Digital Nomads & Taxes

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

B​y: Bobby Casey, Managing Director GWP

tax digital nomad T​he Digital Nomad lifestyle has taken on a much more popular place in the global society. I think humanity goes through phases.

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.

T​hen people found a way to have resources come to them, through an elaborate supply chain, 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, resources are more readily available throughout the world, and with technology, our networks are accessible on our devices.

Now people can stay or go based on desire rather than strictly need, which is great! Being nomadic isn’t novel, but being an individual and digital nomad was more on the eccentric side not that long ago.

M​ore 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.

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.

I​f you’re an American, 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 follow you.

I​t’s a ridiculous reality where Americans live in an 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 be silver.

T​here are three different criteria by which individuals could be obligated to pay taxes

Citizenship-based: This is where a country taxes its citizens’ income no matter where they are. (E.g. US 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.

I​f you are a US person or citizen, you need to tend to your tax situation.

Residence-based: This is the most common with 130 countries participating in this tax structure. It is where you pay taxes based on their country of residence’s tax laws, not their country of citizenship. (E.g. Most of the EU, Mexico, Japan and Australia)

T​his could be problematic in some case for high earning Americans because of the potential for double taxation.

Territorially-based: This is where you are only taxed if you earn income from within your country of residence. (E.g. Singapore, Thailand, Paraguay, Panama and Costa Rica)

Most digital nomad visas require that you earn from outside the country, because they want to keep their jobs for their citizens.

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 slaves, so best to set up your domicile in a different state, just in case.

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)

I​f 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 that doesn’t even require you to be there or go there except to renew your driver 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.

T​he US is notorious for balkanizing its tax regime, so income taxes aren’t the same as FICA taxes. 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.

T​hat that end, self-employeed folks still owe 12.4% of your income for Social Security and 2.9% of your income for Medicare.

T​here 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 is worth bringing up with your tax adviser.

N​ow for the silver lining and some of its terms and conditions.

Foreign Earned Income Exclusion (FEIE)

T​his exclusion is for the first $112,000 of earned income (for 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 a very particular thing.

So if it so 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.

N​on-earned income could be passive income or annuities such as interest and dividends, pensions, and capital gains.

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 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 is a little more involved. You would be 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. 180 days

Foreign Housing Exclusion

T​his 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.

S​elf-employeed individuals would need to file the Foreign Housing Deduction, as they would not qualify for this. These housing expenses must be paid with employer-paid income. Here’s what qualifies: Rent, Property or Occupancy insurance, and Utilities

W​hat would not qualify are 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. T​his 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.

T​here are multiple forms that will likely need to be filed, albeit your actual liability could be low or even zero.

  • 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 (FACTA)

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.

I​t sounds like a lot, but if you get a tax expert who specializes in working with expats and nomads, you should have to problem keeping up.  There are some great benefits to living abroad, it just takes a little preparation and forethought.

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