US Taxes for American Digital Nomads – A Guide
Digital Nomads are a new breed of American pioneer, roaming the world while working remotely. The Digital Nomad lifestyle allows Americans to explore far off lands and cultures without taking time off work, and it can also offer financial advantages, such as opportunities to save money. Understanding US tax rules is an important aspect of this, so read on, and be sure to seek specialist expat tax advice if you have any questions.
Do Digital Nomads have to file US taxes?
While the Digital Nomad lifestyle has never been more popular, the US has an unusual tax system that requires all American citizens and Green Card holders to file US taxes, reporting their worldwide income, wherever in the world they happen to travel or live.
This means that American Digital Nomads abroad are still required to file US taxes, reporting their global income.
Americans filing from abroad receive an automatic filing extension until June 15th, and they can request a further extension until October 15th if they still need more time. This may be because they have to file taxes in another country through qualifying as a tax resident there, although many Digital Nomads move strategically from country to country and so avoid this. Digital Nomads should check the tax rules in each country where they spend time to find out whether they have to file local taxes anywhere.
Up until just a few years ago, many Americans living abroad didn’t bother filing US taxes because they assumed they were beyond the IRS’s reach. Nomads should be aware though that thanks to the same globalized world that has enabled the rise of the Digital Nomad Lifestyle, the IRS now has global reach too.
Do Digital Nomads have to pay US income taxes?
While American Digital Nomads who earn over $12,200 (for tax year 2019, or $12,400 for 2020), or just $400 of self-employment income worldwide, always have to file a US tax return, when they file they can usually claim an IRS provision to reduce their US tax bill, often to zero.
“Digital Nomadism is a hot topic and a growing trend, especially among entrepreneurs. Being a Digital Nomad isn’t just about travelling the world and making everyone back home jealous on social media. Some of us on the road are doing it for the savings.”
For example, Nomads who qualify as a tax resident in another country and pay income taxes there at a higher rate than the US income tax rate can claim the Foreign Tax Credit on IRS Form 1116. This allows them to claim US tax credits up to the same value as the foreign taxes that they’ve paid. For many people, this will eradicate their US tax bill completely.
Many Nomads choose to claim another provision called the Foreign Earned Income Exclusion, which allows them to exclude up to around $105,000 (the figure rises to reflect inflation each year) of their global earned income from US taxation. To claim the Foreign Earned Income Exclusion, they must either demonstrate permanent residence in another country, or (more usefully for many Digital Nomads) demonstrate that they spent at least 330 days outside the US in a 365 day period that is either the tax year or coincides with the tax year. Digital Nomads can claim the Foreign Earned Income Exclusion by filing IRS Form 2555.
What about State taxes?
Whether Digital Nomads have to pay State income taxes or not depends on the rules in the state where they last resided.
Some states only release you from having to file as long as you don’t still have significant ties in the state, such as property, investments, bank accounts, dependants, or a driving license, so it’s prudent to familiarize with the rules in the relevant state.
What about US Self-Employment and Social Security taxes?
American Digital Nomads directly employed by a US firm will have to continue paying US employee Social Security taxes. Self-employed Digital Nomads meanwhile will have to pay both the employer and employee portion of Social Security taxes, as well as Medicare tax.
US self-employment taxes consist of 12.4% Social Security tax and 2.9% Medicare tax, so a total of 15.3% of income. Unfortunately, US Social Security taxes can’t be excluded using the Foreign Tax Credit or the Foreign Earned Income Exclusion.
Digital Nomads who pay foreign self-employment taxes may be able to only pay either US or foreign Social Security taxes if the US has a Totalization Agreement with the country where they live. Which country they pay social security tax to depends on how long they intend to live abroad for as set out in each agreement.
Americans living abroad who are employed directly by a foreign registered company don’t have to pay US Social Security taxes, regardless of whether they work remotely.
Strategies to reduce Digital Nomads’ US tax bill
American Digital Nomads who work remotely as freelancers can sometimes pay very little tax – as little as zero in fact. It depends on where they choose to live, and how much they earn.
For example, a Digital Nomad who earned under around $100,000 could theoretically choose to establish a corporation in a country with a tax system that only taxes residents or doesn’t tax at all, then move from country to country avoiding spending enough time in any one country to qualify as a tax resident there.
Their company would then invoice their clients, and the company would pay them as an employee. This way, as an employee of a foreign company, they wouldn’t be liable to pay US Social Security taxes, and as an expat they could claim the Foreign Earned Income Exclusion to exclude their income from US tax.
The foreign company will be liable to US reporting requirements though. Digital Nomads should note that not paying US Social Security taxes can also affect future Social Security benefits entitlement. Whether or not this sort of arrangement is beneficial depends on each Digital Nomad’s individual situation, so always seek advice from a US expat tax expert.
Are there any other US reporting requirements?
American Digital Nomads who have any foreign registered bank or other financial (e.g. investment) accounts may have to report them by filing an annual Foreign Bank Account Report (FBAR). Penalties for not filing FBARs (or for incomplete or inaccurate FBAR filing) are steep, even if the error wasn’t intentional. The IRS is receiving information directly from most foreign banks and other financial firms, so FBAR filing is an important requirement. FBAR filing includes business bank accounts, even if registered in the business’, rather than the business owner’s, name.
Americans who have over $200,000 of foreign registered financial assets also have to report them by filing IRS Form 8938.
Resources for American Digital Nomads
With the rise of the Digital Nomad, lots of services have sprung up to cater to them. Here are some of the best:
– NomadList provides comprehensive information about Digital Nomad hub locations around the world, as well as remote work listings.
– Coworker is a database of over 9000 coworking spaces around the world.
– Earth Class Mail provides virtual office services and mail forwarding.
– NoDesk provides information about working remotely and remote work job listings.
– Upwork is a remote work opportunity platform for freelancers.
– NomadStack is a curated information resource for Digital Nomads.
– World Nomads provides travel insurance and other resources for international Digital Nomads.
– Copass provides access to coworking spaces around the world.
To ensure that you are filing in your best interests while avoiding future penalties, it’s always worth seeking advice from a reputable US expat tax specialist.
If you’re behind with your US filing or reporting from abroad, it may be possible to catch up without facing penalties, as long as you do so voluntarily before the IRS contacts you.
Bright!Tax is a 100% remote working firm with most of our employees Digital Nomads too, so you are in safe hands!