Navigating the Foreign Housing Exclusion: A Digital Nomad’s Guide to Anxiety Free Living in a Foreign Land

The Foreign Housing Exclusion can be free money for the working Digital Nomad!  Let’s find out how to qualify.

Hey there, globe-trotting digital nomads! So, you’ve swapped your cubicle for a hammock in the Philippines, Bali, or even Thailand. Did you know the Foreign Housing Exclusion availble to Digital Nomads can reduce your income by as much as $94,060?!

Trading in the 9-5 grind for sunsets on an exotic beach and conference calls from a mountaintop (with internet) is the dream for millions.

Sounds amazing, doesn’t it? But wait, before you go posting that envy-inducing Instagram story, let’s chat about something slightly less exciting but still super important: U.S. taxes.

Yep, even in paradise, Uncle Sam wants a piece of your piña colada fund. But fear not, my wanderlust-filled friend, because the Foreign Housing Exclusion (FHE) might just be your ticket to maximizing those beach bucks while staying on the right side of the IRS.

The Foreign Housing Exclusion is for employees.  You get a paycheck with taxes withheld.  There is a Foreign Housing Deduction which is available to those who are self-employed.  Click this link for an article on the Foreign Housing Deduction.

What’s the Foreign Housing Exclusion and Why Should Digital Nomads Care?

In a nutshell, the FHE is a tax perk for U.S. expats (like yourself) allowing you to exclude certain housing expenses from your taxable income.

Sounds perfect, doesn’t it?  You can travel and work abroad while potentially excluding from your income the costs of housing WHILE IN ANOTHER COUNTRY!

Think of it as the IRS throwing you a bone for braving monsoons and mastering the art of haggling in Phuket. It’s their way of saying, “We get it, living abroad can be pricey,” and it’s designed to ease the financial burden of your overseas adventure, er, employment.

Qualifying for the FHE: The Basics

Before you can qualify to exclude your housing costs, you must qualify for the Foreign Earned Income Exclusion.  There is no way around it.  If you don’t qualify for the FEIE, you won’t qualify for the Foreign Housing Exclusion.

Second, to snag this tax break, you’ve got to pass the bona fide residence or physical presence test, proving you’re more than just a tourist with a laptop. This means either living in your country of choice for a full tax year or being physically present there for at least 330 full days in any 12-month period. And no, visa runs don’t count towards this, so nice try.

The above is imperative.  If you think of it rationally, it would be pretty tough to qualify for a FOREIGN housing exclusion if you aren’t in a foreign country.

Once you’ve got that sorted, you’ll need to show that your earnings are from bona fide work. Streaming your beach life on TikTok or Instagram might not cut it unless you’re actively treating this as a business.

This is the income to apply your Housing Exclusion against.  You gotta have foreign EARNED income, people.

Calculating Your Exclusion: The Fun Part

Here’s where it gets a bit mathy, but stick with me. The IRS isn’t giving you carte blanche to write off your entire island lifestyle. There’s a limit to how much you can exclude, based on the cost of living in your Foreign locale compared to Washington D.C. (random, right?).

For 2023, the base housing amount is 16% of the Foreign Earned Income Exclusion (FEIE), which is set at $126,500, making your baseline exclusion about $20,240.  This is the amount the US government has determined you would spend on your housing.

The above is a perfect example of why our politicians are so out of touch.  But it is what they give us, and in this case it helps.

The second part is your locale cost.  This is a table the IRS puts together outlining the limits of various areas.

Part IX shows what the IRS considers the maximum housing cost in a specific locale (or country, if small).  In the example, Thailand costs $59,000 to house yourself in 2024.  If you spent more than $59,000 in 2024, you are limited to that $59,000 amount.

Subtract the base amount ($20,240) from the amount on the table ($59,000) for a net amount of $38,760.  You can exclude this amount on your Form 2555 (Foreign Earning Income) to exclude an additional $38,760 from being taxed.

Qualified Expenses: What Counts and What Doesn’t

Eligible expenses include rent, utilities (minus telephone charges, because apparently, the IRS thinks we’re still using landlines), real estate fees, and even the cost of leasing a Buddhist Temple if that’s your vibe.  TV subscription fees are also not qualified (like Netflix or Hulu).

Additional qualified expenses are leasing fees, rental of furniture, and renters insurance.  Items that don’t qualify are payments made to purchase realty (principal, interest, and escrow fees), domestic labor, or anything that can be looked at as extravagant or unnecessary.

This exclusion is specifically for your domicile in the foreign country.  Your daily halo-halo fix and weekend getaways to Machu Picchu are on you. The key here is that the expenses must be reasonable (no gold-plated toilets) and directly related to your housing.

Let’s Take a look at a current example

Milicent has a lifestyle blog where she posts YouTube videos of life as a Digital Nomad in Southeast Asia.

She has decided to live in Thailand, Laos, Vietnam, and Cambodia for a year each before moving to the Philippines for good.

She fully qualified for the Foreign Earned Income Exclusion and is considered to have satisfied the Physical Presence Test by living in the same country for at least 330 days of a consecutive 12-month period.  You don’t have to live in the same country for the entire period, but remember that we are talking about your DOMICILE.  You won’t qualify by simply traveling around the world since you won’t have a “domicile”.

Milicent lived in Thailand for all of 2024.  She had $200k or self-employment income, of which 100% was earned as an employee while in Thailand.  We won’t be dealing with her Foreign Earned Income Exclusion here, just the Housing Exclusion.

Her qualified costs of housing for the year were $50,000.

Milicent can exclude $29,760 from being taxed ($50,000 – 20,240 = $29,760).  You are still responsible for your self-employment taxes.

Getting It Right: Tips and Tricks

This is an area the IRS will scrutinize.  For this reason, I would advise you to go a little nuts with your record-keeping.  Track everything and keep receipts.

1. Keep Impeccable Records: The IRS loves paperwork more than you love sunset selfies. Keep every receipt, lease agreement, and utility bill. If it proves you paid for housing, save it.  If your bank account is with a local bank, save the statements.  The same goes for credit card statements.

2. Understand the Local Cap: Each location has its cap based on the cost of living. Manila might have a higher cap than a remote beach town. Know your limits to maximize your exclusion.

IMPORTANT: This is also important if your cost of living is LESS than the base established by the IRS (the 16% amount).  If you don’t have $20,240 in qualified foreign housing expenses, you won’t have a Foreign Housing Exclusion.

3. Professional Help is Key: You know me.  I’m not dismissing anyone’s mental capacity, but it would be really easy to make a mistake on this.  If you make a mistake in one year, chances are the mistake will be on multiple years’ returns.  With an issue with a higher audit risk (such as the Foreign Earned Income Exclusion and the Foreign Housing Exclusion), I will always advise you to seek professional help.

4. Timing is Everything: The timing of your expenses and income matters. Planning and smart financial management can help you leverage the FHE more effectively.

Milicent made the decision to live in 5 different countries over a 5 year period.  She was planning FOR the FEIE and FHE.  She made sure to qualify for both each year knowing she could save thousands in taxes by planning properly so she could benefit from the FEIE, and by extension, the Foreign Housing Exclusion..

5. Tax laws tend to change, or be “adjusted” annually.   What’s accurate now might be outdated by your next visa extension. Keep up to date or have someone do it for you.

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Conclusion – Living the Dream Without the Tax Nightmare

So, there you have it, my wandering friends. With a bit of specific planning and a keen eye on your expenses, the Foreign Housing Exclusion can help make your digital nomad dream a bit sweeter (and more affordable). Remember, it’s not just about finding the perfect beach or mastering the art of remote work; it’s also about smart tax planning to ensure your adventure continues as smoothly as possible.

And let’s be real, nothing says “successful digital nomad” like sipping a coconut on the beach, confident in the knowledge that you’ve got your tax situation locked down tighter than your Instagram game. So, go ahead, and enjoy that sunset. You’ve earned it – both the view and the tax savings. Cheers to living your best life, wherever in the world that may be!

And with the tax savings, you can start your own Solo 401k, save for retirement, AND save even MORE on taxes!

There you have it folks.  Stay cool and talk later.

JKC

Digital Nomads Have a Great Opportunity to Save: How To Use a Solo 401k to Fund Your Nest Egg.

Digital Nomads Using the FEIE Are In a Great Position to Save For The Future!

Yeah.  I know.  A Solo 401k Plan even SOUNDS boring. Nothing about that sentence is, or sounds sexy or fun.  It’s what your mom/dad, or grandma/grandpa tells you all the time.

I hate that they are right.  You won’t feel it while you’re young and have the benefit of time.  If you have a few light years, no biggie.  You’ll make up for it next year.

If you don’t put some away, you will next year.

Bull.

Digital Nomad Lifestyle – Who I’m Talking About

I qualified the “type” of Digital Nomad this article addresses.  If you can, or do, take advantage of the Foreign Earned Income Exclusion, you need to read this article.  The tax savings from using the FEIE can be used to fund a Solo 401k account.

What a great idea Jerry!  Tell me more!

Tax-Saving Strategies for Digital Nomads

Consider The Tax Problems Your Country of Choice May Reveal

Two things.  Does your country have a tax treaty with the US?  At a minimum, any income tax paid to your countries taxing agency will qualify for a foreign tax credit.

Second thing.  Does you country have a Social Security Totalization agreement?  This is a biggie.  As the name implies it deals with each countries social security program.  If your country of choice doesn’t have an agreement with the US, you will most likely be paying into the social security program of both the US and your foreign choice.

The biggest issue with this is if you can qualify for the foreign countries social security benefits.  In the US you must pay into the system for forty (40) quarters.  That’s ten years.  If you stick around for a few years before moving on tot he next country, you may never see any benefits, not to mention the constant updating of addresses (some states will call you a resident if you have an address is their state) and tracking of payments you’ve made to the various countries.

Plan So You Can Take The Foreign Earned Income Exclusion (FEIE)

This is the key to this strategy.  If you take advantage of the FEIE in 2023, you will exclude $120,000 of income.  If you can take advantage of the Foreign Housing Deduction, you can reduce your taxable income by another $36,000.

That’s around a $28,000 tax savings for a single taxpayer.

Digital Nomads = Self Employed = Business Deductions

As a Digital Nomad you must keep meticulous records regarding your business deductions.  You may be able to take advantage of deductions state bound business owners generally do not enjoy.

With the transient nature of being a Digital Nomad and if your blog/vlog/channel/website involve travel or exploration themes, you will have more travel and entertainment costs.  Digital Nomads also have a much higher than typical technology costs.

Why Do A Solo 401k as a Digital Nomads

.This is subjective.  This is my Dad opinion.  With the ability to make a good to great income, the ability to shelter up to $120,000 of income in 2023, and the ability to deduct expenses most of us can’t, there is cash available to further reduce your tax AND sock away a nice piece of change.

This is where the Dad opinion comes in.

Even if you only do a little.  Maybe put $10k away.  Do this for five years.

And don’t touch it.  That’s the key.  Leave it the f&ck alone.

If you leave it for 25 years and let it grow (we’ll assume 5% per year) you’ll have almost a quarter million dollars.  From a $50k investment over 5 years.

You’ll thank me later.

Why a Solo 401k Plan?

I’m a huge fan of Solo 401k’s for self employed taxpayers and husband/wife partnerships (or S Corps.)

A Solo 401k is actually a combination of two different retirement plans.  It’s a fusion of a SEP (Simplified Employee Pension) and a 401k plan.  This plan is specifically for the self-employed (and husband/wife teams).

For 2023 you are allowed to contribute the first $22,500 of your income towards the 401k portion of the plan.  The SEP calculation is based on your net self-employment income.  I use 20% as a rule of thumb (it’s close enough to estimate).  The sum of the two plans cannot exceed $66,000.

If you are over 50, you can add an additional $7,500 with a “catch-up” contribution.

Solo 401k Tax Savings

Making the maximum contribution will reduce your income tax.  It doesn’t reduce your self-employment tax unfortunately.

To maximize your tax benefit, you need to be making a lot.  Calculating in my little brain you would need net self-employment income of around $160k to see decent tax savings.

Have a discussion with your tax preparer about the level you are comfortable with.  Approaching this from the other direction, tell your tax person what your liquidity allows and they can come up with a few options.

Flexibility and Control Over Investments

These plans provide autonomy in selecting diverse investment options, empowering digital nomads to tailor their retirement portfolio according to their risk tolerance and long-term goals.

How a Solo 401k Works

A Solo 401k is a  combination of two retirement plans.  A (pseudo) 401k plan, and a SEP plan.

401k contributions are usually taken from your paycheck, but this type of 401k plan can also ber taken directly against all income, with the calculation based on net self employment income.  The takeaway from this is you don’t need to be on payroll.

This means $23,000 and potentially another $7,500 in catchup contributions if older than 50, can be contributed as a 401k contribution as a sole proprietor as long as net self employment income is as least $30,500 (using 2024 limits).

After the 401k contribution, you would now calculate the SEP component.  For purposes of this article, we’ll use 20% of self employment income as the contribution amount (the actual calc is 25% of NET self employment income, which is another calculation).

As you can see, there is an opportunity to put a large amount away for retirement and save a bunch on taxes at the same time!

Creating a Budget and Savings Plan

The flexibility of a nomadic lifestyle demands a structured budget and a dedicated savings plan, aligning financial goals with the unpredictability of remote work.

Do You Need Professional Help?

When dealing with taxes as an Expat, I will always suggest you find someone versed in Expat taxes, and someone who understands the foreign tax code of your country of choice.  If the country in which you established residency doesn’t have a Totalization agreement, you’ll really need someone.

With regards to investment advice, I wouldn’t recommend trying to self direct a Solo 401k.  I don’t think you can, so you will need to find a financial advisor.

Conclusion: Digital Nomads and Solo 401k Plans

As a true Digital Nomad, you have an opportunity to make a lot of money.  With so many ways to monetize your content, it’s not unusual to see a digital warrior making well over $20k per month.

Add in the benefits given to anyone working outside the US for an extended period (years) and you can be in a great cash position.

Use that power to further reduce your tax liability AND put money away for that cheezy rainy day.

Digital Nomads have been given an opportunity to do something most US Citizens will never have.  You are being given free money.  I’m going the Dad route and advising you to put this money away in a retirement account.

The savings from the Foreign Earned Income Exclusion and the Foreign Housing Deduction can be substantial.  I’m talking about $40k in tax savings if you only take advantage of the FEIE and the Foreign Housing Deduction.

Plus, depending on the type of “Nomad” or influencer you are, you may have an opportunity to write off some of your living and travel expenses.

All in all, you have a chance to save a lot in taxes AND put away for the future.  Taking advantage of the current tax laws as a Digital Nomad seems like a no brainer to me.

As always, let me know if you have questions.  Have a great new year and stay cool.

JKC

How To Use the First Time (Penalty) Abatement to Get Rid of Nasty Penalties!

Did you know that the IRS will give you a First Time Abatement of a penalty?  What this means is if you are assessed a penalty on your tax return, there is an easy way to get out of it.

This wonderful tool is called, drum roll, the First Time Abatement, or FTA and is statutory (in the IRS code).  This means, if you qualify you get the penalty tossed out.  All you have to do is ask.

Depending on the type of penalty and when it was assessed, if you qualify you can save thousands.  Let’s take a good look at how I use it and how you would qualify.

Let’s talk about the IRS Penalty Maze

The IRS can imposes a penalty on just about anything tax related.  Generally the penalty is based on the tax liability (but not always).  They have late filing, late payment, underpayment, under-reporting and substantial under-reporting penalties.

They will charge a partnership by the number of partners if the return was filed late.

If you forget to take a required minimum distribution from your IRA, they charge you on the amount you should have withdrawn EVERY YEAR until you correct the non distribution (i.e. take the money out).

And as a further slap in the face, they charge you interest on your penalty and then again on the added interest.  No joke.  They can calculate interest daily.  Each day adds to the balance, so you are essentially paying interest on the penalty that caused more interest to get charged.

See.  A freaking maze.  With eight types of penalties in their quiver.

The IRS Throws you a Penalty Sized Bone.  The First Time Abatement Program

The FTA gives relief by waiving certain tax related penalties, provided you qualify.

Penalties that can be waived are:

  • Failure to File penalty – You filed your tax return late.
  • Failure to Pay penalty – You didn’t pay your taxes before the deadline.
  • Failure to Deposit penalty – You didn’t make your tax deposits by their due date.

Failure to file penalty waivers are for Individual, partnership and S Corporation returns.

Failure to pay abatement is also limited to the amount shoul, but not paid by the return due date; or tax that wasn’t on the return but was later assessed by the IRS and NOT paid by the due date on the notice.

Qualifying is straight forward.  To qualify:

  • Timely file the same tax return for the three years prior to the year you are requesting abatement.
  • Didn’t receive any penalties during those three years, or have a penalty abated by the FTA.
  • If you are self-employed and required to make periodic deposits, be they estimated tax payments or payroll deposits, you can still be granted FTA is you have no more than four waived failure to deposit penalties.

How To Apply for Penalty Relief with the First Time Abatement

  • The first way is to read the notice the IRS sent.  Some notices have instructions on how to have the specific penalty you have been assessed on the letter abated.
  • Give the IRS a call.  I’ve gotton most of my penalty abatements over the phone.  Once again, check your notice.  The appropriate number you need to call will be in the upper right hand corner.
  • Write a letter (here’s a template) and send to the address on the notice.
  • Form 843, Claim for Refund and Request for Abatement can also be used.  Since it is used for several purposes, it might seem confusing.  This would be your last option.

You won’t have to specifically ask for First Time Abatement as they are supposed to review your account first to assess whether you would qualify for FTA.  If you don’t qualify, you may qualify using an Administrative Waiver, or having a Reasonable Cause.

Make That Interest Disappear Too!

Even though the First Time Abatement helps remove penalties, it doesn’t directly address interest charges, indirectly it reduces interest by removing an amount that would usually have an interest charged against it.

No penalty, nothing to charge interest on.  The gift that gives a little more than expected.  Not bad IRS.

Success Stories?

I won’t insult your intelligence with some BS made up story about how John Q Taxpayer avoided $25,000 in penalties using the FTA.  In all honesty, abatements that large are highly unusual.  For someone to have a $25k penalty abatement, at a minimum they owed $100,000 pre-penalty (the max late filing penalty would be 25% of the tax liability).

But the above scenario is more than possible.  Maybe you know you owe a bunch and are doing nothing more than avoiding the pain.  But you’ve inflicted a lot more pain by being avoidant.

This should be the first tool used when a tax problem appears.  If you qualify, you can’t be denied.  That’s a success in itself.

You Need to MAINTAIN Tax Compliance Now

Part of qualifying is having a perfect tax record for the prior three years.  You can’t use the FTA for another three years.

But that’s not my point.  Maintaining a clean tax record takes a little organization.  And it’s an area you must develop unless you want to be back in this position (or worse) next year or the year after.

In my career, I have noticed that people who have tax issues tend to have them for a great part of their life.  It’s not usual for me to have to help clients deal with multiple tax years, multiple times.  You need to make a concerted effort to make sure htat isn’t you.

Conclusion: FTA is a No Brainer and you Don’t Need to Hire Me!

I think the First Time Abatement for penalty reduction is underutilized.  Most taxpayers (i.e. not tax geeks like me.  You know.  Normal people.) are aware of the premise of an Offer in Compromise.  They understand there is a way to get their tax debt reduced.

They know they can make payments over time using an Installment Agreement.

I’ve even had people come through my doors asking if I can help get them on Currently Not Collectible status.

But no one seems to know about the easiest and most automatic relief available.  If you qualify, there is a letter (here’s a template) you send in and the IRS approves you.  If you don’t qualify for FTA, you can still apply for a waiver based on an Administrative Waiver or a Reasonable Cause.

The FTA isn’t going to be life changing, but every dollar saved matters.  Plus, it gives you some of your lost power back.  Nothing is worse than the feeling of financial stress (been there, hate that I’ve done that).  I hope my articles can help you get your power back.

That’s it for now.  Hit me up in the comments if you have questions.

Stay cool.

JKC

The Foreign Earned Income Exclusion Isn’t Scary. It’s A Wonderful Gift to Digital Nomad’s From the IRS

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

How To Avoid State Taxes as an International Digital Nomad.

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

Digital Nomad Tax Questions: 10 Important Questions You Better Have About Your Taxes

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

The IRS Currently Not Collectible Status: A Tax Guys Magic Wand

I’ll say it.  The IRS Currently Not Collectible status is THE BEST.

Anyone with a big tax problem, with neither the resources nor time currently available to resolve said tax problem, should look into being classified as Currently Not Collectible.

The complexity and depth of tax laws and financial obligations can sometimes lead even the most diligent and proactive individuals and businesses into some really dark places.

A great fear many people share is that fear of the IRS coming and taking your car or cleaning out your bank accounts.

Yeah.  That can happen.  But you really have to screw up for them to go that far.  As long as you communicate with them, they will work with you on your tax problem.

Financial hardships happen.  If paying your taxes becomes an insurmountable burden, the Internal Revenue Service (IRS) offers a lifeline in the form of the Currently Not Collectible (CNC) status.

A Currently Not Collectible status won’t relieve you of your liability.  What it does is give you a temporary reprieve from IRS collection activity, and time to reboot your financial life.  CNC status lasts from 6 to 12 months.  It is possible (probable in my experience) that if approved, you will be on CNC status multiple years

How To Qualify for CNC Status

On the surface this seems easy.  You can’t pay.  You don’t have the money.  Your hours were cut back, or you were laid off and can’t find another good job.

The cornerstone of obtaining CNC status is by demonstrating your financial hardship. This entails showcasing an inability to pay basic living expenses due to dire financial circumstances.

You prove your hardship by showing bank statements, bills, past due notices…any third party documentation that can paint a clear picture of your hardship. Providing a complete and accurate picture of your financial situation is crucial, necessitating comprehensive documentation of income, expenses, assets, and liabilities.

How Do You Apply?

The application process is deep.  You will need to share everything as it relates to your financial health.  The key to being approved is to paint a picture of your situation using paystubs and bank statements to show income/money in, and bills, invoices and past due notices to show expenses/money out.

Prepare Form 433-F or 433-A, depending on your individual or business status. These forms serve as comprehensive snapshots of your personal and business situation.

The IRS takes this information, and reviews and analyzes the data to formulate an opinion as to your financial health.

If you are patient, diligent and thorough, you can put together a packet that gets you approved for CNC status.  However, if you don’t feel confident in dealing with an IRS Revenue Officer, contact a professional.  Be aware that not all CPA’s and Enrolled Agents do tax resolution.  Tax resolution is a specialty within the tax preparation realm. 

Now We Wait……..

Now the hard part (for you).  The IRS will analyze your documentation and poke and prod your finances until they understand where you are.

It’s very likely that the IRS will come back to ask for clarification, or additional information.  Make sure you get this to the Revenue Officer working with you ASAP.  Your Revenue Officer is working on upwards of 70 cases at a time, but if you get your info to them in an expedient way, they will bump you up their list of priorities.

After carefully scrutinizing your information, the IRS will issue a determination—approval grants the CNC status, temporarily suspending collection actions, while denial comes with an explanation of the reasons and alternative courses of action.

The Good, Bad and Ugly of CNC Status

What’s good about CNC status?

The benefits of obtaining CNC status are obvious. The IRS halts all collection activity against you.  You get a reprieve of sorts, allowing you to do what needs to be done to better your financial health.

A huge benefit (to me) is the fact that the IRS 10-year collection period DOES NOT TOLL.  This means it doesn’t stop.  This is a big deal since it reduces the time available for the IRS to pursue the tax debt.

What’s bad about CNC status?

On the surface, this does nothing with regards to reducing or paying your tax debt.  Interest and penalties also continue to accrue, adding to the debt.

What’s ugly about CNC status?

The ugly is the IRS doesn’t hand this status out like Tic Tacs (not TikTok for you Gen Zers :^)) .  It’s a complex process that involves a lot of back and forth with your Revenue Officer.

It also lasts just 6-12 months.  The IRS will require periodic updates to make sure nothing’s changed in regards to your finances.  This can also be a good thing.  If your financial situation remains static, say due to medical issues or a lawsuit, you may be able to retain CNC status for multiple years.

How can you lose CNC Status?

At the risk of sounding like a jerk, you’ll lose your CNC status if you start making enough money to pay something back each month.

Improving your financial situation will move you closer to losing CNC status.

If your situation hasn’t improved, then to maintain CNC status you must file all tax returns on time and pay your current taxes.  We don’t want to add to your already large balance. 

What can you do besides CNC Status?

Bankruptcy?

Removing federal taxes through bankruptcy is possible, but you have several hoops to jump through initially AND, the IRS can deny the write off.  I had a client qualify via bankruptcy to write off all but $350k of a $1.8mil tax debt.  IRS council denied the write off.  We ended up going a different route that cost the client $220k.  I wonder if that attorney lost their job?

Offer in Compromise?

If you’re in this position, and OIC is something to seriously consider.  You will probably be inundated with ads proclaiming they can get you off for “pennies on the dollar”.  An OIC might be the right direction, but it will cost you a lot more in professional fees.

Installment Agreement (or Partial Pay Installment Agreement)?

This is the most used option.  If you are having money problems now, I don’t see this as an option.  After taking a few years to clean up your finances, and depending on the sze of the tax debt, I can see using CNC to remove a few years from the 10-year collection window, then applying for a partial pay installment agreement.  This is the long way, but for a lot of people, the best way out.

Conclusion:  Using The Magic Wand That is Currently Not Collectible Status

CNC Status can be used in many different ways.

Time.

The IRS has 10 years to collect the tax you owe.  Use CNC Status to get the IRS to stop collection activity, thereby giving you time (and energy) to fix your money situation.

Easy to morph to another option.

You’ve already collected the info needed to prepare an Offer in Compromise, or a Partial Pay Installment Agreement.  If you foresee your financial situation remaining status quo for the foreseeable future, you may consider an Offer in Compromise at this time.

The same can be said about a Partial Pay Installment Agreement.  This option would be available if our situation improved a little and you could send “something” to the IRS.  You must also apply for a Partial Pay Installment Agreement.

Interest and Penalties.

Interest and penalties will continue to accrue, adding to our balance.  These are statutory charges, with minimal opportunity to remove.  Collection activity stops.  The debt doesn’t.

As a tax professional I’ve used CNC status A LOT.  When a client walks in looking like Eeyore, you know things are bad.  Tax problems are a big deal in the US.  There are over 14,000,000 open tax cases at the IRS.  Knowing the available options and how to use them is essential to getting you out of trouble.

But knowing how to use different options together is when you really save a lot of money.

So that’s it for today.  Thanks for your time and talk soon!

Stay cool.

JKC

Will an Offer in Compromise Relieve Me of this Horrible TFRP?

If the IRS has assessed a “Trust Fund Recovery Penalty” (TFRP) against you, you must take this very seriously.

As money withheld from employee paychecks, the IRS is very protective of this “Other People’s Money”. If this “other peoples money” is not properly deposited with the IRS, The TFRP will be assessed on those responsible for withholding and remitting payroll taxes to the government.

This penalty can be assessed on your own business, or, if you are an employee (not an owner of the business) and the withheld taxes have not turned over to the IRS, the could call you a “Responsible Person” and ask you to pay.

Wait!  That can’t be right, can it?  If you work for someone and part of your job duties were to prepare payroll, and your boss instructed you to NOT make the required payroll tax deposits, the IRS can hold you responsible???

Yep.  That’s what I’m saying.  Fair or not, the IRS calls this a “responsible person” penalty.  The IRS will always try and collect their money.

I. What’s a Trust Fund Recovery Penalty (TFRP) and Can an Offer in Compromise Help?

A. What’s a Trust Fund Recovery Penalty

Part of preparing payroll includes calculating the taxes to be withheld on each paycheck.  The company then adds their portion to this number and that would constitute that pay periods payroll tax deposit.

Most businesses will pay the payroll taxes withheld within a few days of payroll. If you owe less than $1,000 for a specific quarter, these taxes are paid when you file the quarterly payroll returns.

Payroll taxes are considered “Other People’s Money” (remember, you calculated the taxes to be withheld from your employee’s paychecks) so the IRS treats these payments a little differently than your income taxes.

That’s where the “Trust Fund Recovery Penalty” comes into play.  A responsible person can be the business owner(s) or the person tasked with preparing payroll and remitting taxes.

You CAN be a responsible person even if you don’t own any part of the business, or have signature authority on the bank accounts.

B. What’s an Offer in Compromise?

An Offer in Compromise is an IRS program designed to assist people with large tax debts (such as a trust fund recovery penalty) who won’t be able to pay without it horribly affecting their lives.

I don’t want to suggest that this is an easy way to get out of paying your taxes.  Ads claiming to get you out from under your big tax debt for “pennies on the dollar” are misleading.

The IRS is patient and will wait for you to pay. They have 10 years to collect. An Offer in Compromise may get you out of tax trouble, but you must qualify and the qualification bar is high.

There is also the cost of having someone prepare your application.  You can try yourself, but your chances of being approved are pretty low.  The OIC acceptance rate is usually around 33% overall (per the IRS in 2019).  You will see studies out there claiming anything from 5% to over 40%. 

C. Can an OIC help with my TFRP?

Short answer, yes.  But you have to qualify and the calculated amount must be less than the tax plus cost to prepare the application.

Let’s find out how to qualify.

II. Why The IRS Needs the Trust Fund Recovery Penalty (TFRP)?

A. Definition and Purpose of TFRP

The Trust Fund Recovery Penalty is put in place to ensure the government has enough money to operate.

Payroll tax deposits made by US businesses is the cash flow our government uses on everything it does.

When someone doesn’t remit the taxes withheld on peoples’ paychecks, there is less cash available to pay for things like our military, social security payments and money paid to states for things like education and Medicare.

How would your life be impacted if your employer stopped paying you, but still insisted that you kept working?  The TFRP allows the IRS to go after those who had responsibility to remit these withheld taxes.

B. How Does the IRS Know Who to Assess the Penalty Against?

The IRS can assess the TFRP against the business owner, an officer, a partner or an employee.  An owner, partner or officer can be held liable statutorily since they are already liable for other actions taken by the business.

The touchy one is when they go after an employee.  If you prepared the payroll and generally remit tax deposits, the IRS can hold you liable.

If you are/were an employee, the first thing we would do is collect evidence to support the fact that you DID NOT have any control or responsibility.  Easier said than done, but the first step.

III. Can An OIC Solve Your TFRP Problems?

A. The First Step Is to Do a Preliminary OIC Calculation

This is a seat-of-the-pants calculation to give you an idea what your offer will be.

Here’s part 1 of the calculation:

  1. How much is your monthly income?  If the amount is inconsistent, then come up with an average.
  2. What are your monthly expenses?  You’ll need to list these out.
  3. Regarding your monthly expenses, the IRS has limits on many expenses based on where you live.
  4. After paying your bills, you will know what your disposable income is.
  5. This amount is now multiplied by either 12 or 24 depending on how quickly you want to pay the IRS.

The next step is deciding how fast you can remit your offer amount to the IRS. If you use the 24 month amount, you have 24 months (or less) to pay off your liability.

If you use the 12 month amount, you must have your tax bill paid off within 5 months of IRS acceptance.

Part 2 of the calculation is as follows:

  1. Take the calculated amount from above.  We’ll pretend that number is $12,000.
  2. Make a list of all other assets and their purpose, i.e. business or personal.
  3. Exclude assets used for your business.  They must be business assets to exclude.  
  4. Figure out the equity in each asset.  That’s the amount you would get if you sold it. 
  5. As an example, this number is $25,000.  Add this amount to the first calculated amount.
  6. This is your offer to the IRS.  If you owed $250k, the $37k amount looks much better.  If you owed $25k, no bueno.

When attempting an OIC for a TFRP you must understand the “line” for the IRS is much higher. This is money that belongs to your employees, not you.

B. Who can apply?

This is actually pretty straight forward.  You can apply if:

  1. No unfiled or missing tax returns.
  2. Are not in bankruptcy.
  3. If you are the business owner, you must be current through the last 2 quarters with tax payments and employment tax return filing.
  4. If you are including the current year, you must be extended if you haven’t filed yet.

C. How To Apply

If you are an employee, you fill out form 656 and submit with the application fee, any tax deposit required and supporting documentation.   Supporting documentation can be anything from bank statements, bills and invoices you paid, and paystubs.

If you are the business owner, you will need to fill out form 433-OIC instead of form 656.  Depending on the amount owed, you may need to prepare forms 433-A and 433-B.

IV. Apply and Hurry Up and Wait

A. Submit your Offer in Compromise Application

Fill out the appropriate application and submit it with all supporting documentation.

If you make a claim on your application that you feel is important, make sure to include documentation to prove your point.

B. Now We Wait………

The IRS will now go over your application with a fine-tooth comb.  They will prepare their own calculations comparing them to your offer.  They can also corroborate your documentation.  The initial look-through will take around 6 months.

After the initial review, the IRS will most likely reach out to you asking for further corroboration.  They will be inquiring as to whether your financial situation has changed.  If your situation remains the same, they’ll look at the file again before making their decision.

C. Yes, No or We Need to Talk

Based on your application the IRS will either accept your offer or reject it.

Many times, however, they will come back to you with a different offer, or allow you to re-open negotiations.  Keep in mind that they WANT to resolve this case.

Once the IRS accepts your offer, you are required to keep up with your tax filigs, payments and estimate payments.  For the next 5 years, you cannot file or pay late.  You must pay your estimates if required.  You must be a model taxpayer.  Don’t give them an excuse to rescind the agreement, making the entire balance, plus penalty and interest fully due.

VI. What Alternatives Are Available?

A. Installment Agreements

This option allows you to pay the liability off over a period of time.  You have up to 72 months (6 years) to pay the debt.  There is also a possibility of a partial pay Installment Agreement.  If your finances won’t allow for full payment, then there is a possibility of making payments for 72 months and not fully paying the debt. Due to the size of most TFRP’s, a partial pay installment agreement might be the best course of action.

B. Currently Not Collectible (CNC)

This is a temporary fix.  Currently Not Collectible status is a pause in collection activity. This is for taxpayers who are in a temporary bind and only need time to sort things out.  If granted, the IRS will leave you alone, usually for 12 months.

This can be used to buy additional time to figure out your options.

C. Challenge the Trust Fund Recovery Penalty Assessment

THis is the first thing to look at.  The IRS will cast as wide a net as possible to collect their money.  There are two things the IRS looks at:

  1. The duty to perform the collection, accounting for and payment of trust fund taxes (what payroll withholdings are considered).
  2. The power to direct these actions.

The Chief Financial Officer of the company would qualify as a responsible person.  A data entry clerk simply doing what the boss says would not be a responsible person.  Many times, this must be proven to the IRS.

IX. Conclusion to Using an OIC on your TFRP

Finding yourself in this situation can be paralyzing.  Typically, the dollar amount is big.  Huge sometimes.  If there are a lot of employees, the required deposit will be large.  2-3 full-time employees paid twice a month can conservatively amount to $10k per month.  One quarter will then be $30,000 PLUS PENALTY AND INTEREST!

This all becomes even worse if you were an employee and have no ownership stake.  It makes no logical sense that you, as an employee, can be held liable for your employer’s tax debt but in this case it’s possible.

To qualify to apply you must be current on all tax return filings and not currently going through bankruptcy proceedings.

The IRS looks at three things when deciding whether to review your file:

  • Doubt as to Collectability – You don’t/won’t have enough income/assets to full pay.
  • Doubt as to Liability – The IRS made a mistake in assessing the tax.
  • Effective Tax Administration – This is subjective.  Think ‘Do the right thing” as it relates to the IRS.  I use this for elderly clients who will never be able to pay.  Effective tax administration isn’t as readily accepted as the other two options.

For the IRS to accept your offer, you must demonstrate:

  • An inability to fully pay your debt.
  • The hardship you would experience if you paid the debt in full. 
  • The amount offered must be more than the “Reasonable Collection Potential” amount calculated by the IRS using the info you submitted.
  • You must show the ability to pay the offer amount within the repayment period.

The IRS deals with payroll tax debts differently than income tax debts.  Payroll tax deposits is the cash flow the US Government uses for daily operations.

If you find yourself in this situation you need to contact an expert in the field.  The IRS will do everything in their power to collect.  We need to be ready to defend your actions and responsibility to make this bad dream go away.

You Don’t Need To Be Making Big Time Money To Need An LLC

Four reasons why you need an LLC, and three reasons you don’t.

Do you need an LLC? The world is full of people with expectations.  These expectations are generally founded on nothing more than “Joe has one, I must need one too”.

As a business owner, you are constantly presented with choices that can affect your business and life. One such decision is whether to form a Limited Liability Company (LLC) as the legal structure for their business.

Do you need an LLC?  It depends on your situation.  Many tax guys like me suggest that your income level should determine whether you form an LLC or not.  I don’t think your income level is as important as some would lead you to believe. There’s more to this decision than saving on taxes.

I like to look at a clients financial life outside of their business to help determine their needs.  What needs protection?  Is there family or spousal wealth that needs to be considered?  Income level is an important consideration, but so many other things need to be considered.

Let’s be honest.  Saying “I have an LLC” or “I’m incorporated” feels good.  We sound legitimate.  We sound like a real business, like Microsoft or Google.

Let’s take a look at a few reasons why you should and a few reasons why you shouldn’t.  Not everyone needs to house their business within an entity, such as an LLC or Corporation.  Let’s figure out what’s best for you.

Four Big Reasons You Need an LLC

1. Liability Protection Just In Case!

An LLC will protect it’s members (shareholders). This means that your personal assets, are kept separate from the company’s liabilities.

The business will be held liable if you, or an employee or agent of the company does something that caused loss to someone.

In the event that the business faces financial or legal troubles, your personal wealth remains shielded. This protective barrier is a powerful safety net, offering peace of mind and security to entrepreneurs.

If you have employees that drive around on company business, affording yourself additional liability coverage has a lot of benefits.  My employees do drive around to pickup documents from various clients.  I incorporated around the time this was starting up.

2. You Pick How You Want To Be Taxed

This is something that I don’t see a lot of on various “Why You Need an LLC” articles. There are two types of LLC’s you can choose from.

A Single Member LLC (SMLLC) or a Multi Member LLC (MMLLC) are the two types of LLC’s you can pick from.

A Single Member LLC is reported on Schedule C when you file your taxes.  This designation is chosen if there is only one principal to the business. This is the default selection for a one person business.

A MMLLC is a partnership and reported on form 1065.  This is a separate return from your personal return.  Form 1065 will produce K1’s for each partner.  The info on the K1’s is used to prepare each partners individual return.  A K1 is kind of like a W2 for partners.

So far, you can report your LLC’s tax activity as a Sole Proprietor or a Partnership.  You can also elect to be taxed as a corporation by filing form 8832 – Entity Classification Election.

Once you elect corporate status, you then need to decide if you want to be an S Corp or a C Corp.

How you file will depend on your personal (and your partners if any) tax and financial situation.

I’ll write an article on how to choose your entity later.

3. Easy Management Structure

Compared to a corporation, an LLC has much less required annual maintenance.  Other than a tax return, the only other thing you need to do to maintain your LLC status is generally file an information return with your state Secretary of State every other year.  This is also required for corporations, but not for unregistered businesses.  Most business not an LLC or Corp are considered unregistered.

A corporation is required to maintain minutes of shareholder meetings.  Most states require at a minimum, one annual shareholders meeting.  LLC’s have none of these requirements.

4. You’re a REAL BOY Business now!

This reason is the primary reason people form LLC’s, and it’s not a bad reason.  Housing your business in an LLC or corporation tells the world that you are serious about your business.

The cost to form an LLC on MyCorporation.com (it’s who I use) is around $500, l if you do it yourself.  It’ll cost upwards of $2,500 to have an attorney do this for you.  You could probably find a better use of your money this early into your venture.

But.  Perceptions are real.  An LLC appears more like a real business than someone selling oranges out of his trunk.  It’s a perception.  It may not even be real.  The guy selling oranges might have 1,000 other people selling his oranges out of their trunks.  That’s a real business.  But the perception is less than.

Getting financing or other funding is also easier if you are a registered entity, such as an LLC.

Three Important Reasons Why You Don’t Need an LLC

1. Additional Cost and Other Troubles

Setting up an LLC costs money.  Depending on your needs it can cost upwards of $2,500.

In California (and in other states as well) there is an LLC Gross Receipts fee.  They also charge a minimum tax of $800 each year, regardless of whether you have taxable income or not.

You can also count on a higher tax preparation fee.  A Single Member LLC is reported on form Schedule C on your federal return, but there may be additional returns needed at the state level.  These state level returns add at least an additional $250 to your return prep costs.

If you elected to be treated as a Multi Member LLC or as a Corporation (S or C) you can count on an even higher fee to prepare the LLC’s own return.  An properly prepared LLC or corporate return will usually start at around $800.

2. Ever See an LLC as an IPO?

I love LLC’s.  I think they are the perfect entity to hold your business.  You have the liability protection of a corporation, without a lot of the compulsory rules that make having a corporation too much for a small business.

But what if your dream is to build a business, sell it, then build another?  You want the life of a serial entrepreneur.  In this case, an LLC may not be the best choice.

You can absolutely sell your business if it’s not in an LLC or Corporation.  But you won’t receive proper value.  And generally the tax code has more ways to save on taxes if you  sell from a corporation.  Under some circumstances, you could even sell your corporation and reinvest the funds into another small business stock, without paying tax on any possible gains.

Compliance, compliance, compliance.  The biggest headache when having an LLC is the amount of compliance and record keeping that is required.

Let’s talk about record keeping.  Keeping books.  You are required to keep a full general ledger set of books.  A balance sheet, profit and loss, and maybe a cash flow statement are what you should aim for.

Maintaining a good, solid, accurate set of books is essential to running a business.  No one can tell how their business is doing just from “touch”.  Running your business from the seat of your pants is a slow walk to insolvency.  How can you make educated decisions without accurate information?

Compliance is actually the easy part.  Your state Secretary of State will require your LLC to file an information return every (or every other) year.  This is needed so the state has a record of your officers or managers on file.

Conclusion

Do you need an LLC?  Why?  Are you planning on growing, then selling your business?  Have you given any thought to your long term plans?  Do you have a need to protect assets not in use or owned by your business?

The decision to form an LLC to hold your business and its assets is usually the right choice.  The only fault I can find in forming an LLC and using it to hold your business, is the timing.

Here’s what I look for when determining whether an LLC is a proper choice.

  • What is the basis for your business (service or selling product)?
  • What personal assets needs protecting (home, real estate, savings)?
  • Along the same lines, how much income from other sources will you have?
  • What are your long term plans (grow, sell,…)?
  • Will you have employees out in the field?
  • What other kind of liability exposure are you concerned with?

When I mentioned timing above, I mean “When did you form the LLC?” and “Why did you choose that time to form the LLC?”

If you are in business as your livelihood (not some part time gig type endevor) and growth, and possibly passing the business on to heirs are some of your biggest concerns, you will be forming an LLC (or a corporation) eventually.  But there’s no hurry.

I’m not a fan of wasting money on unnecessary expenses.  If you’re serious about starting and growing a business, you will be forming an entity at some point.  Don’t do it before you need it.

Simplified Auto Expense Deduction Rules for the Frugal Entrepreneur in 2023

Don’t be afraid to take the auto expense deductions the law allows, even if the IRS scares the bejesus out of you!

I’ve been self-employed for close to 35 years and one of the first things I learned were the rules for auto expense deductions (gotta learn how to deduct that Dream Porsche!  Damn The Tax Reform Act of 86!).

The aforementioned Tax Reform Act of 1986 (referred as TRA86) started the higher scrutiny on what is and what is not deductible in regards to automobiles. This is our starting point with defining the auto expense deduction rules that will give you the biggest deduction.

1986 introduced the concept of a Luxury Vehicle (anything that cost more than $25k if you can believe it) and the rules for deducting high priced cars.

We’ll also learn about leases and how they are accounted for with a weird little twist at the end.

This article will provide a comprehensive look at auto expense deduction rules for self-employed individuals in 2023.

We’ll cover eligibility, types of deductible expenses, calculation methods, special considerations, record-keeping and reimbursements.

What Are The Rules for Auto Expense Deductions?

Obviously you need to be self-employed and use your car for business purposes. The vehicle can be either used exclusively for business (think like a plumbers van full of knobs and hoses and toilet stuff) or used for both personal AND business purposes (my Porsche which I might take a Sunday drive with). There is no deduction allowed unless there is a business purpose.  Personal vehicles expenses aren’t deductible other than part of the annual state registration.

What Auto Expenses Are Deductible?

Track all expenses.  Gas, oil changes, car washes, repairs and maintenence, registration, parking and tolls, monthly payments…

Track it all.  You may not be able to write it all off, but you might be able to get a bigger deduction if you do.

If you purchased the car, you can write off the interest (not the entire payment) and take depreciation.  If you are leasing the car, you can take the entire lease payment, but you’ll have to add back a “Lease Inclusion” amount based on the fair market value of the vehicle.  Leases will be explained in more detail in the next section.

Leases and why they exist

Leasing a car as a business decision can be a good thing.  A lot of people use them to “have” a nicer car than they can afford.  You’re basically renting a car long term.

This example will be for a vehicle less than 6,000 lbs GVWR (Gross Vehicle Weight Rating).  Vehicles with a GVWR over 6,000 lbs are treated differently.  I’ll discuss this a little later on in the article.

Leasing For a Business?

But leases for a business are another story.  When you purchase a car you are able to depreciate that vehicle over 5 plus years.

When you lease a car, you get to deduct the lease payments less a small amount called the Lease Inclusion.  The IRS publishes tables showing how much you must add back, based on the FMV of the vehicle.

This usually results in a larger auto expense deduction than depreciation.  But the cost of leasing the car is generally more than if you buy.

Let’s pretend you are buying a delivery van with a retail price of $50k.  At 8% over 5 years, your loan payment will be around $1,000.  If you were to lease that same van, your lease payment would be a lot less, say $650 a month.

On the surface, this looks like a great deal.  $650 is a lot less than $1,000.  But what are you getting?

At the end of the lease, you have the option of buying the car (or what’s called the residual value, which was established when you initially leased the car.  This is generally around 50-60% of the original asking price,  So after leasing the car for 48 months (I usually recommend no more than 36 month terms), you can buy it for $25-30k.

You’ve paid $31,200, the car is 4 years older and they want you to pay $30k to keep the car.  From a financial perspective, this is a lousy deal.

As a business owner, the ability to deduct the actual lease payments generally gives you a better deduction, even when taking depreciation into consideration.  It would be to your advantage to do a buy or lease comparison prior to plunking down your hard earned cash.

Vehicles with an over 6,000 lb GVWR

This is only an issue if you purchase the car (not lease).

If a vehicle has a GVWR of over 6,000 lbs its generally a large or midsize SUV or truck.  A vehicle with a 6,000 GVWR is treated differently and has the ability to deduct much more than vehicles with a GVWR under 6,000.

Vehicles above the 6,000 lb limit have the ability to take more depreciation via Section 179 or Bonus Depreciation rules for 2023.  For 2023 the max section 179 deduction allowed is $28,900.  Under the 6,000 lb threshold, the maximum depreciation you can take the first year is $20,200 (including $8,000 in bonus depreciation).

Calculation Methods for Auto Expense Deductions

Self-employed individuals have two primary methods for calculating auto expense deductions:

  • Standard Mileage Rate Method:
    • The IRS sets a standard mileage rate for each tax year. For 2023, the standard mileage rate is 65.5 cents per mile (this can change mid year like it did in 2022).
    • Self-employed individuals can deduct the business-related mileage by multiplying the total business miles driven during the year by the standard mileage rate.
  • Actual Expense Method:
    • Under this method, self-employed individuals can deduct the actual expenses incurred for the business use of the vehicle. This includes fuel, repairs, maintenance, insurance, depreciation, and other eligible expenses.
    • To use the actual expense method, detailed records of all vehicle-related expenses must be maintained.

Choosing Between Standard Mileage Rate and Actual Expense Method

Miles?  Or actual costs?  Which is higher?

The mileage rate for 2023 is $ .655 per mile.  Drive 20,000 miles for business and you get a $13,100 mileage deduction.

But what were your actual costs?  Repairs, insurance, registration, gas and oil.  Depreciation?  Which is higher?  Doesn’t matter.  Whichever gives you the biggest deduction is the one you get.

The one thing to be aware of, if you do want the option to switch between mileage and actual cost, you must use mileage the first year you use the car for business.

Special Considerations for Luxury Vehicles

Luxury vehicles are treated a little differently in an attempt to not allow people to abuse the tax code and write off a $300k Lamborghini.  Luxury vehicle limits are $58,000 for 2023.  If you purchase a car that cost over $58,000 and has a GWVR under the 6,000 lb threshold, there are special rules involved.

The max allowable depreciation, section 179 and bonus depreciation are all limited.  It’s very likely you will be depreciating a $100k vehicle for up to 13 years.  Car’s are generally depreciated over 5 years.

You MUST Keep Good Records

Accurate and detailed record-keeping is vital when claiming vehicle expense deductions

Get an app for your phone that tracks mileage.  I use MileIQ, but QuickBooks Online has one available as part of its software package.

Stay current with your miles tracking.  Make sure you go out every week and identify business versus personal miles.

Always use a credit or debit card when paying for your vehicle’s expenses.  Cash expenses are harder to prove, even with a receipt.  We have to think like an IRS auditor here.  If you were an auditor, would you be satisfied with your records?

State-Specific Rules to Know

I will admit I have to look up the various state rules I don’t know (I’m in CA).  Most states allow you to deduct your vehicle expenses in the same manner as the feds.  Some are just plain strange and take a percentage of SOME of the expenses.

What I have noticed is they all play off the federal calculation in some way.  This is just one more reason to properly track our total vehicle costs. 

Conclusion

Deducting your vehicle expenses is one of the most scrutinized areas of an IRS auditor.  Knowing the rules and keeping good records will go a long way in keeping you out of trouble in the event of an audit.

There are different rules as to what’s deductible depending on whether you purchased or leased the car.

The type of vehicle also matters.  Cars with a GWVR under 6,000 lbs, cars between 6,000 and 14,000, and vehicles with a GWVR over 14,000 all have a different set of rules.

Make sure you track all your mileage in a contemporaneous manner.  I recommend you put an app on your phone (I use MileIQ) that utilizes the GPS function your phone has.

MileIQ will log all your trips and save the data to their website.  You can then go out to your log and note which trips were for business and which were personal.

At year end you can print a report to help prepare your taxes.