Being an expat or digital nomad brings a wealth of new experiences, opportunities, and challenges. From immersing yourself in a new culture to exploring unique destinations, the adventure can be thrilling. However, one crucial aspect that many digital nomads and expats face is understanding the tax implications.
Double Taxation for Expats and Digital Nomads
First things first, you must be aware that the U.S. requires all U.S. citizens to report their worldwide income and file a tax return regardless of where in the world they live or travel. The US is one of only two countries in the world that require this.
Let’s explore the 4 key tax tips to avoid double taxation for expats and digital nomads.
1. Tax Treaties with the US and Their Impact
Tax treaties play a significant role in determining how income is taxed across borders. The US has tax treaties with many countries to prevent double taxation, but the specifics can vary significantly.
If you plan to be or are an expat already, make sure you understand the tax treaty between the US and your new resident country. Without that knowledge, you may struggle with taxation.
For example Spain vs. France
Spain and France are both popular destinations for American expats, yet their tax treaties with the US differ substantially in terms of how they treat retirement income.
Spain: Spain has the right to first taxation of income, including Social Security, for U.S. residents who live there. This means that retirees may find themselves paying Spanish taxes on their Social Security income, even though they’ve already paid into the system in the US.
France: France’s approach is different. The country assesses taxes based on the income source rather than the residency of the taxpayer. Therefore, US citizens living in France only pay taxes to the US on Social Security benefits. This can lead to favorable tax treatment for retirees in France compared to those in Spain.
Are you considered a tax resident in your new home? As an expat, it’s crucial to know this information as part of your planning.
2. US Foreign Tax Credit
To alleviate the burden of double taxation, US expats can take advantage of the Foreign Tax Credit, which provides a dollar-for-dollar reduction on taxes owed to the US government. Here’s how it works:
If you pay income taxes to a foreign government, the Foreign Tax Credit allows you to claim a credit for these taxes on your US tax return. This credit applies directly to reduce the tax you owe. Thus, you avoid double taxation for expats and digital nomads.
For example, if you paid $3,000 in taxes to Spain on retirement income, you could reduce your US tax liability by the same amount, up to the limit allowed by the IRS.
Sometimes, this can eliminate any US tax obligation. Can you see how this allows you to avoid double taxation?
It’s important to note that the Foreign Tax Credit only applies to income taxes, not other types of taxes, such as property or sales taxes, which vary greatly from country to country. Additionally, the US limits the credit to the portion of US tax attributable to the foreign income, meaning you can’t claim more credit than you would have paid on that income if it were US-sourced.
If you have any unused tax credit, you can carry it forward for up to 10 years.
3. The Foreign Earned Income Exclusion (FEIE)
Another useful provision for Americans working abroad is the Foreign Earned Income Exclusion (FEIE). The FEIE allows US digital nomads to exclude a certain amount of foreign-earned income from their US taxes (up to $126,500 in 2024), but they must meet specific requirements to qualify.
Residency Test:
This test applies to US citizens who establish themselves as bona fide residents of another country for an entire tax year. Essentially, if you can demonstrate a permanent residency in a foreign country, you may qualify for the exclusion. If you have a visa, then you most likely qualify for this test.
Physical Presence Test:
This test is for individuals who don’t meet the residency test but spend a significant amount of time outside the USA. To qualify, you must be physically present in a foreign country (countries) for at least 330 full days during a 12-month period. This is often used by people who travel frequently but spend most of their time outside the US. Make sure to document your travels so you have proof should the IRS question you.
There are a couple of caveats for the FEIE:
1. It only applies to earned income, such as wages, salaries, and business income. Unearned income, like dividends, rental income, or retirement income, is not eligible for the exclusion, though it may still qualify for the Foreign Tax Credit.
2. It doesn’t apply to self-employment taxes. You CAN owe self-employment taxes without owing any income tax.
4. Other Important Considerations for U.S. Expats
Filing Requirements:
US citizens living abroad must file a US tax return just as if they were residing in the US. Additionally, expats must often file other forms, such as the Foreign Bank Account Report (FBAR) if they have foreign bank accounts with a combined value exceeding $10,000 at any time during the year.
State Taxes:
Depending on the state you last resided in before moving abroad, you may still be required to file state taxes, as some states are particularly stringent about residency status. Consulting with a tax professional who specializes in expat taxes is wise if you’re unsure about your state tax obligations.
Healthcare Considerations:
While not directly a tax issue, many expats need to consider how moving abroad impacts their Medicare eligibility, access to healthcare, and the tax implications of contributing to foreign healthcare programs.
Final thoughts
For Americans deciding to move abroad or travel full-time, it’s essential to be aware of the tax complexities that can arise. Understanding the intricacies of tax treaties, the Foreign Tax Credit and the Foreign Earned Income Exclusion can help prevent costly mistakes and ensure compliance with US tax laws.
While these tax rules may seem daunting, they’re manageable with the right planning and professional guidance. Whether you’re working overseas or enjoying retirement, taking the time to understand these tax implications will help you make the most of your digital nomad or expat lifestyle.