If you have sworn off the nine-to-five “lifestyle” and are making your living while traveling across the US and abroad, it is important not to forget that you still must pay taxes – almost certainly in the US and possibly abroad. Here, international attorney Jiah Kim answers some frequently asked questions and provides tips for reporting your income and paying taxes as an American digital nomad.
As a digital nomad, you work to support your lifestyle. You do what you love, and gone are the days of spending long hours boxed in (literally) while you accumulate vacation hours and count the minutes until you can go home. You do what you want when you want. While it still takes work, you ultimately have the freedom that most people spend a lifetime trying to achieve.
Of course, there are still some limitations. Being a digital nomad takes discipline, and your whims are often subject to immigrations controls and airline schedules. Then, there are the inescapable US tax laws. As an American citizen living abroad, it is important not to forget that you still owe certain obligations to the Internal Revenue Service (IRS).
FAQs: Paying Taxes as an American Digital Nomad
Do I have to report income I earn overseas to the IRS?
Most likely, yes. As a United States citizen, you are subject to US tax on any income you earn worldwide. While the amount of tax you owe will depend on the amount you earn, the deductions you can take, and the entity structure (if any) you have in place, as a baseline you must report your income to the IRS. Failure to report your income, even if you do not actually owe any tax, can lead to audits and headaches that you will generally want to avoid.
Of course, as with all tax-related matters, there are certain exceptions, and anyone working overseas should consult with a tax attorney before making any decisions about reporting income or paying taxes to the IRS.
Do I qualify for the foreign earned income exclusion (FEIE)?
Maybe. The foreign earned income exclusion (FEIE) is an IRS rule that allows US citizens living abroad to exclude slightly over $100,000 (for the 2016 tax year – this number is adjusted annually for inflation) of their foreign earnings from their US-taxable income. In order to qualify for the FEIE as a US citizen, you must either:
- Be a bona fide resident of one or more foreign countries for the entire tax year; or
- Be physically present in one or more foreign countries for at least 330 full days during any period of 12 consecutive months.
Importantly, while the FEIE can reduce your income tax liability, it does not reduce your self-employment tax. This is the 15.3 percent tax you must pay for social security and Medicare.
Do I have to pay income tax in the country (or countries) where I lived and worked during the year?
It depends. Some countries that are popular destinations for digital nomads do not have an income tax. These include:
- Bahamas
- Bermuda
- Cayman Islands
- Monaco
- Qatar
- United Arab Emirates (UAE)
If you lived and worked in a country that has an income tax, in most cases, the question of whether you owe tax there will hinge on whether you qualify as a “resident.” Generally speaking, establishing residence requires physical presence for six months or longer. Of course, each country’s tax laws are unique, and you will need to seek advice on the laws that apply to your personal circumstances.
Does it matter which state is considered my “domicile” in the US?
Yes, absolutely. Residents of most US states must pay state and local income taxes in addition to paying taxes to the IRS. Here, too, the laws vary from one jurisdiction to the next. While it can be somewhat time-consuming and expensive to do so, if you are not currently considered a resident of a state with no income tax, it may be worth considering whether you should relocate your US residence to limit your tax liability while you travel abroad.
The US states that do not have an earned income tax are:
- Alaska
- Florida
- Nevada
- New Hampshire (tax on investment income only)
- South Dakota
- Tennessee (tax on investment income only)
- Texas
- Washington
- Wyoming
While you generally only need to pay state tax if you earned income while “domiciled” in the state, some states (like California) make it difficult to prove that you do not owe them tax. As a result, this is another area where planning ahead can pay significant dividends when it comes to simplifying your reporting obligations and reducing your overall tax liability.
Should I establish an offshore company and receive a salary as an employee?
Maybe. Despite what you will read on some other websites, the answer to this question is not as straightforward as it may seem. For one, while establishing an offshore company can defer your tax liability, it does not result in complete tax avoidance. There are also costs and administrative burdens involved in establishing and maintaining an offshore company – and then there are the questions of:
- What type of entity should you form?
- In which country should you form your company?
Forming a foreign company can have estate planning and asset protection implications as well. So, while it may be your best option for tax purposes, you should not form an offshore entity until you have carefully assessed all of the relevant considerations involved.
What if I haven’t been reporting my income to the IRS?
If you have been living and working abroad and haven’t been reporting your income or paying taxes to the IRS, you cannot simply avoid the issue. The longer you wait, the worse your situation could become. The IRS offers streamlined filing and compliance procedures as a type of amnesty program for US citizens who have not reported their foreign-earned income, and following these procedures can reduce or eliminate the otherwise-applicable penalties for those who qualify.
7 Tax Tips for American Digital Nomads
Here are some of my top tips for limiting your income tax liability and ensuring that you satisfy your tax filing and payment obligations as an American digital nomad:
- Have a plan that takes the tax implications of your travels and lifestyle into consideration.
- Choose travel destinations based, in part, on their income tax regimes.
- Take advantage of the FEIE and any other exclusions or deductions that may apply to your work as a digital nomad.
- Seek help from a tax lawyer and accountant who have specific experience with foreign-earned income issues.
- Make an informed decision about whether to form an offshore company.
- Develop an asset protection plan that can help protect your earned income and investments.
- Don’t ignore your tax obligations. They will catch up to you eventually.
Speak with an International Tax Lawyer at Jiah Kim & Associates
If you would like personalized guidance on tax planning as an American digital nomad, contact Jiah Kim & Associates for a confidential initial consultation. We represent clients in tax planning, estate planning, asset protection planning, and business-related legal matters worldwide. To schedule an appointment at your convenience, call us at (646) 389-5065 or get on our calendar today.
This blog post is written for educational and general information purposes only, and does not constitute specific legal advice. You understand that there is no attorney-client relationship between you and the blog publisher. This blog should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.