Digital Nomad Taxes: A Complete Guide

06/07/2022

As remote work goes mainstream, more and more professionals are ditching the 9-to-5 lifestyle to instead live as digital nomads: workers who leverage technology to work from anywhere they want.

The digital nomad lifestyle comes with many advantages. More freedom, location independence, a better work-life balance, working in your pajamas…It’s not hard to understand why the lifestyle makes so many people dream (#goals).

As appealing as those fancy Instagram pictures of working by the beach might seem, however, some aspects of the digital nomad way of life aren’t too dreamy. It’s as if not everything on social media is as perfect as it seems. Hmm, who could have thought?

Common issues digital nomads face include having to rebuild their social circle from scratch after switching countries and integrating into a new culture. But one important issue that digital nomads often neglect is how to manage their taxes while abroad…

…which is too easy to forget as you’re busy improving your broken Spanish or booking that cute bungalow in the mountains on Airbnb.

The thing is, it doesn’t matter where you currently live, whether it’s on the beaches of Mexico or in the jungle of Bali. Since the US applies citizen-based taxation, American digital nomads have to comply with the tax regulations of the IRS.

In this blog post, let’s find out what taxes American digital nomads still have to pay as they travel around the world and what they can do to minimize their taxes.

Must Digital Nomads File US Taxes?

As a digital nomad, if you’re making more than the minimum threshold to declare, then the answer is yes. There are three types of tax systems worldwide:

– Citizenship-based taxation: Under this system, a country taxes its citizens’ worldwide income no matter their location. The US is an example of a country that applies citizenship-based taxation.
– Residence-based taxation: Digital nomads under this form of taxation pay what they owe in taxes based on their country of residence’s tax laws, not their country of citizenship. Examples of countries in this category include France and Australia.
– Territorial taxation: Digital nomads are only taxed if they earn income from within their country of residence. Examples include Panama and Costa Rica.

And if you don’t comply with tax obligations, it could result in hefty penalties. Yikes.

A trap that US digital nomads should avoid is spending too much time in a country with residence-based taxation. Many countries will consider anyone who spent six months or 183 days on their territory as a tax resident.

That means that if you stay too long in a country with residence-based taxation, on top of your US taxes, you may have to pay taxes for that country as well. Digital nomads must research the taxation laws of each country they travel to avoid bad surprises. Make sure to consult a tax professional to learn the best ways to avoid double taxation.

Other digital nomads that may not realize they need to file their US tax returns are also known as Accidental Americans. These digital nomads may have been born in the US but moved overseas when they were younger and are American citizens by default, which means they also have to comply with IRS obligations.

In this case, Accidental American nomads can go through the IRS’ Streamlined Filing Compliance Procedures program, which helps them stay tax compliant without paying any penalties.

What Happens if Digital Nomads Don’t Pay Their Taxes?

But if you just run as far away from the US and hide in your secret bunker in Siberia, the IRS will never find you, right?

If only things were that easy. Due to the Foreign Account Tax Compliance Act (FATCA), banks worldwide have to report the foreign assets of American expats to the IRS. Yeah, even banks in Siberia according to the IRS’s list of countries who participate in FATCA compliance.

The consequences of non-compliance can vary. You can have fines that cost you thousands of dollars, lose out on benefits that low your tax obligation, or lose your US passport in extreme cases.

What Taxes Do Digital Nomads Still Have to Pay While Abroad?

Here are the income tax forms and obligations that digital nomads still have to comply with overseas:

State Taxes

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. As a digital nomad, you will still have to pay state taxes if you’re earning money from the following states:

– California
– Virginia
– South Carolina
– New Mexico

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:

– Florida
– South Dakota
– Wyoming
– Washington
– Texas
– Nevada
– Alaska

Self-Employment Taxes

Many digital nomads don’t have remote jobs but are self-employed entrepreneurs and manage their own businesses. Even if you live abroad, you have to pay self-employment taxes, including social security tax of 12.4% and medicare tax of 2.9%.

That said, an aspect that will influence whether you’ll still pay your social security taxes in the US is the country in which you reside.

24 countries throughout the world have Totalization Agreements with the US. According to these agreements, you are exempt from US social security taxes if you already made contributions to the country’s social security system.

On the other hand, if you’re not residing in a country with a totalization agreement with the US, or residing permanently in any country abroad, as is the case for most digital nomads, you’ll still have to pay self-employment taxes back home in the States.

The Foreign Bank Account Report (FBAR)

Outside of filing your US tax return, if you have a bank account in another country, you might have to file a Foreign Bank Account Report (FBAR) with US authorities. It will be the case if you hold more than $10,000 in all of your foreign bank accounts combined.

For example, let’s say you have $4000 in a Costa Rican bank account, $3000 in Mexico, and $5000 in Japan. In this case, you’ll have to file your FBAR report for compliance with your obligations, because you have $12,000 (more than $10,000) in accounts abroad.

US citizens have until October 15th to file their FBAR to the US Treasury Department. If you don’t comply, you may have to deal with hefty penalties, such as a monetary fine of $10,000 or 50% of the balance you have in your accounts.

IRS Form 8938: Statement of Specified Foreign Financial Assets (FATCA)

As part of your US tax return, digital nomads may also have to file Form 8938 if the value of their foreign assets exceeds a certain amount. It will be the case if while residing abroad, you own foreign investments worth more than at least $200,000 on the last day of the tax year.

For joint returns filed by residents abroad, the threshold starts at $600,000 at any point in the tax year or $400,000 on the last day of the tax year.

Do Digital Nomads Have Any Tax Exclusions or Deductions?

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 Foreign Earned Income Exclusion (FEIFE), digital nomads can exclude up to $112,000 (2022) of their income earned overseas from US taxable income. . 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 1 calendar year
– Physical Presence Test: Another way to be eligible for FEIE is to prove that you’ve been outside the US for 330 days in any 365 day period, that doesn’t necessarily have to be a calendar year

Check out some of our previous tax advice content to learn more about these two tests:

When you qualify for FEIE, you can exclude up to $112,000 (2022) of foreign earned income. 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 in the US again.

That said, it’s worth noting that FEIE doesn’t apply to unearned income such as interest, dividends, or pension income.

Foreign Housing Exclusion

The Foreign Housing Exclusion (FHE) allows digital nomads to exclude income from what they owe in US taxes. The FHE calculates how much you can exclude based on your spending on foreign housing expenses overseas. Housing expenses that qualify under the FHE include:

– Rent
– Property insurance
– Occupancy insurance
– Utilities

Expenses that the FHE does not cover include:

– Domestic labor
– Mortgage payments
– Any “lavish” purchases

You’ll first need to qualify for the FEIE before you can benefit from the FHE as well. To learn more, feel free to read our previous post The Foreign Housing Exclusion: A Brief Guide for US Expats.

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 $2000 to the US but paid a $500 tax credit to Spain. With the FTC, you’ll owe $1500 in US taxes instead.

Can Digital Nomads Catch Up on Taxes Without Penalties?

Yes! Before you lose your cool and start to panic about your Uncle Sam’s penalties, The IRS offers the Streamlined Foreign Offshore Procedures that allows non-compliant digital nomads (or any taxpayer residing abroad for that matter) to catch up on their tax situation without paying any fines.

There are two requirements to meet to catch up using the Streamlined Foreign Offshore Procedures:

– Non-resident: US taxpayers need to be (or have been) overseas to participate in the program. They either need to have spent 330 days overseas during one of the most recent 3 past tax years.
– Non-willful: Digital nomads must attest that their non-compliance was unintentional. Acceptable reasons for non-compliance can include negligence or any misunderstandings – oftentimes just an innocent mistake or a situation in which life got in the way

Our team at Bright!Tax has mastered the Streamlined Procedure to make the process as simple and straightforward as possible for digital nomads behind on their taxes. Our tax specialists have been successfully submitting Streamlined Procedures for the last 10 years, and will guide you every step of the way to prepare your taxes before the IRS contacts you and it’s too late.

4 Best Tax-Friendly Countries for Digital Nomads

Digital nomads can minimize what they owe in taxes by relocating to countries with low tax rates. The best tax-friendly countries for digital nomads include:

Greece

On top of its glorious ancient history and stunning landscapes, Greece offers digital nomads a great opportunity to save money on their taxes. On September 4, 2021, Greece implemented Law 4825/202, which allows remote workers to emigrate to the country. The policy allows digital nomads to pay 50% less on their income tax and social security fees.

Croatia

The southeast European country of Croatia has a special program that offers total tax exemptions for digital nomads. To benefit from the program, US digital nomads must fill out an online form for Croatia’s Ministry of Interior and provide all the necessary documents (copy of passport, proof of health insurance, etc.).

Once the Ministry of Interior approves your application, you have to travel to Croatia and register your temporary stay within 30 days.

Georgia

Situated in the Caucasus regions of Europe, Georgia is a small country full of culture that offers attractive tax opportunities for digital nomads.

Georgia has a digital nomad visa called “Remotely From Georgia” and only taxes 1% of your gross income up to $155,000. To qualify for the visa, you must prove to have a monthly income of at least $2000 or a bank statement of $24,000.

Outside of its low taxes, Georgia is a country with low living costs and one of the most affordable countries in Europe. It’s also ranked as one of the safest countries in the world.

Cyprus

Cyprus has a Digital Nomad visa with a special “non-dom tax residency” policy. The Mediterranean country classifies digital nomads that become tax residents of Cyprus as non-domiciled in their territory for 17 years. Foreigners under this program do not have to pay taxes on any income earned overseas.

Don’t Let Taxes Ruin Your Digital Nomad Experience

To live life as a digital nomad is a once-in-a-lifetime opportunity. You get to explore the world, discover new cultures, and create memories, all thanks to your laptop.

But as you can see, managing taxes as a digital nomad can be a complicated and stressful process. The tax complications can add unnecessary headaches to your journey, preventing you from fully enjoying what the digital nomad lifestyle offers.

If you still have questions about navigating taxes as a digital nomad, we’re here to help with our tax services. At Bright!Tax, we’ve helped countless remote workers fulfill their tax obligations for more peace of mind. Register today, and our team will be in touch within hours to guide you with your US tax return.