Millions of Americans have struck out for new opportunities in both the virtual world and the real world beyond US borders. Thinking about joining them?
Here’s a primer on the tax and financial aspects of the digital nomad lifestyle.
US Tax Basics
Let’s start at the beginning: as a US citizen or green card holder, you’re subject to US tax on your worldwide income. This is true even if
- you live outside the US,
- your business has nothing to do with the US,
- you never set foot in the US,
- all of your assets are outside the US,
- etc. etc., you get the picture.
As a digital nomad, you still need to think about US tax, and you still need to file a US tax return each year in which you have income over the minimum filing requirement.
However, as a digital nomad, you can often drastically reduce or even eliminate your US tax bill by using the foreign earned income exclusion (the “FEIE”). The FEIE allows you to pay zero US income tax on about $100,000 each year of “foreign earned income,” which is basically income you earn from providing personal services while you live outside the US. You can even use the FEIE to avoid US tax on income from a business you own, but the FEIE works best here only if you have the right legal structure in place (as discussed further below).
To qualify for the FEIE, you must pass the “physical presence test.” This test requires you to spend at least 330 days outside the US in any 12-month period. Counting days is important, and there are some details to pay attention to (e.g., a day spent travelling to or from the US is counted as a day in the US). Keeping careful track of each day you spend in or travelling to/from the US can save you a ton in tax at the end of the year.
Now, if you decide to settle down in one country, you could also qualify for the FEIE by passing the “bona fide residence test.” This test is subjective and looks at all the facts and circumstances to determine if you have really settled down for the indefinite future in one country. The benefit of meeting this test is that you can spend more time in the US than you can by using the physical presence test.
Additionally, the IRS imposes several disclosure requirements for assets held outside the US. For example, you’re required to file the Foreign Bank Account Report if you have more than $10,000 in non-US bank accounts, and you must include a special disclosure form with your US tax return each year that you own a non-US company. There’s no reason to be discouraged by this disclosure or to drastically alter your life to avoid it—the IRS just wants some paperwork when certain events occur, and it’s easy enough to simply prepare the paperwork.
State Tax Basics
State tax is typically not a big worry for digital nomads. A state can only impose tax on those with a “domicile” in that state. A person who leaves a state and does not have a clear and definite intention to return is not domiciled in that state anymore—so, the state can no longer impose tax on such person. Also, income for state tax purposes typically starts with income for federal tax purposes. So, if you can eliminate all of your US tax by using the FEIE (as discussed above), then you’ve typically eliminated all potential state tax burden as well.
However, there are more issues to consider for people leaving states (such as California and Virginia) that are notorious for trying to maintain taxing jurisdiction over their ex-residents. Also, California is even worse because it doesn’t recognize the FEIE. Some people leaving these states establish a domicile in a different state before making the final leap outside the US; whether this is a good idea for you depends on your facts and your willingness to spend time and money switching states before moving out of the US.
Non-US Tax Basics
See this article for more details. The local tax rules obviously vary depending on where exactly your journey takes you.
However, here are a couple of guidelines to keep in mind:
- you won’t be subject to income tax in most countries as long as you don’t become a resident of that country (as the term “resident” is defined under that country’s tax laws), and
- even if you do become a resident, some countries only tax income earned in that country.
It’s fairly common for countries to treat someone as a resident for tax purposes only if they stay for at least 6 months. So, simply don’t stay in any country longer than six months per year and you should generally not be subject to non-US income tax. Now, obviously this is only a general rule of thumb-each country will have its own rules here.
Finally, one way to further insulate yourself from tax concerns in your local jurisdiction is to make sure your assets are kept out of that jurisdiction to the extent possible. You can potentially do this by holding your assets in an offshore company.
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Structuring your Business
See this article for more detail. The short version: you may qualify to hold your business through a non-US corporation, which provides massive US tax benefits. By using this structure, you can pay zero US tax on the first $100,000 of salary your company pays you.
Moving Money Around
Operating a business from outside the US often requires more conscious thought about payment structures for both your business and your life. While living in the US, you most likely only dealt with US dollars in your business and personal life, and it is very easy to convert money from one form to another and transfer funds from one account to another. Things aren’t always so easy beyond US borders.
The best payment structure is often to largely keep doing business banking in the US but to move it underneath your offshore company. Banking in the US is easy and cheap, and services like PayPal integrate well with US bank accounts; neither of these is generally true with non-US banks.
Simply banking in the US will not cause your offshore company to be subject to US tax or cause you to not qualify for the benefits of this structure as described above.
Also, I get a lot of questions about the US tax aspects of moving money around. People often ask whether it’s better to get paid onshore or offshore, or whether amounts paid in a US account can still qualify as foreign earned income.
In general, the US tax aspects of a transaction depend on the substance of the transaction, and it doesn’t matter whether the currency involved is US dollars or something else, or the money is held in or moves to the US or somewhere else.
So, money you earn while working outside the US is foreign earned income even if you get paid in a US bank account, and simply moving your own money from a non-US account to a US account (or vice versa) has no tax consequences (you are just moving it from one of your pockets to another).
Now, when you operate through a non-US company, you want to make sure to observe all corporate formalities and be able to clearly demonstrate when funds have moved from the company to you, and those movements have tax consequences. But, other than that, your money is your money, and you can put it wherever you’d like.
A US address is almost a necessity, even if just for a zip code to tie your US credit card to (and you will definitely want to hang on to a US credit card for online purchases). If you can’t or don’t want to use a friend’s or relative’s address, there are several services that will scan and email incoming mail and then store the paper mail for you. Many of these services can even deposit checks you receive in the mail.
Also, many digital nomads aren’t sure what address to put on their US tax return. There’s really no magic here, just put any address that’s useful for you. An address on a US tax return just tells the IRS “I will receive mail you send here”—you aren’t representing that you reside at that address. You can still use the FEIE with a US address on your return—the FEIE form itself covers this situation by asking for your non-US address if it’s different than on the main part of your return.
One caveat here-if you’re leaving California or Virginia, don’t put an address in that state on your US tax return. They’ll likely contact you to ask why you aren’t filing a state tax return anymore (and you can bet that’s a fun conversation).
No One-Size-Fits-All Solution
The basics of the lifestyle (operating a business through an offshore company and bouncing around to avoid non-US tax) are fairly similar across most digital nomads, but of course differences in goals and preferences shape the solutions crafted by each individual. The enormity of putting it all together can be intimidating at first, but facing those sorts of challenges is part and parcel of the digital nomad experience.
The solution that works best for you is out there waiting for you to discover it. Get in touch if you’d like to discuss.
Want to know more? The Tax-Savvy Expat courses teach you everything you need to know about expat tax.