Even if you have reached the point where you can freely travel and work remotely around the world, there is still a topic that most individuals dislike discussing or considering: taxes. Regardless of whether you are a permanent expatriate, a full-time nomad, or someone who occasionally works while on vacation, all American citizens are required to report their income to the IRS on an annual basis. Failing to fulfill this obligation, regardless of the duration of your absence, could result in significant problems.
Before tax season comes along, there are certain things that all American digital nomads should be aware of. If you don’t take the time to file correctly, Uncle Sam may come knocking on your door and you could face steep fines or even lose your passport. Therefore, Nurall advises consulting with an advisor before making any major moves.
Digital Nomad Taxes
Many foreign countries provide Digital Nomad Visas for US Taxpayers and foreign nationals who desire to spend a period in a specific foreign country without aiming for permanent residence or citizenship. The Digital Nomad Visa, in contrast to other visa types, mainly necessitates that the taxpayer earns a particular amount of money that is sufficient to not rely on resources allocated for the country’s residents and citizens. When a US Person possesses a Digital Nomad Visa, one of the more intricate aspects is related to US taxation, as the person technically remains a US individual and remains accountable to US tax regulations and foreign account reporting, even if they reside overseas. Let’s explore some fundamental aspects of the tax consequences of being a digital nomad.
Worldwide Income
The United States Tax System distinguishes itself by following a Citizenship-Based Taxation model. This means that unlike many other countries, the United States taxes individuals on their worldwide income solely based on their US Person status, rather than where they reside. It is worth noting that the term “citizenship-based taxation” is somewhat misleading since individuals who are both US Citizens or Residents of the United States can still be considered to have the United States as their tax home.
Digital Nomads Need to Pay Taxes
One misconception that many digital nomads have is that they are exempt from paying taxes. However, if their income exceeds the minimum requirement for filing, they are required to submit a tax return to the U.S. government. This obligation exists regardless of whether they earn income in the U.S. or not, as the U.S. tax system is based on citizenship rather than residency. In addition to wages, income that needs to be declared includes interest, dividends, and rental income. Digital nomads commonly have to complete various tax forms.
- Form 1040: This is the form that all Americans use to report their income to the IRS
- FBAR (FinCEN Form 114): The Foreign Bank Account Report is used to report any money or assets held in a foreign institution or bank to the U.S. Treasury.
- Foreign Earned Income Exclusion Form 2555: One of the ways digital nomads can avoid being double-taxed.
- Foreign Tax Credit Form 1116: Another form that digital nomads can use to lower their U.S. tax bill.
- FATCA Form 8938: This is used to report certain financial assets to the IRS.
- Form 5471, 8621, and 3520: These are forms used to declare returns from shares in a foreign company, or transactions in foreign trusts.
Tax Benefits for Digital Nomads
Filing your taxes and paying taxes are not equivalent. If your individual situation permits, it is possible that you won’t owe any U.S. taxes. This is achievable for digital nomads due to two important tax advantages known as the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC), which help prevent double taxation.
- The Foreign Earned Income Exclusion (FEIE) excludes a certain amount of foreign earned income from your U.S. taxes, lowering or even eliminating your tax bill. The amount is adjusted each year for inflation. For the 2022 tax year, the amount is $112,000. In order to qualify for this exclusion, you must be a bona fide resident of another country, or physically present in a foreign country or countries for at least 330 full days out of the year.
- The Foreign Tax Credit (FTC) allows you to reduce your U.S. tax bill if you pay taxes in another country. This credit gives you a dollar-for-dollar reduction.
Tracking Your Time Abroad
To receive these tax benefits, it is necessary to spend a certain amount of time on foreign land. The Internal Revenue Service (IRS) considers a day spent on foreign soil as a complete 24 hours starting and ending at midnight, excluding the time spent traveling over international waters. If you fall short by an hour or two, you might not be eligible for the Foreign Earned Income Exclusion or Foreign Tax Credit. This could result in a larger U.S. tax payment than expected. As a digital nomad, keeping track of your travel hours is crucial to ensure that you continue to meet the requirements for tax benefits.
Foreign Bank Accounts
If you are residing overseas, it might be necessary for you to complete additional documentation apart from your U.S. tax forms. In the event that you possess a bank account in a foreign country (including digital accounts) and the total amount reaches above $10,000 at any point throughout the tax year, it could be required of you to fill out the Foreign Bank Account Report (FBAR), which is submitted to the US Treasury department. Should you possess foreign assets that surpass $300,000, it will be necessary for you to complete FATCA Form 8938.
Filing Taxes in Another Country
If you live in a country for a certain period of time or earn a certain amount of money, you may have to file taxes in that country along with the United States. Each country has its own tax obligations. Greece and Portugal, for example, offer digital nomad visas that can reduce your tax bill. Other countries in Asia and South America have different tax rates and reporting requirements. If you plan to be a digital nomad and travel globally, it is important to research before spending a significant amount of time in any other country. Avoiding an unexpected tax bill is crucial.
Social Security Tax
If you are a freelancer or have your own business, you may still be required to pay U.S. self-employment tax on any income earned from foreign sources. This requirement remains in effect even if you qualify for the Foreign Earned Income Exclusion. However, there are exceptions for countries that have tax treaties with the U.S., which are called Social Security Totalization Agreements. These agreements aim to prevent freelancers from being subject to social security taxes in both countries. However, digital nomads who frequently relocate may be liable to pay social security tax, particularly if they are not considered tax residents in another country. Navigating these tax agreements can be complex, so Nurall suggests seeking advice from a tax professional prior to filing your taxes.