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