Digital nomad taxes: Tackling US and international tax obligations for remote workers

The digital nomad lifestyle offers a world of freedom – literally.

Working from beaches, bustling cities, or serene mountain retreats sounds like a dream, but this dream can turn into a nightmare if you overlook your tax obligations.

Digital nomads, who frequently travel or live abroad while working remotely, face unique tax challenges, both in the US and abroad.

Let's break down the essentials of digital nomad taxes to help you stay compliant and, most importantly, keep your hard-earned cash.

Understanding US tax obligations for digital nomads

As an American citizen or green card holder, the US taxman has a long reach. The US is one of the few countries that taxes its citizens based on citizenship, not residency.

So, even if you're living your best life in Bali, sipping coconut water by the beach, you're still expected to file a US tax return if you meet the income threshold.

Filing requirements and thresholds

The IRS requires all US citizens and green card holders to file an annual tax return if they earn above a certain amount.

The filing thresholds vary depending on your age, filing status, and income type. For digital nomads who are often self-employed, the threshold is surprisingly low – just $400 in net earnings for the year.

Pro tip: While living abroad, US citizens get an automatic two-month filing extension, pushing the deadline to June 17, for the previous tax year. However, any taxes owed must still be paid by the usual April 15 deadline to avoid interest. If you need more time, you can request an extension until October 15.

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Managing self-employment taxes

Most digital nomads are self-employed freelancers or run their own small businesses. This setup is great for flexibility but comes with additional tax responsibilities.

Apart from the regular income tax, you'll also owe self-employment taxes, which fund Social Security and Medicare. The self-employment tax rate is a whopping 15.3%.

To avoid paying double tax on the same income, you may want to look into Totalization Agreements. These agreements between the US and other countries prevent digital nomads from paying into two social security systems simultaneously.

The US has such agreements with over 30 countries, including Canada, the UK, Australia, and Germany.

Reducing your US tax bill: key benefits for digital nomads

The US tax code does provide some relief to digital nomads in the form of tax benefits designed to prevent double taxation and help you keep more of your earnings.

Here are the two most common benefits:

1. Foreign earned income exclusion (FEIE)

The Foreign Earned Income Exclusion (FEIE) allows digital nomads to exclude a certain amount of their foreign-earned income from US taxation.

For the 2024 tax year, the exclusion is up to $126,500. To qualify for the FEIE, you must meet one of two tests:

• The Physical Presence Test: This test requires you to spend at least 330 full days outside of the US in a consecutive 12-month period. This is the easier test for most digital nomads to meet since they frequently travel and work abroad.
• The Bona Fide Residence Test: This test is for digital nomads who establish residency in another country for at least an entire tax year. However, this is more suitable for those planning to stay long-term in one location.

Pro tip: Remember, FEIE only applies to earned income like wages or freelance work – not passive income such as dividends or rental income. Also, this exclusion doesn’t exempt you from paying self-employment taxes.

2. Foreign tax credit (FTC)

If you're paying income taxes to another country, the Foreign Tax Credit allows you to claim a dollar-for-dollar credit against your US tax liability for taxes paid to a foreign government.

This is a valuable tool for avoiding double taxation. However, note that the FTC cannot be claimed on income excluded under the FEIE.

Example: Imagine you owe $10,000 in US taxes but already paid $13,000 in taxes to Germany. You can use the $10,000 as a credit to eliminate your US tax bill and carry the remaining $3,000 forward to future tax years.

State taxes: sticky states and how to escape them

While federal taxes are unavoidable, some digital nomads forget about the sticky situation of state taxes.

Certain states, like California, New York, and Virginia, are notorious for their tight grip on former residents, making it difficult to break tax ties even when you're far, far away.

How to sever state tax residency

To avoid being taxed by your former state of residence, you need to prove that you have cut significant ties.

Here are a few steps to take:

1. Sell any property you own in the state.
2. Close any local bank accounts.
3. Cancel your voter registration and driver's license.
4. Update your mailing address to a location outside of that state, preferably in a tax-friendly state like Florida or Texas.

For more details, you can check the guidelines on your specific state’s official tax website or consult with a tax advisor.

Foreign tax obligations and digital nomad visas

Digital nomad visas are all the rage, with countries like Spain, Portugal, and Thailand offering special visas to attract remote workers.

These visas can offer tax benefits, but they also come with their own set of rules.

Understanding residence-based taxation

Most countries tax based on residency. If you stay in one country long enough – typically over 183 days – you may become a tax resident, subject to taxes on your worldwide income.

It’s essential to understand these rules and plan your stay accordingly.

For example, some countries offer flat tax rates for digital nomads, like Spain’s 24% flat rate, while others may provide full or partial tax exemptions.

Pro tip: Always read the fine print of your digital nomad visa to understand the tax implications. Some visas come with tax benefits, but not all. For instance, Malta’s digital nomad visa exempts holders from Maltese income tax.

Double tax treaties and social security agreements

To avoid double taxation, it’s crucial to be aware of any tax treaties between your home and host countries.

These treaties often define which country has the right to tax certain types of income and can provide exemptions or credits to minimize your tax liability.

Likewise, Totalization Agreements can help digital nomads avoid double-dipping into social security systems.

The complexities of corporate taxes for digital nomads

For those running their own businesses, the tax landscape becomes even more complex.

Employing yourself in a foreign corporation, depending on the country, might help you reduce your tax liability, but it comes with risks.

A permanent establishment can be created, potentially exposing your business to corporate taxes in another country.

If you’re considering setting up a foreign corporation, it’s best to consult a tax expert who can help navigate these waters. As the OECD explains, understanding the concept of a "permanent establishment" is crucial for businesses operating across borders.

Staying compliant with reporting requirements

The US government has a wide reach when it comes to monitoring Americans' foreign financial activities, thanks to the Foreign Account Tax Compliance Act (FATCA).

If you have more than $10,000 in foreign financial accounts, you'll need to file an FBAR (FinCEN Form 114).

This requirement includes not just bank accounts but also digital payment platforms like Wise or Revolut.

Don’t forget Form 8938

Americans with foreign financial assets exceeding $200,000 on the last day of the tax year (or $300,000 at any point during the year) must file Form 8938 (Statement of Specified Foreign Financial Assets) along with their tax return.

This form helps the IRS keep track of US citizens' foreign assets.

Final thoughts: don’t go it alone

Digital nomad taxes are not a "one-size-fits-all" scenario. Your tax obligations will vary based on your income sources, countries visited, and length of stays, among other factors.

Consulting with a tax professional, especially one experienced in expat and digital nomad taxes, is often the best approach to avoid costly mistakes and stay compliant.

While the digital nomad lifestyle offers unparalleled freedom and adventure, staying on top of your tax obligations will ensure that you keep those adventures going – without any unexpected knocks from the tax authorities back home or abroad.