and Financial Accounts (FBAR)
- Form 8938: Statement of Specified Foreign Financial Assets (FATCA)
You might not need to file all of these, but it’s good to be aware of them so you aren’t surprised. You can always mention them to your tax consultant and see what they say about your circumstances.
Digital Nomad Taxes: What’s Your Next Step?
It sounds like a lot, but if you get a tax expert who specializes in working with expats and digital nomads, you should have no problem keeping up. There are some great benefits to living abroad; it just takes a little preparation and forethought.
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