Traveling Nomad: Tax Benefits And Drawbacks

As a digital nomad, you are required to pay taxes, and the process can be complicated. The US, for example, taxes its citizens based on citizenship rather than residence, meaning that even if you live and work abroad, you are still required to file a US tax return and may owe US taxes. This is further complicated by the fact that different countries have different tax systems, and you may be taxed in multiple countries. Understanding the tax laws of the countries you spend time in is crucial to ensure compliance and avoid penalties.

US citizens and taxes abroad

US citizens are required to file income tax returns, estate tax returns, and gift tax returns, and pay estimated tax in the same way as those residing in the US. This is because the US uses citizenship-based taxation (CBT), meaning that US citizens are taxed on their worldwide income regardless of where they live and where the income was earned.

US citizens living abroad are also required to report any foreign bank and financial accounts to the US Treasury Department, even if these accounts do not generate taxable income. This can be done by filing a Report of Foreign Bank and Financial Accounts (FBAR) electronically by 18 April 2022.

US citizens who qualify as digital nomads—Americans who frequently travel or live abroad while working remotely—are also subject to the same tax requirements as those living in the US. However, they may be eligible for tax benefits such as the Foreign Earned Income Exclusion (FEIE) and Foreign Tax Credit to avoid double taxation and reduce their US tax bill.

To qualify for the FEIE, digital nomads must pass either the physical presence test or the bona fide residence test. The physical presence test requires spending more than 330 full days outside of the US during any 12-month period, while the bona fide residence test requires establishing a residence in a foreign country for an entire calendar year with no plans of returning to the US in the foreseeable future.

It is important to note that US citizens living abroad may still be subject to state taxes depending on their previous state of residence. Some states impose state taxes on former residents if they still have ties to the state, such as a driver's license, vehicle registration, or bank account. To avoid this, digital nomads may consider relocating to a state with more favourable tax benefits before travelling abroad.

Overall, US citizens living and working abroad must navigate complex tax requirements and consider various factors such as their income, foreign tax credits, and state residency to ensure compliance with US tax laws.

State taxes

Some states, like Florida and Texas, have no state income tax, while others, like California and New York, have high state income tax rates. This means that even if you are a resident of a high-tax state but spend most of your time in no-tax states (or outside the US), you may still be liable for state taxes in your resident state.

Furthermore, some states have a 'convenience of the employer' rule, which means you could be subject to state taxes if you work remotely for a company based in that state, even if you are not physically present there.

When it comes to state taxes, the specific rules and requirements can vary widely from state to state. For example, some states may impose taxes on individuals who have a driver's license, own property, or are registered to vote in that state. This can create a complicated situation for digital nomads who may have ties to multiple states.

To avoid potential issues with state taxes, some digital nomads choose to relocate to a state with more favourable tax laws before beginning their travels. For instance, the Akpans, mentioned earlier, adopted Florida as their domicile state due to its lack of state income taxes.

It is essential for digital nomads to understand the tax laws and requirements of the states they are associated with or plan to spend significant time in. Consulting with a tax professional who is well-versed in state tax laws can be extremely beneficial in navigating these complexities and ensuring compliance with the relevant regulations.

Self-employment taxes

Self-employed individuals are generally required to file an annual income tax return and pay estimated taxes quarterly. Self-employed individuals must also pay self-employment (SE) tax, which is a Social Security and Medicare tax for individuals who work for themselves. The self-employment tax rate is 15.3% for the 2023 tax year, consisting of 12.4% for social security and 2.9% for Medicare. For 2024, the self-employment tax rate remains the same, but the threshold for the Social Security portion increases to the first $168,600 of earnings.

To determine if you need to pay self-employment tax, your net earnings from self-employment (excluding church employee income) must be at least $400. If you had church employee income of $108.28 or more, you must also pay self-employment tax.

You can use Schedule C to calculate your net earnings from self-employment and Schedule SE to calculate how much self-employment tax you owe. It is important to note that you may need to make quarterly estimated tax payments throughout the year if you expect to owe a certain amount in federal income taxes.

Additionally, you can deduct half of your self-employment tax on your income taxes. This means that if your Schedule SE indicates that you owe $2,000 in self-employment tax for the year, you can deduct $1,000 on your 1040 tax form.

Furthermore, self-employment can provide various tax deductions, such as the qualified business income deduction, which allows you to deduct up to 20% of your self-employment net income. Other deductions include those for your home office, health insurance, and more.

It is always recommended to consult with a qualified tax professional or advisor to ensure you are complying with all relevant tax laws and taking advantage of applicable deductions.

Foreign tax obligations

Whether or not you will be taxed in a foreign country depends on whether you are a tax resident of that country or earn income sourced from that country.

Most countries have a residence-based taxation system, meaning they tax individuals based on their tax residency. Typically, a country will tax its residents on their worldwide income, while taxing non-residents only on the income sourced within that country.

To determine your tax residency status, you must refer to the specific criteria set by each country. One common rule across many countries is the 183-day rule, which states that if you spend more than 183 days in a country within a tax year, you are generally considered a tax resident. However, each country has its own unique rules and criteria for determining tax residency, which can include factors such as the number of days spent in the country, employment status, and the location of your main home.

Even if you are not a tax resident, you may still be taxed on income earned within a country's borders. This is known as local source income or territorial taxation. For example, if you rent out a property in Country A, you will likely be taxed on that income by Country A, even if you are not a tax resident there.

Some countries may also have specific rules and regulations in place to prevent tax avoidance, so it is important to understand the tax laws of each country you plan to spend significant time in or earn income from.

To avoid double taxation, which occurs when two or more countries require an individual to pay taxes on the same income, many countries have tax treaties or double tax agreements in place. These agreements set out rules to determine which country has the right to tax certain types of income or how taxation rights are shared between countries.

As a digital nomad, it is crucial to understand your tax obligations in each country you plan to work in or earn income from. This may involve seeking professional advice from a tax specialist or accountant with experience in international tax issues.

Tax benefits

Being a digital nomad comes with a unique set of challenges, including navigating complex tax laws and requirements. While the tax obligations of digital nomads can vary depending on their country of citizenship, residence, and income sources, there are some tax benefits that may apply broadly to this group. Here are some key tax benefits that digital nomads should be aware of:

Foreign Earned Income Exclusion (FEIE)

The FEIE is a significant tax benefit offered to US citizens and residents who live and work abroad. It allows them to exclude a certain amount of their foreign-earned income from US taxation. For the 2024 tax year, the exclusion limit is set at $126,500. This benefit is particularly advantageous for digital nomads as it can significantly reduce their US tax liability. However, it's important to note that the FEIE only applies to earned income, such as self-employment income, and not unearned income like social security payments.

Foreign Housing Exclusion/Deduction

In addition to the FEIE, digital nomads may also be eligible for the Foreign Housing Exclusion or Deduction. This benefit allows Americans living abroad to deduct certain housing expenses, such as rent and utilities, from their US taxable income. However, there are specific requirements that must be met to qualify for this exclusion, such as having qualified housing expenses and paying these expenses from employer-provided income.

Foreign Tax Credit (FTC)

The FTC is another powerful tool for digital nomads to reduce their US tax liability. It allows them to claim dollar-for-dollar tax credits on foreign income tax payments, which can be applied to their US tax bills. This benefit is especially useful for digital nomads who pay higher income taxes in their country of residence than they would in the US. By claiming the FTC, they can eliminate their US tax liability and even receive tax credits for future years.

Tax Treaties and Double Tax Agreements

Digital nomads should also be aware of tax treaties and double tax agreements between their country of citizenship and the countries in which they work or reside. These agreements are designed to avoid double taxation, where the same income is taxed by two different countries. While the specifics of these treaties can be complex, they can provide significant tax benefits to digital nomads by clearly outlining the taxation rights of each country involved.

Digital Nomad Visas and Tax Advantages

Some countries have introduced digital nomad visas to attract remote workers. These visas often come with tax advantages, such as exemptions from certain types of taxes or favourable flat tax rates. For example, Portugal offers a Digital Nomad Visa that provides tax benefits, while countries like the Bahamas and Georgia have territorial tax systems, only taxing income earned within their borders.

In conclusion, while the tax obligations of digital nomads can be complex and vary depending on their specific circumstances, there are several tax benefits available that can help reduce their overall tax liability. It is important for digital nomads to carefully consider their tax residency, income sources, and the tax laws of the countries they work in or reside to maximise these benefits and ensure compliance with tax regulations.

Frequently asked questions