Digital nomads, by definition, are people who use telecommunications technologies to earn a living and, more generally, conduct their life in a nomadic manner. They often work remotely from foreign countries or any other place than a traditional office. Whether rightly or wrongly, digital nomads have appeared to gain a reputation as tax dodgers. Many people assume that digital nomads do not need to file tax returns or pay taxes. However, if you are one of the digital nomads, you should pay attention to the following example.
Mr. Johnson is an American citizen living in Thailand. He works as a freelance software engineer for American companies. He enjoys the lifestyle of a digital nomad as he likes to travel and live in different countries while remains a stable income. He heard the rumors about someone like him is exempt from filing a U.S tax return, so he asks for help in clearing his confusion.
Mr. Johnson: Let us straight to the point. Do I need to file U.S taxes while living abroad?
Answer: Yes. As long as you are a U.S citizen/green card holder, you are required to file and pay U.S tax no matter whether you live and work.
If any digital nomads who earn over $12,950 in 2022, or just $400 of self-employment income world, they always have to file a U.S tax return.
Mr. Johnson: Is there any legal way to stop having to file my U.S tax returns?
Answer: Yes. Expatriate, which means to give up your U.S citizenship or green card.
Mr. Johnson: I am working for multiple American companies, so my only income is from the U.S. Do I have to pay taxes only on my income from the U.S, or also foreign income?
Answer: The U.S tax system is taxed worldwide. If you are a U.S citizen/green card holder, your need to pay taxes on your worldwide income. However, there are some exclusions to avoid the double taxation between the U.S and the foreign countries.
FEIE (Foreign Earned Income Exclusion), which allows you to earn $107,600 per year without paying any U.S income tax for the 2020 tax year (for returns filed in 2021). It only applies to earned income, such as salary, consulting income, and professional fees. It does not apply to unearned income, such as interest, dividends, pensions, social security payments, and capital gains. To claim FEIE, you must either demonstrate permanent residence in another country, or 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. You can claim the Foreign Earned Income Exclusion by filing IRS Form 2555.
Mr. Johnson: The FEIE has made me feel more comfortable about my taxes. What about the State tax? I originally came from New York, but I don’t have any property in New York.
Answers: In general. If you really have left your home state indefinitely, you are not required to pay State Tax there. However, 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, dependents, or a driving license, so it’s prudent to familiarize yourself with the rules in the relevant state.
Mr. Johnson: I am planning to expand my freelance business to earn additional income for my next trip, but I don’t want to pay too much tax to the U.S government. Do you have any legal tax strategy to redact my U.S tax bill?
Answer: You can choose to establish a corporation in a country with a lower tax rate. Your company should invoice your clients directly. Once your clients paid your company, and company would pay you as an employee. This way, as an employee of a foreign company, you would not be liable to pay US Social Security taxes. On the other hand, you can claim the Foreign Earned Income Exclusion to exclude the income from US tax.
Also, keep in mind the added complexity of owning a foreign corporation as a US citizen. For example, you will have to file Form 5471 every year (including an income statement and balance sheet for your corporation).
If you are considering implementing any of the above strategies you should do the research on the country where you want to establish your corporation and really talk to a qualified, independent tax advisor specializing in tax for Americans abroad.