A “digital nomad” is someone who works remotely while traveling from country to country, often without a fixed home base. In 2022, an estimated 16.9 million U.S. workers identified as digital nomads.
While this exotic lifestyle offers freedom and flexibility, paying taxes as a digital nomad can be complicated. Without a clear understanding of both American and international tax obligations, you may face significant penalties.
This article will guide you through everything you need to know about digital nomad taxes, including U.S. tax obligations, state tax considerations, taxes in foreign countries, Social Security benefits, self-employment taxes, and the essential tax forms you need to file in order to remain compliant with the Internal Revenue Service (IRS).
American Tax Obligations for Digital Nomads
As a U.S. citizen, living abroad doesn’t exempt you from filing taxes. American tax law is based on citizenship, meaning your worldwide income is still taxable, even if you haven’t stepped foot in the U.S. all year. Understanding your tax obligations as a digital nomad is crucial to avoid hefty penalties.
Below are three key points every aspiring digital nomad needs to keep in mind:
- U.S. Citizenship-Based Taxation
All U.S. citizens must file taxes, no matter where they live or earn their income. The IRS taxes worldwide income, which includes wages, interest, dividends, and rental income, among other sources. If your total income exceeds the filing threshold, you’re required to file a U.S. tax return. - Foreign Earned Income Exclusion (FEIE)
Digital nomads can exclude up to $126,500 of foreign-earned income from U.S. taxation (2024). To qualify, you must pass either the physical presence test (spending 330 days or more outside the U.S.) or the bona fide residence test, which proves you’re a resident of another country. - Foreign Tax Credit (FTC)
The Foreign Tax Credit allows you to claim a dollar-for-dollar credit for taxes paid to foreign countries. However, this credit does not apply to income that has already been excluded under the FEIE.
State Considerations Regarding Taxes as a Digital Nomad
As a digital nomad, managing state tax obligations can be just as important as understanding federal taxes. Even if you live abroad, some U.S. states will still expect you to file a return or pay taxes if they consider you a resident. To avoid surprises, it’s crucial to know the difference between domicile and tax residency and how states determine where you owe taxes.
Domicile vs. Tax Residency
Your domicile is your permanent home, while tax residency refers to where a state considers you a resident for tax purposes. These concepts are key for digital nomads because states will tax you based on your last domicile, even if you live overseas. If you plan to travel, it’s essential to establish your domicile in a tax-friendly state.
States Known for Aggressive Tax Policies
Some states, such as California, New Mexico, South Carolina, and Virginia, are notorious for pursuing taxes from former residents. These states may continue to tax you even after you leave if you still maintain ties there, such as a driver’s license or voter registration.
Factors States Use to Determine Residency
Here’s how states typically determine whether you are still considered a resident for tax purposes. Each of the following factors can keep you on a state’s tax radar
- Driver’s license
- Voter registration
- Property ownership
- Bank accounts
- Where your family lives
States might use any of these factors to argue that you’re still a resident and thus liable for state taxes. Minimizing these ties can help you reduce your state tax obligations.
Strategies to Manage State Tax Liability
To reduce state tax obligations, digital nomads often establish residency in no-income-tax states such as Florida. You should also cut as many ties as possible with your previous state — i.e., cancel your voter registration, switch your driver’s license, and close local bank accounts.
Foreign Country Tax Implications
Living and working in foreign countries doesn’t just bring cultural adventures — it also triggers potential tax obligations. To manage your international tax responsibilities effectively as a digital nomad, it’s important to understand the tax systems of the countries you visit (and the duration of your stay).
Overview of Common Tax Systems
Countries generally follow one of two tax systems: residence-based or territorial-based:
- Residence-based taxation, used by over 130 countries, including the EU, Canada, and Australia, taxes residents on their worldwide income — regardless of where it’s earned.
- Territorial-based systems, found in countries like Costa Rica, Singapore, and Panama, only tax income earned within their borders.
General Rule for Tax Liability Abroad
A common rule across many countries is that spending 183 days or more within a year in a single country often triggers tax residency. Once you’re considered a tax resident, you’re typically required to file and pay taxes in that country. Tracking your time and income sources is important for avoiding any tax surprises.
Tax Treaties
Tax treaties between countries help prevent double taxation, ensuring that neither the U.S. nor the foreign country taxes the same income twice. However, not all countries have treaties with the U.S., meaning digital nomads may still face complex tax situations in certain regions. It’s crucial to check the tax treaty status of any country you spend significant time in.
Social Security and Self-Employment Taxes
Digital nomads who are self-employed face additional tax obligations beyond regular income taxes. In the U.S., self-employment tax is a total of 15.3% of your income, which includes 12.4% for Social Security and 2.9% for Medicare. These taxes apply even if you qualify for the Foreign Earned Income Exclusion, meaning you cannot exclude them from your U.S. tax liabilities.
Totalization Agreements
Totalization agreements are designed to prevent double taxation on Social Security taxes (and not just income). The U.S. has agreements with several countries, including the UK, Germany, and Japan, which may allow self-employed digital nomads to avoid paying Social Security taxes in both the U.S. and the foreign country. However, these agreements vary by country, so it’s important to verify your obligations based on where you’re living or working.
Strategies for Self-Employed Digital Nomads
To stay on top of tax payments, self-employed digital nomads should set aside money for quarterly estimated tax payments. This will prevent you from facing larger bills at the end of the year. Additionally, some nomads consider forming an S-Corp, which can potentially offer tax savings by reducing the amount of income subject to self-employment taxes.
Essential Tax Forms for Digital Nomads
Filing the correct tax forms is key to staying compliant with U.S. and international tax laws. Below are the main forms U.S. digital nomads need to file.
- Form 1040: U.S. Individual Income Tax Return: This is the basic tax form that all U.S. citizens and residents must file annually. It’s the starting point for any digital nomad’s U.S. tax filing obligations.
- Form 2555: Foreign Earned Income Exclusion: If you qualify for the Foreign Earned Income Exclusion, you’ll use Form 2555 to exclude up to $126,500 of foreign-earned income. This form helps reduce your U.S. tax liability if you meet either the physical presence or bona fide residence test.
- Form 1116: Foreign Tax Credit: Use Form 1116 to claim a credit for taxes paid to foreign governments. This is useful if you are taxed on your income both in America and abroad, as it provides a dollar-for-dollar reduction of your U.S. tax liability.
- FinCEN Form 114 (FBAR): Report of Foreign Bank and Financial Accounts: You must file this form if the combined value of your foreign bank accounts exceeds $10,000 at any time during the year. This report is submitted separately from your tax return, but it’s critical for staying compliant with the IRS.
- Form 8938 (FATCA): Statement of Specified Foreign Financial Assets: If your foreign assets exceed certain thresholds ($200,000 for single filers), you’ll need to file Form 8938 to report those assets. This form helps the IRS track financial activity in foreign countries.
- Form 5471: Information Return of U.S. Persons with Respect to Certain Foreign Corporations: This form is required for American citizens who are shareholders in foreign corporations. It helps the IRS track U.S. ownership in foreign companies.
Expat CPA can assist with preparing and filing all of these forms to ensure you stay compliant with U.S. tax implications, regulations, and laws.
Get Expert Help With Your Digital Nomad Taxes Today
Navigating the complexities of living and working abroad can be overwhelming, from understanding U.S. tax obligations to managing state residency and foreign tax liabilities. With multiple forms to file and various rules depending on where you live and work, staying compliant requires careful attention.
Professional assistance can make a significant difference in ensuring you meet your tax obligations while maximizing available benefits. Expat CPA specializes in helping digital nomads tackle these challenges, offering expert guidance and services tailored to understanding tax implications for your unique situation.
Contact Expat CPA now to simplify your tax reporting and avoid costly mistakes.