1 in 36 Americans doesn’t have a home and doesn’t want one! They are happy to be digital nomads.
What makes them less happy is trying to understand how to pay taxes.
Taxes are often a confusing topic for digital nomads, partly because of the lack of knowledge and partly because of the complex tax system.
Here is a detailed guide to how digital nomads pay their taxes.
Please note that this guide is only for digital nomads who are citizens of the United States. If you're a resident of another country, kindly do relevant research at your end. Also, the following guide shouldn't be considered financial advice. Work with your accountant or tax preparer before taking any decision.
Do You Need to File and Pay Taxes as a Digital Nomad?
Being a digital nomad has many benefits. It allows you to live and work wherever you want, and you can say goodbye to the 9-5 office life. However, the US has an unusual tax system.
If you are an American citizen or a Green Card holder, and you earn over $400 in a year, you are liable to file taxes regardless of where in the world you live or travel.
That said, Americans filing taxes from abroad get an extension till June 15th, and they can request a further extension till October 15th.
Until a few years back, digital nomads didn't have to worry about filing taxes, as they assumed they were away from the IRS' reach. However, the very technology that has enabled the digital nomad lifestyle has also enabled the IRS to find American citizens globally.
Tax Basics Digital Nomads and Remote Workers Should Know
Before delving deep into the federal tax for remote work professionals living outside the US, let's discuss the financial and tax basics.
US Tax Basics
If you are a US citizen or Green Card holder, US tax will be levied on your worldwide income. This applies even if you don't live in the US or your business has nothing to do with the US. Even if you have never set foot in the US, but you are a US citizen or Green Card holder, you need to pay US taxes.
However, digital nomads can reduce or even get complete exemption from their US tax bill by qualifying for the foreign earned income exclusion (FEIE). Here is all you need to know about qualifying for FEIE.
State Tax Basics
As a digital nomad, state tax won't be a problem for you in most cases. States can impose a tax on people with permanent residence in that state. If you leave the state and don’t show the intention of returning, the state would consider that it isn’t your permanent residence and won't impose a tax on you.
Non-US Tax Basics
It is equally critical to consider the local taxes of the country you are living in. While the local tax regulations can vary from country to country, here are a couple of things to keep in mind.
- You will be subject to income tax in most nations only if you become a resident.
- Even after becoming a resident, you will need to pay tax on the income earned in that country.
Most countries consider a person as a resident for tax purposes if they stay there for more than six months. So, traveling to a different country every six months is an easy way to avoid local taxes.
US Self-Employment and Social Security Taxes
If you are a US citizen, you must file taxes in the US for your self-employed income. If you live in another country, you may pay taxes in that country and have to file a tax return with the IRS. If you're self-employed, you'll need to pay Social Security and Medicare taxes. The payable tax percentage is as follows:
- Social Security Tax: 12.4%
- Medicare Tax: 2.9%
Therefore, the total payable tax will be 15.3% of the total income.
How to Pay Taxes as a US Digital Nomad from Abroad?
Having discussed the nitty-gritty of paying taxes as a US digital nomad, let's now look at the step-by-step process of filing taxes from abroad. Here are the key steps to follow.
Find an Accountant or Tax Specialist Who Can Manage US Taxes
The first step is to find an accountant or tax preparer specializing in tax planning for digital nomads. Ideally, you should find an accountant before you start your journey as a digital nomad.
If you are wondering what's the difference between a tax preparer and an accountant, here's a quick explanation:
An accountant is a financial expert versed in handling a wide range of financial tasks, with filing taxes being one of them. Tax preparers, on the other hand, are skilled in filing taxes. They are not fully qualified accountants, but they have enough expertise to take care of your digital nomad requirements.
Send Your Income Information to Your Tax Preparer
Next, share your income information with your tax preparer. You can send a monthly spreadsheet mentioning your income (both active and passive). Contrarily, you can also permit your taxpayer to access your income information directly from the online tax system. Discuss with your taxpayer what information they need to take care of your taxes and how you can best organize the data and send it to them.
You will also need to send your expense records. This helps you maintain clearer records and enables the taxpayer to file tax returns more effectively.
Pay Taxes
After doing the taxes, your tax preparer will tell you the tax you owe or the refund you are eligible for. Once you know the due tax amount, you can make the tax payment online or receive a refund.
How to Reduce Your Federal Tax Bill?
Paying taxes as a digital nomad may hurt your wallet. Thankfully, there are several ways to save big on your taxes. Let's discuss some effective techniques to save your taxes and keep more of your earned income to yourself.
Foreign Earned Income Exclusion (FEIE)
The US has a citizenship-based tax system as opposed to a residence-based system. It requires you to pay federal income taxes as long as you are a US citizen, regardless of where you live. However, digital nomads not living in the US can leverage FEIE to save tax on up to $120,000 (for 2023) of earned income. You need to clear the Physical Presence Test and the Bona Fide Residence Test to qualify for FEIE.
S-Corp Election
If you are a business owner, you might already know about the importance of incorporating. However, deciding which type of business entity you should choose can be confusing. A Limited Liability Company (LLC) is a popular option for small business owners and self-employed professionals.
When you incorporate as an LLC, you have two options, to be taxed as a Disregarded Entity or as an S-Corp. After incorporating yourself as an S-Corp, you can save a substantial amount on taxes the FEIE doesn't include.
Understand Your Deductions
This method of reducing taxes is so simple that many digital nomads overlook it. Often, digital nomads and even freelancers don't realize their deductions and end up paying far more in federal taxes.
Some common deductions that digital nomads tend to ignore are:
- Coworking space or home office
- Computer, laptop, the internet, and other equipment/tools
- Travel meals
- Moving expenses
- Mileage driven (business reasons)
Avoid Healthcare Expenses
The Affordable Care Act requires citizens to have health insurance, even if they are not in the country for several months. This could be a significant financial burden for a digital nomad. Thankfully, most digital nomads can avoid ACA requirements.
If you have a bona fide residence outside of the US or are out of the country for 330 out of 365 days, you are exempt from the healthcare coverage. If you are not making enough money, you can also qualify for Medicaid or low-income healthcare exemption.
Establish Your Tax Home
Claiming deductions on moving and travel expenses can save you a lot of money when tax time comes. However, to be eligible for travel deduction, you need to have a residence. If you are constantly moving and have no primary residence for your business, the IRS will consider you to be an itinerant. Itinerants are individuals who have no permanent residence and keep moving from place to place.
Itinerants are not eligible for travel expense deductions. So, it is important to establish a place for your business. It doesn't have to be the US, but you need to have a tax home for your business.
Avoid Penalties
Federal taxes can be complex enough to manage regardless of whether you work remotely as an employer or employee. If you fail to file the return properly, you can incur hefty penalties.
The interest penalty is one of the most common penalties self-employed digital nomads incur. It arises when you fail to file your quarterly estimated payments. It's recommended to file and pay taxes throughout the year instead of only in April.
If you have a bank account and hold financial assets outside of the US, you may need to submit Foreign Bank and Financial Account Report (FBAR) and/or Form 8938.
To conclude, finding an accountant or tax preparer is the first step every digital nomad should take. The tax system can be complicated, and not fully understanding it can attract penalties. Seeking professional expertise helps you stay compliant and avoid penalties.
Frequently Asked Questions
How much do digital nomads make?
Though digital nomads don't have a fixed salary, 22% of digital nomads make between $50,000 and $99,000 a year, which is more than the national average.
Are digital nomads rich?
As many digital nomads earn more than the national income in the US, one can say that digital nomads make a good living for themselves.
What exactly do digital nomads do?
Digital nomads work remotely. They could either be business owners running their business online or freelancers working from different places.
Who has higher taxes, the US or UK?
The top rate of income tax in the US is 35% compared to 40% in the UK. Hence, the UK has higher taxes than the US.
