In this world of endless connectivity and worldwide telecommuting, the “digital nomad” has become an increasingly popular way of living and working. Being a digital nomad allows you to free yourself to live anywhere in the world while still earning a living. While this type of freedom allows you endless opportunities to expand your horizons, a lifestyle few can even consider, there are still some important US expat tax implications you have to understand if you are a US citizen or permanent resident.
Does All Income Need to be Reported on My US Taxes?
US Citizens and permanent residents (US persons) are subject to tax on their worldwide income. All income, from all sources, must be reported to the IRS on a taxpayer’s yearly income tax return. It does not matter if the income was earned outside the USA, or if all the taxpayer’s assets are held in a foreign country, by virtue of being a US person you are subject to US tax law.
Now that we’ve established that, let’s discuss the matter of mitigating those taxes. There are provisions in the US tax code to help expats and digital nomads with lowering their US tax obligations. The tax breaks you are eligible for depend upon your travels and your intentions on returning or not returning to the USA.
Can I Qualify for US Tax Breaks?
The largest tax break you may find is the foreign earned income exclusion (FEIE). This exclusion allows for up to $100,800 (for 2015) of your earned (wages) income to be excluded from taxation. This means if your income is less than $100,800 and you qualify for the full FEIE, then you will have no income taxes due to the IRS. This exclusion also allows for an added housing deduction, using the expenses you pay for rent and utilities on your foreign housing. To qualify for the FEIE, you have 2 options:
1) The Physical Presence Test
You need to be physically present in a foreign country (it can be multiple countries) for at least 330 days within a 365 day window that begins or ends in the tax year, but does not have to be a calendar year. This is your qualifying period. Once you establish your qualifying period, you count the number of days within the actual tax year to figure out what portion of the FEIE you qualify for. This test is very strict when it comes to counting days, so you should be careful with your calendars/planning. One day off, and you don’t qualify for any of the FEIE. When considering multiple tax years, you can use different “qualifying periods” in order to figure your FEIE for each year.
2) The Bona Fide Resident test
If you are a bona fide resident of a foreign country you qualify for the FEIE for the portion of the year you qualify as a bona fide resident. Being a bona fide resident comes on a case by case basis and it depends upon your personal set of circumstances. The IRS looks at the nature of your stay while abroad. They ask questions like “Do you intend to return to the USA to live in the foreseeable future?”, “Have you integrated yourself into society?”, “Have you made any statements or declarations to the foreign government that you are not subject to their taxes or laws?”. You can change your country of residence for the bona fide test, but you must establish yourself as a bona fide resident in each country you move to.
Claiming the FEIE, while using the Bona Fide Resident test, is the ideal way to go when talking about being a digital nomad. You are able to exclude income from taxation without having to closely count your days during travel back to the USA.
Foreign Tax Credit
You can also avoid US taxation on your income by using the foreign tax credit (FTC). This credit is a dollar for dollar reduction in your US taxes, using the taxes you have paid to your resident country. This tax credit keeps you from being taxed twice on your income.
Which Digital Nomad Are You?
There are several situations where you may find yourself in. Here are some examples of how your taxes can be affected by your different living situations.
1) You are living outside the USA, traveling and living in various countries as your mood strikes you. You earn a living telecommuting with a finance job that pays you through a US bank account. You return to the USA during the holidays and once for a friend’s wedding. The total number of days you spent in the USA is 26 during the calendar year and you did not earn any income while in the USA. The total amount of your income is $99,500.
You will qualify for the foreign earned income exclusion using the physical presence test. Since you did not live in any one foreign country to establish yourself as a bona fide resident, you will not qualify using that test. You lived outside the USA for more than 330 days, which qualifies you for the physical presence test. Your entire salary will be excluded from taxation using the foreign earned income exclusion. You will still need to file a tax return to report your income and notify the IRS of your qualifications to take the FEIE.
2) You live in the United States but frequently travel outside the USA for work and pleasure. You generally travel for 2-4 weeks at a time, but always return to the USA when your trip is completed. The total number of days you traveled outside the USA during the year was 102. You earn $125,000 in salary during the year, and you pay $4,000 in foreign taxed to Germany on the income earned there during the year.
You will not qualify for the FEIE, as you were not outside the USA for 330 days, and you do not qualify for the bona fide resident test since you return to the USA each time your travels are complete. You would figure your income on the tax return as normal, but you will be able to take a tax credit using the foreign taxes you paid to Germany.
3) You live in China and telecommute to a job in the USA. You have been living in China for 13 months, but decide to move to Thailand to live because you love the food. You earn $150,000 per year, and it all gets deposited to a bank account in the USA. You travel to the USA for business and pleasure for a total of 50 days during the tax year.
You will qualify for the FEIE as a bona fide resident. You will be able to exclude $100,800 of your income on your US tax return. The remaining income will be reduced by your deductions and exemptions, and then taxed. You may qualify to take an additional FEIE deduction using your housing expenses.
Foreign Account Tax Compliance Act
There is another major consideration you will need to consider if you are working and living overseas. The US government requires reporting of interests in foreign bank accounts/financial assets if the balance of the accounts goes over certain thresholds. The US Treasury has implemented FATCA (Foreign Account Tax Compliance Act) regulations, which require you to file form 8938 with your US tax return. The filing thresholds are based on whether or not you live outside the USA.
|Form 8938 Reporting Thresholds|
|US Person Living In the USA|
|Filing Status||End of Year Balance||Highest Balance During the Year|
|Single / Head of Household||$ 50,000||$ 75,000|
|Married Filing Jointly||$ 100,000||$ 150,000|
|Married Filing Separately||$ 50,000||$ 75,000|
|US Person Living Outside the USA|
|Filing Status||End of Year Balance||Highest Balance During the Year|
|Single / Head of Household||$ 200,000||$ 300,000|
|Married Filing Jointly||$ 400,000||$ 600,000|
|Married Filing Separately||$ 200,000||$ 300,000|
You are also required to file FinCEN form 114 (also known as the FBAR) if you have foreign bank account(s) with an aggregate balance of $10,000 or more. This form is filed separately from your tax return and is required whether or not you live in the USA.
Want more information on US expat tax?
Our experts are here to help! Simply contact us today and we will be in touch within one business day.