Digital Nomads: How to Use the Foreign Earned Income Exclusion

Digital Nomads: How to Use the Foreign Earned Income Exclusion
June 1, 2020

Digital nomads may be on the hook for US taxes, but they are eligible for the tax breaks available to other expats. If they want to claim the Foreign Earned Income Exclusion, digital nomads will need to consider their travel schedules, tax home, and if the requirements fit their lifestyle. Read our guide to taxes for digital nomads below, so that you know what to expect tax-wise from your jet-setting lifestyle.

Taxes for Digital Nomads 101: Do I Need to File a US Income Tax Return?

There’s no doubt about it: the landscape of the workforce is constantly evolving. Advances in technology have made it almost the norm to telecommute—not just from home, but from practically anywhere in the world with an internet connection! People are not tied to an office chair, and they love it.

These “digital nomads” have realized opportunities are endless as they hop from country to country, all while holding down a steady job. Though the prospect of traveling the world while earning a living is quite appealing for most, it’s important to keep in mind that you are likely still on the hook to file a US income tax return to report worldwide income, even if you have left the states.

The US imposes citizenship-based taxation, which means no matter where you live and work, as a US citizen or permanent resident (i.e., a Green Card holder), you must file annual US income tax returns to report all of your income, no matter where that income was earned.

The good news is that there are several ways to mitigate US income taxes while working overseas. The most popular is the Foreign Earned Income Exclusion (FEIE).

Want to learn about all the ways you can save on taxes as a digital nomad? Watch our free webinar.

How Do Digital Nomads Qualify for the Foreign Earned Income Exclusion?

The Foreign Earned Income Exclusion and Foreign Housing Exclusion (or deduction, for self-employed individuals) allow digital nomads to exclude a certain amount of income earned in a foreign country from their US taxes:

  • $107,600 for the 2020 tax year
  • $108,700 for the 2021 tax year

It’s important to note that the FEIE applies to earned income only (i.e., wages, salary, bonus, etc.) and does not apply to unearned income (i.e., pension distributions, interest, dividends, etc.).

In order to claim the Foreign Earned Income Exclusion and Housing Exclusion/Deduction, digital nomads must:

  1. Have foreign earned income,
  2. Have a tax home in a foreign country, and
  3. Meet either the bona fide residence or physical presence test.

We’ll explore each of these requirements below.

What Is a Tax Home—and How Is It Determined for Digital Nomads?

The IRS defines your tax home as your main place of business, employment, or post of duty, regardless of where you maintain a home. Typically, this is the place where you are permanently or indefinitely engaged to work either as an employee or self-employed individual.

In the case of a digital nomad, it’s likely that there is no single, main place of work. So, what does that mean? In situations where you do not have a single place of business, your tax home may be where you regularly live.

What if there is neither a single place of business nor a single place of residence? In that case, the IRS considers you an itinerant, and your tax home is wherever you work.

Therefore, if you find yourself living in multiple foreign countries over the course of the year with no single, main place of residence or work, then you will likely have multiple tax homes for the year.

Keep in mind that merely having multiple tax homes in several foreign countries over the year does not automatically qualify you for the FEIE. You still must meet either the bona fide residence or physical presence test for the year.

How Do I Qualify Under the Bona Fide Residence Test?

In order for a digital nomad to qualify for the bona fide residence test, you must establish that you have been a bona fide resident of a foreign country (or countries) for an uninterrupted period that includes an entire tax year (i.e., January 1 – December 31 for those that file on the calendar year basis) – as well as meeting some other requirements (which we’ll talk about in a minute).

You are allowed brief or temporary trips to the US and other countries for vacation or business, but you must have a clear intention of returning from those trips.

However, you are not automatically considered a bona fide resident of a foreign country solely by living in a foreign country (or countries) for more than one year. Other factors are considered, like the intent and nature of your assignment or stay abroad.

For instance, have you set up a residence? Joined local groups or organizations? The more established you are in your host country, the more likey the IRS will consider you a bona fide resident – but it’s not always straightforward.

The IRS determines qualification for the bona fide residence test on a case-by-case basis. Because the number of days abroad is only a piece of the equation, it can difficult for digital nomads to use this test to qualify for tax savings through the FEIE. When in doubt, it’s best to consult an accountant to help make your case.

How Do I Qualify Under the Physical Presence Test?

The other option for digital nomads hoping to qualify for the FEIE is the physical presence test. Unlike the bona fide residence test, the physical presence test is based solely on the number of days you are physically present in a foreign country or countries over the course of the year.

There is no requirement to establish a bona fide residence under this test, which may be preferable for travel-loving digital nomads.

In order to meet the physical presence test, you must spend 330 days in a foreign country or countries during a 365-day period beginning or ending during the tax year (it does not need to be within a calendar year). In other words, you must spend no more than 35 days in the US during the 365-day period.

As a digital nomad, you are more likely to meet the physical presence test since it’s unlikely you will establish a true bona fide residence in any one country.

What If I Do Not Qualify for the Foreign Earned Income Exclusion? 

In the case that a digital nomad does not qualify for those exclusions or earns income in excess of the maximum exclusion amount, you can offset US income taxes by utilizing a Foreign Tax Credit on your return.

In this case, you will need to have paid income tax to a foreign jurisdiction on your earnings.

Greenback Simplifies Taxes for Digital Nomads

Even when you know your requirements, it can be time-consuming and stressful to prepare your digital nomad taxes yourself. If you’d prefer to get back to your adventure abroad, leave your taxes in the hands of the experts.

Experienced expat accountants ensures accuracy and helps you secure the highest possible savings, giving you peace of mind and extra money for your travels. Get started with Greenback today to meet your dedicated accountant.

Want to know how becoming a digital nomad will impact your taxes? Book a consultation with one of our expat accountants to get the advice you need.

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