Month: November 2023

Digital Nomads using the Foreign Earned Income Exclusion while traveling the world is an important benefit that shouldn’t be ignored.

As a Digital Nomad, you’re probably aware of the Foreign Earned Income Exclusion. Logically, if you aren’t living in the US why would you pay tax to the IRS?  Why would you pay tax to your home state?  With regards to making an income, when you are in the USA, the state you are in determines to whom you pay tax.

Unfortunately, it doesn’t work that way.  As a US citizen with income, you will be required to file a federal return. You may even need to file a state return!

With that said, it’s not all bad news.  While it stinks that you have to file a federal return, you can exclude up to $122,000 (in 2023) of income from being taxed on your federal return

Let’s learn about the Foreign Earned Income Exclusion AND the Foreign Housing Deduction saves money for Digital Nomads. Simply put, let’s save you a lot of money.

Understanding the Foreign Earned Income Exclusion (FEIE)**

Digital nomads need to have a clear understanding of the Federal Earned Income Exclusion to properly take advantage of its benefits.  Let’s take a deep dive into the FEIE and how it can help you.

This is what the Foreign Earned Income Exclusion is.

The Foreign Earned Income Exclusion is exactly what it sounds like. It’s the perfect tool for a Digital Nomad.  It allows you to EXCLUDE $122,000 (This is the 2023 amount which will index every year) from your tax calculations on your federal return.  Unfortunately, you will be liable for self-employment tax.  To report the FEIE and the Foreign Housing deduction, use IRS form 2555.

There are 2 ways to qualify as a US citizen.  They are:

• A US citizen or resident alien who is physically present in a foreign country (or countries) for at least 330 days of any 12-month period (must be consecutive months).  Time spent in Cuba (a violation of US travel restrictions) does not count towards the 330 days.
• A US citizen who is a bona fide resident of a foreign country (or countries) for an uninterrupted period that included an entire tax year.
• A third qualifier is only available if you are a US Resident alien who is also a citizen of a country with which the US has an income tax treaty in effect and who has been a bona fide resident of a foreign county (or countries) for an uninterrupted period that includes a full tax year.

How About the Foreign Housing Exclusion/Deduction?

You read that right.  Under certain circumstances you can write off, or exclude certain occupancy costs.  So how can you qualify for the Foreign Housing Exclusion!?

The first step is for the Digital Nomad to qualify for the Foreign Earned Income Exclusion.  To qualify for the Foreign Housing Exclusion, you must either:

• Be a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year, or;
• You must have been physically present in a foreign country for 330 or more full days over a twelve-month period.  This period can be over two tax years.
  • As an example, you moved to Mexico on Jun 1, 2022.  You can extend your return until the Oct 15 filing date next year and use 5 months in 2023 as your 12-month period.  This will give you 12 consecutive months to qualify, even though you were only in the country for 7 months of the tax year in question.

Once you pass one of these qualifications, the next step is to calculate a possible deduction.  To do this, you must know what expenses are allowed.  They are:

• Rent for an apartment, condo or house in a foreign country.
• All utilities paid except for phone and internet (you’ll take part on your Schedule C reporting yourself employment income).
• Renters insurance.
• Any leasing fees that may be charged.  One of the things I’ve noticed while researching foreign countries is that many of them treat foreigners differently and will be charged accordingly.  This means more.
• If you had to rent furniture, this is deductible.
• If you had to pay for parking by your residence, this would also qualify.
• Under certain circumstances, repairs made to the rental property are deductible.

If you’ve qualified for the FEIE as a Digital Nomad, your chances to qualify for the Foreign Housing deduction is good.

Once you’ve gathered all the info you’ll need, we can calculate your potential deduction.  Your location will determine the actual amount.  

After collecting all of your qualified housing expenses you must find the max allowed by the IRS based on your locale.  For example, Moscow in 2022 would have allowed a $107,000 housing deduction.  Barcelona would allow a $40,600 deduction.  These maxes are based on the actual cost of housing in that area, hence the differences.  If your locale isn’t located on the chart, your max will be $36,000 in 2023.

After collecting all of your information the actual calculation is simple.  The equation is:

(FEIE amount x 30%) – (FEIE amount x 16%) = Amount deductible.  

The annual limits change annually to index for inflation but the equation remains unchanged.

Using the above formula and assuming your max allowable is $36,000, you would be able to deduct in 2023:

($120,000 x 30%) – ($120,000 x 16%) = X

($36,000) – ($19,200) = $16,800

Your housing exclusion would be $16,800.  This is the full tax year deduction and is calculated using annual amounts.

The reason for the disparate limits could help if you are travelling and in different cities throughout the tax year.  In this case, you would calculate your housing exclusion using the daily limits.

Let’s do one where you spent 183 days in Bermuda and 182 days in Hua Hin Thailand.  Bermuda has a $246.58 daily rate.  Hua Hin has a default rate of $98.63.

Your calculation would be:

((246.58 x 183) + (98.63 x 182) – (120,000×16%) = X

(45,124.14 + 17,950.66) – (19,200) = X

(63,074.80) – (19,200) = 43,874.80

In this example your maximum housing deduction would be $43,875.  If you spent less than the max allowable, you would take that into consideration.  If your actual expense was $40k for Bermuda and $15k for Hua Hin, the amount paid is $55k which is less than the calculated amount.

Your allowable deduction would be 55,000 – 19,200 = 35,800.  $35,800 would be your allowable housing deduction.

You Qualify as a Digital Nomad for the FEIE.  Now what?

As mentioned earlier, you needed to keep not just good, but great records. Collect your records.  They should be:

• Full days spent in a country.  Travel days are considered US days. Driving from one country to another doesn’t count towards either country.  It is considered a USA day.
• As a Digital Nomad trying to qualify for the FEIE, you must keep a set of books.  This should include a balance sheet and profit and loss statement.
• You should be tracking your qualified housing expenses. Qualified expenses are:
  • Rent and utilities.
  • Renters insurance and leasing fees.
  • Rent paid for furniture and parking spots.
  • Repairs to the rental.
  • Purchasing a house or furniture does not qualify.
  • Lavish expenses do not qualify (like servants)

Once you have collected all the necessary records, you’re ready to get them to your tax preparer.  I would like a Zoom appointment to go over all your info and to answer questions you or the tax pro may have.

Potential Problems and Issues to Consider

The Foreign Earned Income Exclusion is an AWESOME tool that can save you $1,000’s in tax.  Even though, a Digital Nomad must be aware of potential problems, specifically tax treaty and social security totalization agreement implications.

A tax treaty is an agreement between the US and a foreign country as to the treatment of tax and income related items between the two countries.  Without a tax treaty with the US, you may be required to pay tax on the same income twice with no available foreign tax credit.

If there’ a social security totalization agreement in place between the US and the foreign country, then you won’t be required to make social security contributions on the same income to two countries.  Absent this agreement, you will be responsible for paying into two systems in two countries.  And since they aren’t income tax payments, they will not qualify for the foreign tax credit.

Now You Get to Mix and Match

Due to the complexity of the Foreign Earned income Exclusion and the Foreign Housing Deduction, plus the Foreign Tax Credit (based on any income tax paid to the foreign entity, I strongly advise you to hire a tax professional with experience in expat (and digital nomad) taxpayers.

With so many options available to help reduce your tax, you must make sure to only take what you qualify for.   As an example, you can’t take a foreign tax credit on income you excluded via the Foreign Earned Income Exclusion.

Depending on the complexity of your combined returns and any tax treaties and agreements between the country you are in and the US (federal, possible state and foreign country), there are tax issues you may or may not be party to.

A lot comes down to the treaty and/or agreement the US has with your foreign country.

Conclusion to Digital Nomads And the FEIE

If you are a Digital Nomad living in a foreign country you must learn about the Foreign Earned Income Exclusion, and the Foreign Housing Deduction.

The Foreign Earned Income Exclusion will reduce your federal income tax liability.  It does not reduce your self-employment tax.

The Foreign Housing deduction will generally allow a housing deduction of $16,800, but if you are living in a high-cost area such as Hong Kong, the allowable deduction could be as much as $95,100.

You should keep detailed records regarding full days at a specific location.  Travel days are considered days spent in the US (they give you 35 travel days per year).

There are two primary ways for a Digital Nomad qualify for the Foreign Earned Income Exclusion:

• If you live in a country for 365 uninterrupted days in a foreign country that includes a full tax year, then you are a Bona Fide resident and qualify.

• If you lived in a foreign country for 330 days in a 12 consecutive month period, then you also qualify. You can extend your filing date into the next tax year if you don’t have 12 consecutive months in the tax year in question.

You must be careful when utilizing these US benefits given to US citizens working in foreign countries. The ability to take advantage of these benefits is predicated on the tax treaties and the social security utilization agreements between the US and various foreign countries.

All in all, a layperson (which is what most Digital Nomads are) will have difficulty with the Foreign Earned Income Exclusion calculations and qualifications required.  I advise you to find a tax pro versed in expat taxation.

That’s it for today folks.  Thanks for everything and hot me up with questions if you have any.

Stay cool.

JKC

If you’re a digital nomad, crazy as it sounds, yes, they’re paying state taxes!  Or you’re supposed to and aren’t.  Either way you have a problem.  Let’s talk about what’s up with this

Generally speaking, states tax you on income earned within their borders.  Basically, if you work in California, you’ll also pay tax to California on the income earned in California.  Makes sense, right? So why would a Digital Nomad Pay State Tax?

But let’s remember, we’re discussing income taxes.  Making sense would be a bonus.  I like looking at taxation laws in much the same way a bank looks at things.

Just like a bank, the state is trying to maximize revenues while conforming to current laws.  The bank creates different fees for different “services”.  The obvious difference here is banks don’t write their own laws.

Because more and more people are becoming “Digital Nomads” and leaving their home state, there is a real risk to the states of losing a lot of tax revenue.  This article will dive into the state’s vision of taxing digital nomads.

So, What Exactly Is a Digital Nomad?

Simply put, a Digital Nomad is someone who works remotely as an expat, while living in another country.  For the purposes of all of my articles, I’m coming from the perspective of a US Citizen.

A Digital Nomad IS NOT a retiree or someone not working remotely or in their own business.  An Expat can be a Digital Nomad, but an Expat isn’t necessarily a Digital Nomad. On the flipside, an Digital Nomad is an Expat.

A Digital Nomad is someone who takes advantage of the beauty of this type of lifestyle.  The ability to fuse work and travel seamlessly.  However, a common theme for those who partake in this new adventure is the question of state taxes.

What States Don’t Have a State Income Tax?

I’m a fan of easy.  Let’s eliminate the states that don’t have income tax.  These states are:

• Alaska
• Florida
• Nevada
• New Hampshire
• South Dakota
• Tennessee
• Texas
• Washington
• Wyoming

Washington taxes capital gains on high earners and Texas taxes entities (corporations, LLC’s, partnerships…) with what it calls a Franchise tax.  It’s still a tax.  Along those same lines, Tennessee and New Hampshire will only tax you on interest and dividends.  You will most likely have no problems with these states.

So Which States Are Going to Give You Problems?

These states have residency issues which complicate matters.  Each state has its own definition of what a state resident is for tax purposes.  As ridiculous as it sounds, some states will claim your residency for you if they think you “may” return to the state one day.  These states are:

• California
• New York
• New Mexico
• Virgina
• South Carolina

Let’s talk about these states for a bit

California

The state of California will be difficult.  They have the discretion to tell you whether you are a resident or not.  Or whether your income is taxable in CA.

You read that right.

I had a client who lived in Oregon, but travelled to CA every month to take care of his father (he shared care with his sister).  Based on this the State of CA decided he was a resident since he had grown up in the area (duh.  He was taking care of his father).  All of his assets (including real estate) and his business were in Oregon and had been for years (at least 20).

The big concession California makes to Expats is the 546 Day rule.  This rule states “An absence from California under an employment contract for a period of at least 546 consecutive days MAY be considered an absence for other than temporary or transitory purposes”.

Evidently, without an employment related contract, a true Digital Nomad won’t qualify.  To make matters worse, California (along with New York) are states which will tax your worldwide income.

New York

As mentioned above, New York will tax your worldwide income.  The non-resident rules are a little easier than California, but if you maintain a connection to New York (much like California) you could be liable to file a return and pay tax.

By comparison, New Yorks residency rules are similar to California’s.  If New York thinks you have maintained a connection with the State, they will call you a resident and require a return and possibly tax.

New Mexico

New Mexico is another state that is notorious for refusing to terminate a taxpayer’s residency.  The general rule regarding residency qualifications is domicile or physical presence, much like the requirement to take the Foreign Earning Income Exclusion.  These rules are similar to other states.  If you were physically present for at least 185 days, you are a resident.  Obviously if your “home” is New Mexico, you are also a resident.

But what if you “did” live in New Mexico a few years ago but moved to Thailand as a Nomad and haven’t looked back.  They also reserve the right to categorize you as a resident and require a return.

Virginia and South Carolina

 These states aren’t as strict as the above three, but will tax you if you spend any part of the year in their state.  They don’t have the crazy “not-a-resident” rules, but if you are domiciled, they will tax your world-wide income.

What Can I Do as a Digital Nomad to Protect Myself?

Understanding your state tax obligations starts with your residency. Most states generally determine your tax filing requirements based on factors like how many days you were in the state, or where your income is earned.  Digital Nomads have problems when their domicile (where their home is) is still considered their home state, even if they live in another country.

Some things that can determine where your domicile is are:

• Where is your car registered?  If you don’t sell your car and don’t want to sell it (for whatever reason), register the car in someone else’s name.  Make it legal by selling it for some nominal amount.
• How about your ID?  If you have a state driver’s license or ID, turn it in.  You don’t need a California driver’s license in Thailand.
• How about your vote?  If you are still registered to vote in your home district it appears that you are still a resident.  If you plan to be away for an extended period (more than a year) cancel your registration.  Most jurisdictions have a cancellation form you must submit.
• How about rental property or other real estate?  If you own real estate in one of the above states, they most likely will consider you a resident for several years.  In any event, if you have rental property, you’ll be filing a return to report that activity anyway.
• Any other assets in the state?  If your bank account is a local type, I suggest moving all your money to an international bank like Chase or Bank of America.  Do a Google search of US banks in the country(ies) you’re planning to visit or move
• The last thing is where your family lives.  While something to consider, it’s a weak argument by the state if that’s the logic on which they are basing their decision.

Complexities of Digital Nomad Taxation (not just state tax)

Digital Nomads will most likely be required to file and pay tax in your host country.  This is the first step.  Your foreign tax needs to be determined so we can claim the tax paid on your US return.  This part is simple. File a foreign return.

As an expat (and a Digital Nomad), you are also required to file a federal tax return.  Renouncing your citizenship is the only way out of this requirement and that doesn’t always result in no filing requirement.  This part is also simple. File a US return.

Filing your state taxes is also simple, if required.  What’s not simple is getting out of the requirement if the state deems you a resident.  The goal should be to make it simple for the state to accept your non-residency at face value.

As has been noted, this is accomplished by you leaving as small of a footprint in your home state as possible.  Sell your car(s).  Don’t renew your driver’s license, or surrender it if renewal is in the future.  Most states have a simple form you need to submit.  Cancel your voter registration.  Change your bank to an international bank in your target country.  You’ll find one of Wells Fargo, Bank of America, Citibank or Chase almost everywhere.

Should you hire a pro?

Yes. Without a doubt. Hell, without hesitation.

My advice is to hire 2.  One in the US and one in your host country.  If you can find someone versed in both countries’ tax laws, more power to you.  But I think you’ll have a hard time finding someone competent, although this niche is growing by the minute.  Maybe I’ll put together a list of questions you can ask someone like this.  Growing niches equals more scams.  So, prudence is also the word.

What’s The Worst Thing That Can Happen If I Ignore This?

Maybe nothing.  But if you are an affiliate marketer you undoubtedly give your affiliate marketing vendor your banking and other personal information.  If no 1099 reporting is done well, maybe they won’t find out.

But.

A lot of states will look for returns from anyone who filed the previous year.  California will send you a Request for Return if they think you owe a return. It’s also common for them to send a balance due notice for tax based on…. not much.  A client received a notice requesting over $200k in past due tax.  This specific company had never MADE $200k in a year.

Your biggest problem would possibly occur when you came home to the US for a visit.  The IRS and the states have reciprocal information sharing agreements.  They also have the ability to put a hold on your passport.  They will let you back in, but they can also prevent you from leaving until your tax situation is current.   

Conclusion: How Can A Digital Nomad Get Away From State Taxes?

There’s certainly something a little romantic about becoming a Digital Nomad.  It’s a lifestyle that wasn’t available even 20 years ago.  In the old days (back in the 1970’s and 80’s) a lot of kids graduated college and took a year off to backpack through Europe.

These days YouTube, Instagram and other platforms have created the recent wave of Digital Nomad.  From driving a van all over the continent, to sharing how they travel on a budget, to someone who simply relocates to Bali to write a blog and manage their affiliate programs.

With the amount of geographical movement involved, paying taxes to the various taxing agencies becomes an exercise in organization.

And as it relates to the state, you need to decide how you want to be seen by your state.  Are you ok with being classified as a residence going forward?  Or would you like to cut ties with your state because you have no idea if or when you will return?

If you chose to cut ties, reduce that footprint by surrendering your driver’s license, cancel your voter registration and sell your car AT A MIMIMUM.

Don’t wait to deal with your tax situation after the tax year is over.  You should be setting yourself up for success before you even leave.  Define what you want/need and put together a plan.  Don’t forget to include your tax professional(s) in your planning.  It will cost a bit up front, but it will save a lot more (not to mention any potential headaches) on the back end.  And for every year you remain a Digital Nomad.

That’s it for today.  Hit me up if you have questions.

Thanks, and stay cool.

JKC

Demystifying Tax Questions and Concerns for “Location Independent”, i.e. Digital Nomad Taxpayers

With more and more people taking to the road and working remotely, how and to whom we pay our taxes has become increasingly complex. We are in a new era of Digital Nomads and the questions about their taxes are flying all over the place.

Logic says one thing, the tax code(s) say another.  Yes, multiple tax codes.  Logic says if you don’t live somewhere, you don’t have to pay taxes.

Logic is stupid.  Especially when it comes to taxes.  The tax code is NOT logical, nor has it ever been claimed to be.  The tax code is a political endeavor put together by a group of people who all have ulterior motives.  Since they are there for their constituents, their vision of the tax code will vary, sometimes substantially, from the person seated next to them.

If they’re in the other aisle, you can bet they won’t agree on much. 

With the freedom to chooe where you want to actually sit when you work, people are exploring the world and ending up in some really awesome and weird locales.  The only requirement is a good internet connection.

This nomadic lifestyle does raise a lot of questions. Specifically, where taxes are concerned, we put together a list of the top ten questions expats have asked us about their taxes.

(1) I’m a Digital Nomad Living in Mexico. I Didn’t Think My Tax Residency Would Be a Question!

This question has two answers.  For purposes of your federal taxes, as long as you are a US citizen with income, you need to file a federal income tax return.

Your state is a different beast.  Some states assign residency based on where the income is sourced.  Some look at things like vehicle registration or where you are registered to vote.

My advice is to keep good records regarding where you were during the tax year.  I would like a meeting to discuss your future plans so we can map out a strong strategy, especially as it relates to the state.

(2) Will You Pay Taxes in the Foreign Country You Live In? 

Yes.  With a caveat.  Your tax preparer must understand the specific tax treaty your foreign country has with the US.  The easiest thing to do is find a tax preparer in your new country to prepare that country’s tax return.  With this tax return in hand, you can go to a US tax preparer to prepare your US return. As a digital nomad, you will have tax questions related to two (or more) countries.

My reasoning for this is to avoid double taxation on the same income, i.e. paying Thailand tax on your income and then turning around and paying the US tax on the same income.

Some countries tax your worldwide income.  There are some that will only tax income sourced from their country.  Some will let you decide up front, but you will have to stick with this election forever.

(3) Are There Special Tax Deductions and Credits as a Digital Nomad?

Specific to Digital Nomads, no.  But you are considered self-employed, so you get all the benefits of being in business for yourself.

This can include general work expenses, travel costs, health insurance, and more. You may also be able to exclude a rather large amount of income from being taxed using form 2555, Foreign Earned Income exclusion.  For 2023 the amount you can exclude is up to $120,000.  If you are married and both of you qualify, you can exclude up to $240,000 a year.

(4) How Can I Reduce My Tax Liability While Working Remotely?

Reducing tax liability involves strategic planning and utilizing deductions and credits available for digital nomads. Investing in retirement accounts, understanding tax treaties, and optimizing deductible expenses are effective ways to reduce the tax burden.

(5) How Does the Foreign Earned Income Exclusion work and How Does It Impact My Taxes?

The Foreign Earned Income Exclusion (form 2555) allows citizens to exclude up to $122,000 of foreign earned income (2023 amount) if they meet specific requirements.

Qualifications are:

• You must be physically present in the foreign country for at least 330 days during any 12-month period.
• This is for earned income made while in the foreign country.
• You can work for a foreign company.  Remember, as a US citizen, you file a return and pay tax regardless of where you live.  It’s a requirement as a citizen.

If you work for a foreign company that withholds tax on your earnings, and this tax is remitted to the foreign government but excluded the income from your US return, you won’t get your foreign tax credit.

(6) Do I Need to File Taxes in My Home Country While Living Abroad?

This will be on a country-by-country basis, but if you are a US citizen, you will have to file a US return.  You may also be on the hook for a state return.

A big caveat regarding filing your taxes.  I advise you not to miss filing.  The IRS has access to the DOJ (all part of the Treasury) and as such, has access to peoples’ passports.  If the IRS has records indicating you owe tax, or owe tax returns, you may not be able to enter the USA until all those issues are resolved.  

(7) Do I need to form a corporation or LLC or can I Work as a Sole Proprietor While Living as a Digital Nomad?

I would advise against it creating another entity initially.

Once again this is on a country-by-country basis.  Some countries require foreigners to create their version of a corporation to work there.

Most countries, however, do not have this requirement.  It would be a lot more expense and you may need to hire a tax pro in that country on a retainer basis.

(8) Is Social Security Dealt with Differently While Living and Working Abroad?

Digital nomads and social security tax questions seem to go hand in hand. If you are self-employed, you should be making monthly estimate payments on the IRS website.  Self-employment taxes are the same thing as social security taxes.  Some countries (like Austria, Germany and Sweden) have hoops you need to jump through.

If you are a US Green Card holder and receiving Social Security, you may have a problem.  In some cases you file out form SSA-21 and still receive benefits while outside the country.

(9) It Sounds Like Recordkeeping is Important.  How Important Is It?

Because your residency and domicile are imperative in determining your state return (if required) so you’ll be saving more info that when you lived in California and were getting a paycheck every week.  So yeah.  Save what proves your point.

To show you have lft your state, get a drivers license in the foreign country.  You can’t vote, but if you buy a vehicle, that will also be registered in the foreign country.

Start a bank account (you’ll probably need one anyway) but remember you now have to declare your foreign bank account to the DOJ.

Buy a small scanner and scan things to your computer so you aren’t luggin 50 lbs of paper with you.

(10) Do I need Professional Help?

Yes.  It sounds self serving, but its truth. As a digital nomad, you SHOULD have tax questions.

In the next few years I’ll be embarking on my digital nomad phase of life.  You can be sure I’m going to search out a good immigration attorney and a good Charted Accountant to help with my taxes (Chartered Accountants are what the rest of the world calls CPA’s.  USA just gotta be different)

If you’re being honest with yourself, you would hire a tax preparer to do your income tax return if you were in the US.  You know the language, are familiar with US customs and are generally familiar with how US taxes are done (everyone knows April 15th for instance).

So, it sounds a little ridiculous to consider doing it on your own.

Conclusion to 10 Tax Questions from Digital Nomads

Being a digital nomad is an exciting endeavor.  We all have fantasies about travelling the world and having great adventures.  But your responsibilities don’t evaporate once you land in your new country.

As a US citizen, you are required to file an income tax return, and pay tax, on income earned in your new country.  There are certain benefits allowed that can help with your tax bite.

Your new country most likely has tax code and tax filing responsibility as well, so be aware and search out professionals in your new country with experience with expats.

If you owe the IRS or haven’t filed all required returns, the IRS can have the DOJ put a hold on your passport.  You may not be allowed into the USA, and if they do, you won’t be allowed to leave until your tax issues are resolved.

The best tool in your quiver right now is the Foreign Earned Income Exclusion.  For 2023 you can exclude up to $122,000 of earned income on your US tax return.  There are qualifications, the biggest is you must be physically present in a country outside the USA for at least 330 days in a 12-month period.

That’s it for now.  If you have any questions a=or want to see an article on a specific topic let me know in the comments.

Thanks all.  Stay cool and talk later.

JKC