Updated on July 30th, 2018
Are you a US digital nomad or a self-employed American living abroad? This blog post is for you! All U.S. persons (and green card holders) are subject to U.S. tax on their worldwide income regardless of current residence:
- whether you live in the U.S. or outside the U.S.
- have a dual citizenship,
- or are an Accidental American that has never set foot in the U.S.
your tax obligations remain the same as any other U.S citizen living in the U.S.
How To Deal With Taxes On Income Earned Through Online Work In Multiple Foreign Countries?
All U.S citizens whose gross income exceeds the applicable threshold of $10,400 for a taxpayer filing single in 2017 and/or $400 for people with self-employment income must file a US tax return. Now, as a Digital Nomad, you may be traveling from country to country in a short time span. Due to that, you’re not a resident of any of the countries you visit.
Let’s take a look at the general rules. The wages are sourced where the work is performed. So far, so good?
Let’s say you are a digital nomad working on a beach in Thailand. You performed work in Thailand, therefore is it a Thai sourced income. Also, it is subject to Thai taxation. As a US person, you must also report this income to the IRS on your 1040.
What happens if you work abroad for a U.S. employer? Again, do you remember where the wages are sourced from? Exactly, from where you perform the work! It is still a foreign sourced income. You will see in a second where these factors come together to help you reduce your tax liability. However, your American employer might withhold taxes from your salary. You can either claim a refund later or you can give W-4 to your employer. This will allow them to exempt your income from tax withholding. Form W-4 can only be used the second year (since it requires no tax owing in the prior year). For the first year, you would have to use form 673.
The Foreign Earned Income Exclusion And its’ Requirements
The IRS offers a generous exemption to remarkably reduce or in some cases even eliminate your tax bills by using the FEIE, the foreign earned income exclusion. This enables you to acquit yourself of paying any U.S federal income taxes on your foreign sourced earned income.
We already discussed the term foreign. It has been sourced in a foreign country. The other important aspect of the exemption is that it is earned income. That means that any investment income cannot be excluded using the FEIE. The FEIE is adjusted annually for inflation and the maximum amount possible for an exclusion is $101.300 in 2016 and is $102.100 in 2017. You must qualify for the foreign earned income exclusion each year.
You can claim the foreign earned income exclusion and the foreign housing exclusion or deduction using Form 2555. If the foreign earned income exclusion is all you claim, you may use Form 2555-EZ.
However, to even qualify for the foreign earned income exclusion, you must either pass the bona fide residence test or the physical presence test in order to have your residence status in a foreign country determined by the IRS.
How do you pass the Bona Fide Residence test?
- You must be a U.S citizen or a resident alien who is a citizen of another foreign country that has an income tax treaty with the U.S
- You must have a residency in a foreign country
- And you must submit proof that you have been a bona fide resident in one or several foreign countries during the entire tax year by completing Part II of Form 2555
This test is more subjective. To meet as the IRS will investigate the nature and the intent of your stay. If your situation is not clear, you might not know for sure if you will be able to survive an audit.
How to pass the Physical Presence Test?
- You must be physically present in one or more countries outside the U.S for 330 full days during a consecutive 12 month period. (time spend in international waters or in Cuba in violation of the embargo doesn’t count)
This 12 month period does not have to start on your first day spent in a foreign country. You can choose a timeframe that would allow you to claim the greatest exclusion. It is the easiest way to claim the FEIE. If you’re not sure whether you qualify for the FEIE, check out our free FEIE tool that will tell you whether you qualify for the exemption and the amount of the foreign earned income you can exclude.
Self-Employment Tax (Social Security And Medicare) for US Digital Nomad
The self-employment tax is basically the social security and Medicare taxes, which would have been withheld automatically by your employer if you were not self-employed. The FEIE exclusion does not eliminate the self-employment tax. So you still have to calculate your self-employment tax using Schedule SE. All individuals whose net earnings from self-employment exceed $400 are obligated to pay the SE-tax.
Totalization Agreement And Exemption From Self-Employment Tax
Some countries have signed a totalization agreement with the U.S. If you reside in one of them from the list below, you are exempt from having to pay the self-employment tax.
- Italy, Germany, Switzerland, Belgium, UK, Sweden, Spain, France, Austria, Finland, Ireland, Luxembourg, Chile, Australia, Japan, Denmark, Slovak Republic, Norway, Greece, Czech Republic, Canada, Portugal, Netherlands, South Korea, Poland.
Should your entire self-employment income be made in one of these countries, you are exempt from paying the self-employment tax. Despite that, the IRS may still request a Certificate of Coverage from the Social Security Administration of your resident country.
If you are a digital nomad that switches countries frequently including those that are not listed above, it could cause issues for you if you are utilizing a U.S address, as you may have to repeatedly deal with your home state explaining your unique tax situation. In this case, as mentioned above, it highly depends on your individual situation and we advise you to obtain help from a professional expert. Also, bear in mind that deducting or claiming exemption from Social Security payments are possible in some cases and can save you money in the short term, however you may be reducing or risking your Social Security retirement benefits in the long term.
Each individual situation is different. For digital nomads, especially those moving frequently, it can become a great source of stress dealing with their taxes. Our team of experienced digital nomads, tax lawyers and advisors will be more than happy to ease any complications for you. Please do not hesitate to contact us now for further help.