Working remotely offers freedom and flexibility, but it also comes with special considerations for digital nomad taxes.
Whether you’re relaxing on the beach in Thailand or admiring the Azulejo tiles that characterize Lisbon’s architecture, understanding and managing tax responsibilities is necessary for all US expats. Although digital nomads tend to be discussed as a cohort separate from US expats, when it comes to taxes, both groups share the same obligation to file an annual tax return with the IRS.
This applies to any US citizen or green card holder who may be living abroad as an expat or digital nomad.
In the following guide, we dig into:
- When and why taxes apply to Americans living abroad
- How digital nomad taxes may be more complicated than those of other US expats
- How to stay (or get) compliant
- Navigating state tax filing obligations
- Why aligning with a US expat CPA is a smart move from a compliance and financial perspective
Let’s kick off with what is perhaps the most timeless digital nomad question: How do taxes work for digital nomads?
Do digital nomads pay taxes?
Frustratingly, the honest answer to this question, (and, to be blunt, most tax questions), is, “It depends.”
The IRS has a set minimum income threshold determining whether US expats must file. The threshold increases every year to account for inflation.
For single, non-self-employed individuals under 65, the threshold for the 2022 tax year — aka the taxes you’ll file during the 2023 calendar year — is $12,550.
However, the threshold for self-employment income is just $400.
Historically, the self-employment figure has been one to watch for digital nomads. But, the rise in remote working possibilities means that digital nomads need to be diligent about understanding both their employment status (W2 or independent contractor) and how that informs which threshold they’re concerned with.
The minimum filing threshold also varies depending on certain factors, such as age, marital status, and whether or not you’re the head of the household.
If you are a digital nomad and US citizen or green card holder residing abroad who earns above the minimum filing threshold, then you are legally obligated to file a US tax return.
The good news, however, is that you may not necessarily owe any money in US taxes.
We’ll dig into that soon, but first, let’s look at why American digital nomads and green card holders are required to file an annual tax return with the IRS. (Hint: The answer lies within the taxation schema the US uses.)
The US is one of only two countries in the world to use citizenship-based taxation (the other being Eritrea). Under this system, a country taxes its citizens and permanent residents on worldwide income no matter their location. So regardless of where in the world a US citizen or green card holder resides, if they earn above the minimum filing threshold, they must file a US tax return with the IRS, even if they expect to owe $0 in US taxes.
Residence-based taxation, on the other hand, is a tax system that taxes individuals based on their residency status in a particular country, regardless of their citizenship. This means that residents are subject to the country’s tax laws on their worldwide income, while non-residents typically pay taxes only on income earned within that country.
More than 130 countries use this system of taxation, including most of the EU, Canada, Japan, and Australia.
Taxes for digital nomads outside the US
It’s not uncommon for digital nomads to think that the US won’t be able to track their tax obligations because they move so frequently.
However, the US has a wide global reach due to the Foreign Account Compliance Act (FATCA). Among other things, this legislation mandates that foreign financial institutions (FFIs) share the account information associated with all of their US clients.
Some countries are pushing back against this requirement, but for the moment it remains relatively easy for the US government to track the financial activity of its citizens and green card holders overseas. If you’re having an unlucky day, the IRS could tap you at random for missing tax returns – and assess financial penalties.
Cross-border tax considerations for US-based digital nomads
Looking up the tax implications of being a digital nomad may not be as fun as looking up places to go and things to do, but it’s important nonetheless. Different countries have very different tax laws. If you neglect to do your homework beforehand, you risk having much of the wealth you’ve built abroad reduced by taxes, IRS penalties, and/or professional service fees.
Navigating US state taxes as a digital nomad abroad
Whether you continue to pay state taxes as a digital nomad will vary from case to case.
Two factors help determine if you still need to file state taxes while abroad:
- The US state you have financial ties to (read: a rental property, accounts, business interests), and/or
- the US state where you last resided before going overseas.
Different US states have their own tax regulations on residents. Some of the most strict ones include:
- California: You may owe taxes ranging from 1% to 12.3% if
a) you earn income sourced from California or
b) you maintain enough ties to the state to be considered a tax resident.
- Virginia: You may owe taxes ranging from 2% to 5.75% if
a) you earn income sourced from Virginia or
b) you previously lived in Virginia and have not provided proof of a change in domicile.
- South Carolina: You may owe taxes ranging from 0% to 6.5% if
a) you earn income sourced from South Carolina
b) you maintain enough ties to the state to be considered a tax resident
c) you intend to make South Carolina your permanent home or
d) you intend to return to South Carolina at some point.
- New Mexico: You may owe taxes ranging from 1.7% to 5.9% if
a) you earn income sourced from New Mexico
b) you previously lived in New Mexico and have not provided proof of a change in domicile or
c) you spend (or previously spent) 185 days out of one calendar year in New Mexico and have not provided proof of a change in domicile.
If you don’t want to be liable for state taxes abroad, you might consider moving to a US state with a low tax rate before leaving the country
Here’s a list of states that don’t charge income tax on their residents:
- South Dakota
Where to pay taxes as a digital nomad
Many digital nomads and US expats choose to base themselves out of one of the income tax-free states above for tax purposes. There are a couple of primary ways to do so.
You can prove that you intend to make one state your permanent home by fulfilling the following administrative actions within your target state:
- Purchasing property
- Conducting business
- Keeping your belongings there
- Proving your family’s residence
- Adding your in-state address to official documents
- Updating your driver’s license and voter registration
- Opening a bank account
- Holding a deed to property.
This is done by spending enough time in a state to be considered a resident (often at least 183 days, but rules vary from state to state). Anything that proves your physical presence, such as credit card transactions, ATM usage, travel itineraries, phone records, etc. can help support your case.
⚠️ Tread carefully here:
183 days is generally the amount of time required to spend in another country in order to fulfill tax residency status and thus qualify for IRS US expat tax provisions such as the Foreign Tax Credit and Foreign Earned Income Exclusion. We recommend confirming your residency approach to state-based taxation with a US expat tax accountant knowledgeable about your target state for tax purposes.
Do you pay self-employment taxes as a digital nomad?
Many digital nomads don’t work remotely for an employer but are instead self-employed entrepreneurs who manage their own businesses.
Most of the time, these individuals must pay US self-employment taxes, including a Social Security tax of 12.4% and a Medicare tax of 2.9%.
It is possible, however, to incorporate your business in a way that you pay corporate taxes vs. self-employment taxes (more on that later).
Additionally, whether you pay Social Security taxes to the US can depend on which country you reside in. Twenty-four countries throughout the world have Totalization Agreements with the US. According to these agreements, you will pay Social Security taxes to either the US or the country you’re residing in — not both — depending on how long you plan to live in that country.
If you’re not residing in a country with a totalization agreement with the US — or you’re not residing permanently in any one country, as is the case for those who live a truly nomadic lifestyle — you’ll pay Social Security taxes to the US.
How to set up your US business entity as a digital nomad
US expats working as freelancers, entrepreneurs, small business owners, independent contractors, and other types of self-employed workers often choose to incorporate their businesses in the US for tax purposes. Some of the most popular options include:
- Sole Proprietorship: For businesses owned and operated by one single person or a married couple; all business income and loss are reported on your personal income tax return.
- General Partnership: For businesses owned and operated by more than one person, each of whom shares profits and debts; all business income and loss are reported on personal income tax returns.
- Limited Partnership: For businesses owned and operated by more than one person. Partners are either general (actively sharing in income and loss) or limited (investors only). Limited partners have less legal and tax liability, while general partners have greater control of business operations.
- Limited Liability Corporation (LLC): A business entity that limits liabilities for owners while giving them the option to be taxed on their personal tax returns or as a corporation.
- S Corp: A business entity that limits liability for owners with business income and loss reported on their personal income tax returns. Lower self-employment taxes, but typically more complex and expensive to file.
- C Corp: A business entity that limits liability for owners and requires them to file a separate corporate tax return. No self-employment taxes, but typically more complex and expensive to file.
Many small business owners turn to online solutions like ZenBusiness, IncFile, or LegalZoom to form their business entities. However, digital nomads often have special considerations to take into account due to their frequent movement, so we recommend setting yourself up for financial success by proactively collaborating with a US expat tax accountant to advise you on the best small business entity for you and your circumstances.
Digital nomad payroll considerations
If you are employed by a company while living abroad, your paycheck will likely look a bit different than it did when you were based in the US. That’s because US companies whose employees are officially residents of another country must comply with that country’s labor laws and tax system. Some changes you could see include:
- Different income tax rates: Many other countries have higher income tax rates than the US, so your paycheck may be smaller than you’re used to after taxes are withheld
- Social security contributions: Depending on how long you intend to stay in a country — and whether or not the country you’re living in has a totalization agreement with the US — you may be expected to contribute to their social security system instead of (or in addition to) the US system.
It’s worth noting that some employers are hesitant to employ digital nomads due to the additional legal and financial complications it can trigger. So, before you set off on your adventure, make sure you confirm with your employer that they’re on board with the arrangement.
Many companies are hesitant or reluctant to allow their employees to adopt a nomadic lifestyle because it’s something they simply don’t understand. Set yourself up for success by identifying a place abroad where you can work without any legal or financial implications for your company, and propose a short time frame to trial remote work.
How to pay taxes as a digital nomad
Below is a sampling of the most common tax provisions that help reduce (and often eliminate) US taxes owed to the IRS.
Digital nomad tax provisions
While digital nomads still have to pay their US taxes while overseas, they do benefit from various tax exclusions and deductions. These include:
Foreign Earned Income Exclusion (FEIE)
With the Foreign Earned Income Exclusion (FEIE), digital nomads can exclude a certain portion of their income earned overseas from US taxable income — $112,000 for tax year 2022, and $120,000 for tax year 2023. Digital nomads must meet one of these two tests to be eligible for FEIE:
Bona Fide Residence Test: If you are a tax resident of a country and are subject to the taxation laws of that country, then you can file an FEIE report on your tax return, as long as you’ve lived there for at least one calendar year.
Physical Presence Test: Another way to be eligible for the FEIE is to prove that you’ve been outside the US for 330 days in any 365-day period. (This doesn’t necessarily have to be a calendar year.)
FEIE-compliant digital nomads will also be able to come to the US for vacations and holidays, as long as they don’t make any moves that would indicate to the IRS that they intend to take up residence there again.
That said, it’s worth noting that the FEIE doesn’t apply to unearned income such as interest, dividends, or pension income.
Foreign Tax Credit (FTC)
If you’re a resident of a foreign country and pay income taxes in your new home country, the Foreign Tax Credit (FTC) allows you to deduct those tax payments from your US tax bill. For example, let’s say you owe $2,000 to the US but already paid a $500 tax credit to Spain. With the FTC, you can subtract that $500 you paid to Spain from your US tax bill, and end up owing the US government just the remaining $1,500 in taxes.
Worldwide, the number of people who identify as digital nomads is growing, and countries are vying to attract them
After the explosion in remote work brought on by the COVID-19 pandemic, there are more digital nomads than ever. Some 16.9 million American workers described themselves as digital nomads in 2022, up from 7.3 million in 2019 — a whopping 131% increase. Many of these workers are younger, predominantly Millennials (47%) and Gen Z (17%).
So where exactly are these digital nomads choosing to move?
Here are a few of the top locations
- Portugal: Between a dedicated digital nomad visa that includes tax benefits (0% tax on foreign-sourced income and 20% on domestic-sourced income) and the low cost of living, pleasant year-round weather, and rich culture, digital nomads are flocking to this Southern European country.
- Malta: This small island nation offers digital nomads crystal-clear waters, ancient ruins, and a high level of English fluency. Their recently-launched digital nomad visa also boasts exemption from Maltese taxes.
- Thailand: Named one of the best countries to travel to in the world by Condé Nast Traveller, US News & World Report, and Insider.com (among many others), digital nomads in Thailand love the low cost of living, tropical climate, beaches, food, and gorgeous, historic temples.
- Croatia: Beyond offering a pleasant Mediterranean climate, 1,000+ islands, and beautiful historic cities — some of which you might recommend as key filming locations in Game of Thrones — Croatia has a special digital nomad visa that offers total tax exemptions for digital nomads.
- Spain: From big cities to beaches, fine art museums, delicious tapas and tinto de verano, and beautiful medieval castles, Spain offers it all. The fact that their digital nomad visa offers a flat tax rate of 24% — versus up to 47% — just adds to the appeal.
- The Different Income Tax Systems Worldwide
- Tax Rate Schedule – Virginia
- Virginia Residency and Income Tax
- Individual Income Tax – FAQ – South Carolina
- Individual Income Tax – South Carolina
- New Mexico personal income tax rates revised starting in 2021
- Residency – New Mexico Code
- Establishing Residency for State Tax Purposes
- Residency Requirements by State – Taxes
- 2022 Digital Nomads Report