You’ve hit the road as a digital nomad. Good for you for embracing this unique lifestyle filled with new places, new faces, and new experiences. However, don’t forget about taxes as a digital nomad.
The digital nomad lifestyle comes with many advantages. More freedom, location independence, a better work-life balance, working from anywhere, minimalism …It’s pretty easy to understand why so many people dream of the lifestyle.
But there is one very important issue that digital nomads often neglect… Can you guess what it might be??!!?
You got it. TAXES!
It’s all too easy to push them aside as you think about your next destination and all those dreamy goals you have as you roam the world. However, it doesn’t matter where you spend your time. If you’re a US citizen, you have to follow the tax rules of the United States.
Let’s review 5 considerations for US taxes as a digital nomad.
As a US citizen or American, you are taxed on worldwide income, regardless of where you were at the time it was earned. Don’t worry. I got you covered.
If you’re a US citizen, here are the top 5 considerations for taxes as a digital nomad:
1. Foreign Tax Credit (FTC)
2. Foreign Earned Income Exclusion (FEIE)
3. Self-employment taxes & deductions for digital nomad business owners
4. State Taxes
5. Foreign Bank Account Reports (FBAR)
Every country has its own unique tax structure. However, there is also usually a threshold before any tax liability begins. Think about 6 months or 183 days before resident tax might begin. Many countries also have tax treaties with the US.
Lastly, I also urge you to review your visa. Does it permit you to work in that country? Are you working for your own US-based company as you travel?
So many things to consider for taxes as a digital nomad, right?
1. Foreign Tax Credit (aka FTC)
If you spend enough time in a country to file and owe taxes in that country, there’s a provision for this.
Americans who pay taxes to a foreign country can qualify for the foreign tax credit. This is usually credit to help reduce your liability to the US. It could also be a deduction against your US taxable income.
How do you claim this credit? Use Form 1116, to claim taxes you’ve paid to another country.
Be careful here, though, because you can’t qualify for the foreign tax credit on any income you also exclude using the foreign earned income credit (FEIE).
What’s the Foreign Earned Income Credit, you ask?
2. Foreign Earned Income Credit (aka FEIE)
This tax credit allows those who spend a set number of days outside the US or those who are considered residents of another country to be exempt from paying federal income taxes on a part of their earned income. For 2022, that amount is $112,000.
This is a pretty nice benefit for those digital nomads who live outside the USA. I mean who doesn’t want to save on their taxes as a digital nomad?
Let’s define earned income. This includes wages and salaries (think W2), self-employment income (as long as you are active in the business), S Corp earnings, etc.
In order to qualify for the FEIE, you must pass three tests. Don’t worry. It’s not that difficult if you are truly a digital nomad.
Test 1: Bona fide resident or physical presence test…You must meet one of the following to qualify.
1. A US citizen who is a “bona fide” resident of a foreign country
2. A US resident who is a citizen of a country with which the United States has a tax treaty and is also a bona fide resident of a foreign country
3. A US citizen who is physically present in a foreign country for at least 330 days during any 12-month time frame.
Most digital nomads I see qualify using the third option, the physical presence test. This doesn’t need to be a calendar year (January to December). It could be April to April. The important factor here is that you don’t spend more than 30 days in the US.
Test 2: Tax Home test…Where is your tax home or where do you physically earn your money? To pass this test, you must earn your money outside the US. If you’re self-employed (even with an S Corp) and spend your time outside the US, then you pass this test. You are earning your money wherever you are physically located.
Test 3: Abode Test This revolves around where your family is, social ties, and any economic ties you may still have with the US. For example, is your family (think wife, husband, kids) still in the US while you travel? What about owning a home in the US? Is it rented out?
Most digital nomads I work with travel with their spouse or partner and kids if they have them. It’s the lifestyle for the whole family and not a temporary job in a foreign country.
If you still have “adobe” ties to the US, it can weaken your argument that the US is not your permanent home. You still have those ties and your travel is temporary. It won’t necessarily disqualify you altogether, but you may need to argue a bit more.
Now that we’ve covered the basics to qualify, let’s look at some other factors to consider.
3. Self-employment taxes & deductions for digital nomad business owners
So, you’ve determined you qualify for the FEIE. Congrats!
What else might you qualify for on your taxes as a digital nomad?
If you’re self-employed, I’m here to share some possibly disappointing news. The FEIE does not apply to self-employment taxes! These are Social Security and Medicare tax obligations. Every US citizen is responsible for them if they have earned income.
If you don’t know what I’m talking about, you should learn all about self-employment taxes. You pay these quarterly to keep up with your tax obligation as a self-employed individual. Taxes as a digital nomad offers no exceptions to paying self-employment taxes.
As a W-2 employee, your employer covers these obligations. They pay half and collect your half through your salary. It all happens behind the scenes so you don’t have to think about it.
What can you deduct from your taxes as a digital nomad? Great question!
If you’re a W-2 employee, you’re out of luck.
For those who are self-employed, keep reading.
Deductions for business owners
Typical deductions for those who run a remote or virtual business include:
coworking fees, travel specific to a client or to attend a work-related conference, advertising or marketing costs, contract labor, software, supplies, professional fees (lawyer, accountant), phone if you’re using it for business, etc.
Remember, the IRS states that business deductions must be ordinary and necessary for your business. This means all your personal travel doesn’t count as a business deduction. Sorry to disappoint.
If you are questioning whether an expense can be considered a business deduction, talk to a tax professional. Let them guide you on specific write-offs.
4. State Taxes
What about state taxes? Will you owe them as part of taxes as a digital nomad?!?! That depends.
Many states don’t offer any provisions for foreign-earned income exclusion like the federal government does. I suggest picking a resident state that doesn’t have income taxes. The following 7 don’t impose any income tax on their residents – Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. The top 3 states for digital nomads are Florida, South Dakota, and Texas because they all offer “easy” residency requirements. There are also plenty of mail services you can use that are accepted for residency purposes in these states.
Don’t leave the United States without first thinking about your mail and state residency. Otherwise, you’ll be stuck with whatever your state residence was before you left the US.
5. Foreign Bank Account Report (FBAR)
If you have foreign bank accounts with a value over $10,000 during a tax year, then you must file a Foreign Bank Account Report (aka FBAR). This is a separate filing from your regular tax return (1040).
Failure to file this form comes with hefty penalties. As in, a fine of $10,000 or 50% of the balance in the bank account(s). You don’t want to see the penalties.
As an example, if you have $4,000 in a Chinese bank account and $7,000 in Mexico, you must file because your total balance is $11,000. Even if you don’t have over $10,000 at the end of the year if you did at any point during the year, you need to file the FBAR.
You’ll need the following in order to file the FBAR and you must keep records with the following for five years:
- Name on the account,
- Account number,
- Name and address of the foreign bank,
- Type of account, and
- Maximum value during the year.
Taxes as a Digital Nomad
Hopefully, this cleared up some of your questions. If you still have additional questions about taxes as a digital nomad, I suggest you reach out to a tax expert. Otherwise, feel free to leave a question below.
Either way, have fun, enjoy the lifestyle and maybe our paths will cross someday.