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