Digital Nomad Tax Guide for 2023

Digital Nomads Need to Pay Taxes

One misconception as a digital nomad is that you are not required to pay taxes. However, if your income exceeds the minimum filing requirement, you will need to submit your U.S. tax return. This is due to the U.S. tax system being based on citizenship rather than residency. Even if you do not earn any income in the U.S., you still have to file. The types of income that must be declared include wages, interest, dividends, and rental income. Digital nomads commonly need to complete various tax forms such as:

• 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 should not be confused with having to pay taxes. You might not have to pay any U.S. taxes based on your individual situation. This is possible because digital nomads can utilize two important tax advantages, namely the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC), to 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.

Managing Income and Deductions

Tax planning for a U.S. citizen residing overseas is generally similar to tax planning for someone residing in the United States, with the exception of the reporting requirement for foreign accounts and gifts. Nonetheless, there are specific aspects that warrant careful consideration.

The foreign earned income exclusion allows U.S. citizens to exclude their foreign earned income from taxation. This exclusion applies if they are a bona fide resident of another country or countries for the entire tax year or for 330 days during a 12-month consecutive period. It is important to note that income can still be considered foreign earned even if their employer is in the United States and funds are deposited in a U.S. account. The determining factors for this exclusion are the location where services are provided and the tax home being in another country. Starting in 2023, there is a limit of $120,000 for the exclusion. Additionally, taxpayers are not eligible to claim deductions related to the income they exclude.

If you lived in India for the entire year 2022 and earned $100,000 for working for your company in San Francisco, you can exclude the entire amount from your taxable income in the U.S. You have the option to seek a refund for any tax that was withheld from your salary. Another option is to inform your employer to stop withholding using IRS Form 673. The exclusion does not apply to income that is not earned, such as income you receive from a business independent of your services. However, there is also an exclusion for housing provided by your employer.

The exclusion remains in effect once it is elected until it is revoked. However, if you do revoke it within five years of the election, you will need to seek IRS approval to reinstate it. It is preferable to have an understanding of your future income and residency when making the exclusion election. This can be challenging for a nomad who leads a more transient lifestyle, but it is important to make the effort to prevent any unintended tax consequences.

Expense records are important for clients to keep, especially when it comes to deductible expenses. However, maintaining these records may be challenging in a foreign country that has different cultural practices. In such cases, clients may have to pay for certain business expenses in cash or with vendors who do not provide receipts that they are familiar with. Moreover, if clients do have receipts, they are likely to be in other languages and currencies. It is important for clients to understand that they cannot expect to claim deductions for payments that are not backed up by proper records. Instead, they should put in extra effort to keep track of all expenses and accurately report them for taxes.

Even if they are living overseas and have extra money, clients should continue to save for retirement in a U.S. retirement plan. Self-employed individuals might want to think about opening a SEP IRA or solo 401(k). It is usually not any harder to handle the logistics of these plans when done from a foreign location. However, it is important to be aware that the income requirements and limitations must factor in any exclusions for foreign earned income.

If an individual has $100,000 of foreign earned income and chooses to exclude it, they will have no U.S. income available to contribute to a plan. On the other hand, if they have $140,000 of income, the exclusion will only apply to $120,000 of income in 2023. Thus, $20,000 will remain, and most or all of it may be contributed to a U.S. retirement plan to eliminate their U.S. income.

Retirees who are constantly traveling may have a simpler financial situation due to not having any earned income to handle. However, they, along with those who are still working, have the ability to strategically time their income and deductions in order to maximize their tax benefits each year. This usually includes deferring income or speeding up deductions. It may also involve actions such as Roth conversions, installment sales, and tax loss harvesting. These strategies remain the same even when living abroad. However, nomadic individuals should assess the timing of their income and deductions according to the local tax regulations and any changes that may occur when moving between different jurisdictions that impose taxes.

If a retiree is planning to travel abroad for a long time, they may need to think carefully about whether to delay the income from selling their property, based on how it will affect their international situation in the future. Likewise, they should assess how their spending habits between their taxable brokerage account, tax-deferred 401(k), and tax-free Roth IRA will align with their overall international tax situation to achieve the best outcome.