Federal and state taxes can be a complex and often times a confusing topic, especially for digital nomads and expat business owners who live abroad yet want stay in good graces of the United States. Digital nomads often face unique tax situations that require very specialized knowledge and expertise to navigate. Understanding the key differences between U.S. federal and state tax codes as well as the tax laws that apply specifically to digital nomads and expat business owners, is crucial for avoiding costly mistakes while ensuring compliance with all current tax regulations.
A Digital Nomads Income: A Tangled Tax Web
For digital nomads and expat business owners, managing their tax obligations can be particularly challenging. These individuals may earn income from a variety of sources, including clients and customers in different countries, which can complicate tax reporting and compliance. Additionally, they may be subject to different tax laws and regulations depending on their country of residence and the countries in which they do business. As a result, it is important for digital nomads and expat business owners to work with licensed tax professionals who have experience in these areas and can provide guidance on navigating the complexities of federal and state taxes.
When it comes to federal and state taxes, there are many factors to consider, including income tax rates, time spend broad, deductions, credits, and filing requirements. For digital nomads and expat business owners, it’s important to understand how these key factors apply to their unique situations in order to minimize their tax liability while avoiding any potential penalties. By working with experienced tax professionals, digital nomads and expats can ensure that they are meeting their tax obligations while maximizing their legal deductions to help insure the least amount of tax liability.
Understanding Federal and State Taxes for Digital Nomads
Tax Liability and Avoiding Double Taxation
As a digital nomad or expat, it’s important to understand your tax liability. The United States has a citizenship-based tax system which means that all U.S. citizens and green card holders are required to file U.S. taxes, regardless of where they live or earn their income.
As you may already know, the IRS is responsible for administering and enforcing the U.S. tax code upon those that consider the U.S. their home. The tax rate for U.S. citizens and green card holders varies depending on their income and filing status. Failure to file taxes or pay taxes on time can result in penalties and fines and can also impact one’s U.S. citizenship status.
Digital nomads and expats who earn income from a foreign source may be eligible for tax benefits such as the Foreign Earned Income Exclusion (FEIE) (more on this later) and Foreign Tax Credit (FTC). These tax benefits can help Digital Nomads reduce tax liability while avoiding double taxation. After all, no one wants to be taxed twice. That just wouldn’t be American.
Tax Benefits and Tax Deductions
There are several tax benefits available to digital nomads and expats. The combination of tax breaks and tax deductions can help reduce taxable income and lower tax liability. Some common and very basic tax benefits often include:
- Home office deduction: Digital nomads who work from home may be eligible for a home office deduction which allows them to deduct a portion of their rent or mortgage, utilities, and other expenses from their gross profits.
- Business expenses: Digital nomads who operate a business may be able to deduct business expenses such as travel, equipment, and marketing costs.
- Retirement savings: Digital nomads who earn income from self-employment may be eligible to contribute to a Simplified Employee Pension (SEP) or Solo 401(k) plan which can help reduce taxable income today while saving for retirement.
Expat and Digital Nomad Taxation
As we stated earlier, it’s vitally important to understand the tax laws and regulations in both the United States and the country of your residence to avoid penalties and a major tax headache. And trust me, tax international headaches are to be avoided as they are never resolved by simply taking two Tylenol that have you feeling much better 20 minutes later. international tax problems, especially with the IRS, can linger and get quite expensive fast.
Foreign Earned Income Exclusion
One of the most significant tax benefits for expats and digital nomads is the Foreign Earned Income Exclusion or FEIE. This exclusion allows eligible taxpayers to exclude up to about $100,000+ of foreign earned income from their US tax return.
To qualify for the FEIE, taxpayers must meet the criteria of either the Physical Presence Test or the Bona Fide Residence Test to qualify.
Physical Presence Test
To meet the Physical Presence Test, the taxpayer must be physically present in a foreign country for at least 330 full days during a 12-month period. It’s worth noting that this 12-month period does not have to coincide with the calendar year.
Bona Fide Residence Test
To meet the Bona Fide Residence Test, the taxpayer must establish residence in a foreign country. This means that the taxpayer must have a permanent home in the foreign country and intend to reside there indefinitely.
It is important to note that meeting either the Physical Presence Test or the Bona Fide Residence Test does not automatically qualify the taxpayer for the FEIE. The taxpayer must also have foreign earned income and meet a few other requirements too.
Self-Employment and Business Taxes
Self-employed individuals and business owners are responsible for paying taxes that your standard everyday employee does not have to worry about. These taxes include Social Security and Medicare taxes, which are mandatory for most self-employed individuals.
Social Security and Medicare: A Must Paid Tax
Self-employed individuals are required to pay both the employer and employee portions of Social Security and Medicare taxes. The current rate for Social Security tax is 12.4%, and the rate for Medicare tax is 2.9%. This means that self-employed individuals must pay a total of 15.3% of their income in Social Security and Medicare taxes on their personal income.
Avoid Double Taxation: Totalization Agreements to the Rescue
Totalization agreements are agreements between the United States and certain foreign countries that eliminate dual Social Security taxes for individuals who work in both countries. These agreements help ensure that individuals are not paying Social Security taxes in both countries for the same income.
Self-employed digital nomads who work in multiple countries may benefit from totalization agreements. It is important to note that not all countries have totalization agreements with the United States, so it is important to check if a totalization agreement exists with the countries in which you are considering working.
Filing Taxes as a US Citizen Abroad
As you can see, filing taxes as a US citizen living in a foreign country can be a complicated process. It’s critical to understand the key tax forms, ever changing requirements, as well as the Foreign Account Compliance Act (FATCA).
Forms and Requirements
US citizens living abroad are required to file a US tax return annually, regardless of where they reside. The filing threshold for US citizens living abroad is the same as for those living in the US. The deadline for filing taxes is generally April 15th, but US citizens living abroad have an automatic extension until June 15th. However, any taxes owed must still be paid by April 15th to avoid penalties and interest.
US citizens living abroad may also need to file additional tax forms, such as the Foreign Bank Account Report (FBAR). This form must be filed if the total value of all foreign financial accounts exceeds $10,000 at any time during the year. Failure to file this form can result in significant penalties.
Foreign Account Compliance Act (FATCA)
The Foreign Account Compliance Act (FATCA) requires foreign financial institutions to report information about US account holders to the IRS. US citizens living abroad must comply with FATCA by reporting their foreign financial accounts on their US tax return.
US citizens living abroad must also meet residency requirements to claim certain tax benefits, such as the foreign earned income exclusion. To qualify for this exclusion, US citizens must have a tax home in a foreign country and meet either the bona fide residence test or the physical presence test.
State-Specific Tax Considerations
When it comes to state taxes, state-specific considerations are just as important as federal ones. Digital nomads and expats need to be aware of the different state tax laws that apply to them. Here are some state-specific tax considerations to keep in mind:
Residence-Based Taxation
Residence-based taxation is a tax system in which individuals are taxed based on their residency status. In other words, if you live in a certain state for a certain amount of time, you may be subject to state taxes. Each state has its own rules for determining residency status, so it’s important to check the rules for the state(s) you plan to live in.
For example, California has a “safe harbor” rule that says if you spend less than 45 days in the state, you are not considered a resident for tax purposes. On the other hand, New Mexico has a “presumption of residency” rule that states if you spend more than 185 days in the state, you are considered a resident for tax purposes.
Citizenship-Based Taxation
Citizenship-based taxation is a tax system where individuals are taxed based on their citizenship, regardless of where they live. In other words, if you are a U.S. citizen, you are subject to U.S. taxes no matter where you reside.
This can be especially important for digital nomads and expats who might live and work in different countries outside the U.S.. If you are a U.S. citizen and a green card holder, you are considered a resident alien and are subject to U.S. taxes on all of your income. If you are not a green card holder, but are still a U.S. citizen, you may be subject to U.S. taxes depending on your income and some other factors.
It’s important to note that some states have citizenship-based taxation too. For example, the state of Virginia taxes its residents based on their citizenship, regardless of where they choose to live.
Getting You Tax Help That Saves You Money
We offer international tax services to expats and digital nomads to help navigate these complex tax laws and regulations. Our services can provide assistance with tax preparation, compliance, and planning to help put you in the best possible financial position.
Be sure to contact us, with any of your international tax concerns and questions. We are here to help you.