NOTE: A new version of this article is avialble here: The Ultimate Tax Guide for American Nomads & Expats (2020)
The US is the only country in the world (along with Eritrea) to tax citizens and green card holders no matter how long they live outside the United States. The US tax code is also one of the most complex in the world.
That’s why I’ve decided to write a dedicated article looking at taxes for American digital nomads and expats.
In this article, you will learn the fundamentals of how to file your US taxes to avoid heavy fines or penalties, and how to legally reduce the amount of tax you pay to the US and abroad.
Finally, I’d like to give some advice to those of you who value your time and sanity and opt to hire someone to help you with your US tax filings. Continue reading for some exclusive discounts.
Table of contents:
The Foreign Earned Income Exclusion
Physical Presence Test
Bona Fide Residence Test
Tax Home and other Exclusions
Do you feel lucky?
Don’t be fooled by FEIE—you may still be taxed!
Should you form a (foreign) corporation?
How to avoid paying State Taxes
Filing your taxes
What forms to file, and when?
Frequently asked questions
Let’s start with the basics
The obvious disclaimer
Even though I am quite well versed in international tax law (both academically and practically), I am still just “some dude on the internet.” And you definitely shouldn’t trust what random people online have to say about tax.
I’ve compiled this guide based on information gathered from official sources (e.g., the IRS), trustworthy tax advisors/lawyers, and my understanding of international tax principles.
Nothing in it constitutes legal advice, so please just use it as a starting point for further discussions with qualified advisors.
Do you need to file US taxes while living abroad?
Yes, US citizens and green card holders are required to file and pay US taxes no matter where they live and work.
Is there any way to stop having to file US taxes?
The only way is to expatriate, basically giving up your US citizenship or green card.
Do I have to pay taxes only on income from the US, or also foreign income?
You have to pay taxes on your worldwide income. Luckily there are some exclusions available.
Many digital nomads and expats qualify for the Foreign Earned Income Exclusion (FEIE), which lets you earn a bit more than $100,000 per year without paying any US income tax.
And if you are paying income taxes in the country where you’re actually resident (on income that’s not covered by your FEIE), you can credit these against any additional US tax liability.
FEIE (Foreign Earned Income Exclusion)
The amount you can claim tax-free through FEIE is adjusted every year in accordance with the Chained Consumer Price Index and is $104,100 in 2018.
It only applies to earned income, such as:
- Salary & Wages
- Consulting income
- Professional fees
It does not apply to unearned income, such as:
- Social security payments
- Capital gains
It also does not apply to income earned in the United States. Even if you do qualify for FEIE, any income you receive from work performed while physically present in the United States (such as fees from speaking at a conference in Austin) will still be taxed normally.
There are two ways to qualify for FEIE.
- The physical presence test
- The bona fide resident test
Let’s take a detailed look at the two.
Physical Presence Test
This is usually the easiest requirement to meet for digital nomads, as they generally don’t qualify for the bona fide residence test.
You will meet the physical residence test if you spend more than 330 full days in foreign countries in a consecutive 12-month period, starting or ending in the tax year in question.
In cases where you qualify for FEIE for part of a tax year, it is important to choose the 12-month period carefully to maximize your deductions.
Be aware of international waters and airspace
When leaving or entering the United States by air, you can only count the days from when you entered or until you left another country’s airspace.
For example, if you fly from the US to France (and don’t fly over any other countries on the way), you can only count the first full day (starting from midnight) after you enter French airspace.
If you fly from the US to Panama and fly over Mexico on the way there, you can count the first full day (starting from midnight) after you entered Mexican airspace.
The same goes for oceanic travel—you can only start counting your days abroad from the first full day you spend in another country’s waters (excluding international waters).
However, if you travel between countries other than the US, and the trip takes less than 24 hours, you do not lose a day in your calculation.
If, however, the journey takes more than 24 hours, you will lose at least two full days. E.g., if you travel from the United Kingdom to Spain on a ship, departing August 1 at 11pm and arriving August 3 at 1 am, you lose three days: August 1, 2 and 3.
Bona fide resident of a foreign country
Unlike the physical presence test, the bona fide resident test follows the calendar year. As a long-term expat, you might qualify for this. Nomads very rarely do.
These are the requirements you need to meet:
- You’re a US citizen (or resident alien/green card holder from a country the US has a tax treaty with)
- You must have moved to a foreign country and set up your residence there
- You must have your residence there for an entire tax year (i.e., calendar year)
- You can not have any immediate plans for moving away, either back to the United States or to another country
In other words, you are not automatically bona fide resident of another country just by spending a whole calendar year there. If you are there on a temporary work assignment (e.g., a 2-year teaching job), you will not qualify.
If you end up staying from November in one year to November the next, you will still not qualify, since you did not live there for an entire calendar year. You might still meet the Physical Presence Test, however.
If you end up staying from November in one year until April in the third year, you can still qualify for FEIE for November to December in year one, and January to April in year three. This is because you stay the full second year.
Tax Home and other Exclusions
If you meet either the physical presence test or the bona fide resident test, you might still not qualify for FEIE.
To qualify, it’s crucial that your tax home is outside the United States.
According to the IRS:
- Your tax home is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home.
- Your tax home is the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual.
- Having a “tax home” in a given location does not necessarily mean that the given location is your residence or domicile for tax purposes.
- If you do not have a regular or main place of business because of the nature of your work, your tax home may be the place where you regularly live.
- If you have neither a regular or main place of business nor a place where you regularly live, you are considered an itinerant and your tax home is wherever you work.
- You are not considered to have a tax home in a foreign country for any period during which your abode is in the United States.
- The location of your abode is based on where you maintain your family, economic, and personal ties.
- “Abode” has been variously defined as one’s home, habitation, residence, domicile, or place of dwelling.
- Your abode is not necessarily in the United States merely because you maintain a dwelling in the United States, whether or not your spouse or dependents use the dwelling. Your abode is also not necessarily in the United States while you are temporarily in the United States. However, these factors can contribute to you having an abode in the United States.
Another exception is if you’re present in a country in violation of US law. Currently, that’s only applicable to Cuba.
Do you feel lucky?
To claim FEIE, you must attach Form 2555 to your tax return (Form 1040). More information below.
Keep in mind that Form 2555 is full of “booby traps.” Making a single mistake can cost you your FEIE. And if that happens, not only will you get a hefty tax bill about two years after filing. You will also be slapped with interest and penalties that can amount to more than the extra tax owed.
So do you want to risk an additional tax bill of $50,000 or more?
In my opinion, unless you are 100% certain that you can fill out everything correctly, investing a few hundred hiring professionals specializing in doing taxes for nomads and expats is well worth it.
Not only can they save you thousands in avoided penalties, but also help you find ways of legally reducing your taxes.
Another reliable, budget-friendly alternative is Online Taxman. While perhaps a little bit more pricey than Taxes for Expats, they have a reputation for going the extra mile and giving various tips and options for reducing your tax burden. They can also offer advice on more advanced topics such as international business structuring.
I reached out to their founder, Vincenzo Villamena, and managed to score a 10% discount for Nomad Gate readers on any services you might order. There’s no promo code or magical link. Instead, you’ll just have to fill out this 10-second form to get the discount.
A third option to consider is Greenback Expat Tax Services. While similar to Taxes for Expats in their offering, they are a bit more expensive, have fewer independent reviews, etc. But for all I know, they might be just as good.
If you do decide to roll the dice and go the DIY route, at a minimum keep these things in mind:
- Don’t fill out both the bona fide resident and substantial presence test sections. That will automatically disqualify you from FEIE.
- Under no circumstance answer “yes” to the question Have you submitted a statement to the authorities of the foreign country where you claim bona fide residence that you are not a resident of that country?
- Selecting that you’re living in quarters furnished by employer is also likely to disqualify you.
- So is having a temporary visa to the country you’re claiming to be bona fide resident in.
- Also be careful not to take any deductions or foreign tax credits for the taxes you exclude through FEIE. Doing so may revoke your choice to exclude foreign earned income.
But again, why take the chance? At least hire someone to help you with the first year or two living abroad, and whenever your circumstances change significantly.
Don’t be fooled by FEIE—you may still be taxed!
While the FEIE is great, it doesn’t automatically apply to all tax. It doesn’t even necessarily apply to the full $100K something net profit of your business.
So even if you earn way below $100K per year, you may still be liable for some US tax.
This is largely the case for self-employed, i.e., those doing business in their own name or through a pass-through entity (such as a traditional LLC).
Here are some examples:
- Self-employed still have to pay Self-Employment Tax (Social Security & Medicare contributions).
- Capital intensive business (such as e-commerce, Amazon FBA sellers, etc.) can only deduct part of their income under FEIE. (The “30% rule”.)
- Also in cases where your gross income is a lot higher than your net income, the amount of income you can exclude from tax under FEIE is reduced. (The “scaleback rule.”)
Let’s take a closer look at each case, and explore options for eliminating (some of) this tax.
Self-Employment Tax (SE Tax)
While you may not pay federal income tax, you will still have to pay combined Social Security and Medicare contributions of 15.3% on the first $128,400 you earn (in 2018), then 2.9% Medicare contributions after that. This is often referred to as the SE tax.
Can you get out of paying the SE tax?
Perhaps—it will depend on your situation.
If you’re an entrepreneur running an actual business (not just selling your personal services), then there are ways. They are not free, but compared to the amount of tax you can save they are quite affordable.
To avoid the SE tax, you can employ yourself in a foreign corporation, preferably in a country with tax advantages and low operating costs. Note: this strategy only applies to nomads moving from country to country frequent enough to not establish an official tax residency anywhere. You can also not have any US employees or operations.
Depending on your particular business needs (reputation, access to banking, etc.), you may opt to have the foreign corporation own a US LLC which you will use for actually selling your product.
If you incorporate your foreign company on some Caribbean island or another notorious tax paradise (aka offshore), chances are you’ll need an LLC. While this reduces your taxes as much as possible, you’ll have to consider the cost of setting up and maintaining the structure.
Something like this might cost a few thousand dollars to set up correctly, then another thousand or so in yearly maintenance fees. And that’s excluding added expenses for hiring accountants in two jurisdictions, costs related to the extra complexity of filing your US tax return, etc.
If you want to go this route, one name I’ve seen recommended a lot is Stewart at U.S. Tax Services. He specializes in the Belize IBC + Wyoming LLC combination.
If you incorporate in a more reputable jurisdiction (aka onshore—e.g., the United Kingdom or Estonia), you probably won’t need an LLC. While these jurisdictions do have a corporate income tax (of around 20%), that only applies to corporate net profits. If you pay yourself nearly all the income of the business as a salary, the corporate profit will be meager.
There would still be costs involved to establish and maintain the business (a registered address, for example), but these would be closer to $500 in the first year and a couple of hundreds per year after that. Accounting would likely be a lot cheaper too (e.g., check out Xolo (formerly LeapIN) if you incorporate in Estonia.
If your product is your profession, sadly, the answer is no. There’s a legal doctrine in the United States which prohibits directing the income to another person than the one performing the services. Since a corporation is a separate legal person, running the income through it won’t be in accordance with US tax law.
But wait, there are still some ways you could restructure your income to avoid some tax. Basically, if the product you are selling is your time, then that income should be taxed as self-employment income.
However, if you think through what you do, is there any way you could earn income from your knowledge and expertise without selling your time directly?
Probably there is.
Could you perhaps offer an online course for sale, teaching what you usually help your clients with? Or maybe an e-book? Create some subscription service around your skills? Read a bit about productized services and see if you can find some inspiration.
For services like these, you can apply the same corporate structure as described for entrepreneurs above. That way this part of your income would be free of SE tax. But only if the savings can justify the added cost and complexity, of course.
If you’re an expat with an established residency in a foreign country, you are probably already paying Social Security contributions in the country where you live. If the United States has entered into a totalization agreement with your new home country you will typically only need to pay contributions there—yet still qualify for benefits from the US if you return.
This is currently the case for these 25 countries: Australia, Austria, Belgium, Canada, Chile, the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Japan, Luxembourg, Netherlands, Norway, Poland, Portugal, the Slovak Republic, South Korea, Spain, Sweden, Switzerland, and the United Kingdom.
Even if your new home country (where you are an employee) does not have a totalization agreement with the US, you will typically not be subject to Social Security and Medicare contributions in the United States. But you also won’t add to the benefits that you can claim later in your life.
So, should you form a (foreign) corporation or not?
What is the best solution for you will depend on your business, your lifestyle, your non-US residency (if any), plans for the future, income level, etc.
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).
Be wary of advisors who also sell incorporation packages, or seem to recommend a one-size-fits-all solution to everyone.
Here are some extremely simplified scenarios that may point you in the right direction:
- If you’re an employee of a US or foreign business, don’t worry about it.
- If you’re a digital nomad entrepreneur with a sufficiently large net profit, or who run a capital-intensive business (affected by the 30% rule), or have a relatively high gross income compared to net income (affected by the scaleback rule), consider either:
- A foreign corporation in an onshore jurisdiction
- A foreign corporation in an offshore jurisdiction, owning a US LLC
- If you’re a digital nomad freelancer or professional (i.e., selling your time), a corporation won’t help you tax wise. You may consider an LLC for legal protections, separating your personal and business finances, and a more professional image. Also, check with a tax advisor if an S-Corp election will be beneficial in your situation.
- If you are an expat entrepreneur who’s tax resident in a foreign country, consider opening a local corporation there (depending on your local tax situation). Also, check if there’s a totalization agreement between the US and the country you now call home.
Since I can’t cover all possible eventualities in this article—and you shouldn’t trust “some guy on the internet”—if you are considering implementing any of the above strategies you should really talk to a qualified, independent tax advisor specializing in tax for Americans abroad.
Perhaps you will find an even better strategy for your unique situation. If you do, feel free to share it in the comments below or in the community thread!
How to avoid paying State Taxes
If you really have left your home state indefinitely, you are not required to pay State Tax there. But if it’s easy or not to stop paying tax there depends a lot on which state you left behind.
In general, you only need to file and pay state income tax if you lived in the state during the year (usually for at least 6 months) or earned income in that state. But rules vary, so make sure you check with the relevant authorities in your state.
While most states make it relatively easy to officially leave the state, some states make it particularly difficult to give up your “residency” there. The worst states in this regard are:
- New Mexico
- South Carolina
These states even consider factors such as (not a complete list):
- Which state issued your driver’s license or ID card
- Where your spouse and children live
- In which state your vehicle(s) are registered
- In which state you are registered to vote
- Location of banks and brokerages where you maintain accounts
- Where you own property
- Mailing address in the state (even P.O. boxes or a friend or relative’s house)
You will do yourself a huge favor if you take the time to properly sever your ties with these states before leaving the US. If you don’t, it may be hard or in some cases nearly impossible to stop filing and paying state taxes while abroad.
Cancel your voter registration and library cards. Move your bank and investment accounts to a different state. Get rid of any property you own.
To get a mailing address outside your old home state, I’d recommend Traveling Mailbox. They offer addresses in a range of states, including some completely tax-free ones (see below).
You may even want to set up residency in a different, more tax favorable state, before leaving the country.
If you do, keep in mind that the following states do not tax income at all:
- South Dakota
- Washington State
In addition, New Hampshire and Tennessee also have no income tax on earned income, but they still tax interest and dividend income.
Filing your taxes
No matter if you’re filing your taxes on your own or with the help of a qualified tax preparer, you need to collect certain documents, receipts, etc. to fill out your return correctly and claim all available deductions.
Keep all W-2s (employment income), 1099-MISC/DIV/INTs (self-employment/dividends/interest income), etc. you receive during the year.
Bank statements can also be helpful to make sure you didn’t miss anything.
Foreign bank (and bank-like) accounts will also need to be reported, so make sure you collect a list of all your account numbers.
To make deductions, you often need to keep certain documents to prove that you qualify for the deductions (in case of a future IRS audit).
E.g., you should always keep documentation for:
- Income taxes paid (e.g., abroad)
- Housing expenses abroad (including utilities, insurance, etc.)
- Mortgage interest paid (form 1098 if to a US bank, otherwise keep bank statements showing the payments)
- Property taxes paid
- Schooling/college expenses paid for your dependents
- Charitable contributions
- Medical expenses
- Unreimbursed business expenses
Keeping track of expenses and receipts
My number one recommendation is to use Expensify to keep track of it all. You can snap pictures of paper receipts, forward email receipts, or use a browser extension to save online receipts.
While it’s primarily designed for making corporate expense reporting a breeze, it also works great for the record keeping needed to claim all available deductions on your personal taxes.
What forms to file, and when?
Keeping track of all the forms you have to file (and when to file them) as a US taxpayer living abroad can be quite overwhelming. Not only are new forms added, but current forms and their deadlines often change.
To help you out, I’ve listed and explained the most common forms for American expats and digital nomads below:
IRS Form 1040: Individual Income Tax Return
- Filing deadline: April 15 (extensions available, see below)
- Common attachments:
This is your personal tax return, which needs to be filed no matter what. Unless you give up your US citizenship, that is.
Continue reading to learn which additional forms you most likely need to include when filing.
Taxpayers living outside the United States can get two types of “automatic” extensions to file their tax return.
The two-month extension
The first is an automatic two-month extension (to June 15).
To get this extension, you simply have to attach a statement with your tax return stating that you are “living outside the United States and Puerto Rico and your main place of business or post of duty is outside the United States and Puerto Rico.”
This extension applies both to the date you need to file, and the date you need to pay. Keep in mind that it’s not an interest exemption, so interest will still apply from April 15.
The six-month extension
To get this second extension, you have to file form 4868 by June 15. It will get you a filing extension until October 15.
Keep in mind that it is not a payment extension, and you will have to estimate your taxes and pay the estimated amount owed when you file form 4868.
IRS Form 2555: Foreign Earned Income
- Filing deadline: with Form 1040
Use this form to claim the Foreign Earned Income Exclusion (FEIE), as well as foreign housing exclusion or deduction if applicable.
A simplified form (2555-EZ) is available if you don’t have self-employment income, business or moving expenses, and are not claiming the foreign housing exclusion or deduction.
IRS Form 1116: Foreign Tax Credit (Individual, Estate, or Trust)
- Filing deadline: with Form 1040
If you are paying tax in a foreign country, you can deduct that from any taxes you owe Uncle Sam. This does not apply to taxes paid for income that is already excluded by FEIE.
FinCEN Report 114: Report of Foreign Bank and Financial Accounts (FBAR)
- Who needs to file: US persons with more than a total of $10,000 in foreign financial accounts.
- How to file: Online only.
- Filing deadline: April 15, automatic extension to October 15.
- Note: It is separate from your tax return, so a filing extension on your tax return does not apply to FinCEN Form 114.
Anyone with more than a combined $10,000 in foreign financial accounts needs to file this form online.
The deadline was recently changed to coincide with the regular tax return, but it is not submitted along with that. Instead you file it online directly with FinCEN (not the IRS).
If you accidentally fail to file, you can be fined the typical $10,000. But if you “willfully” fail to file, you can be fined the greater of:
- 50% of the amount in the account(s) not being declared
These amounts are for each violation. And each year you don’t file is a separate violation!
IRS Form 8938: Statement of Specified Foreign Financial Assets (FACTA)
- Who needs to file: US persons with more than $200,000 in foreign assets (if living abroad, lower limit if living in the US).
- Filing deadline: with Form 1040
- an American expat living abroad, and
- filing your taxes individually, and
- have foreign assets totaling $200,000 at the end of the year (or reaching $300,000 at any point during the year)
…then you’ll have to include Form 8938 with your tax return.
If you’re filing jointly with your better half, you have double the limits.
If you’re living in the US, the limits are a lot lower—only a quarter of the above. If you don’t qualify for the FEIE, you are not considered to be living abroad.
Unlike the FinCEN Form 114, this form is filed with your regular US tax return.
Like most of the other forms here, the penalty for not properly filing this form is $10,000. The fine can be increased with another $50,000 if you still fail to submit the form after being notified by the IRS.
IRS Form 5471: Information Return of U.S. Persons With Respect to Certain Foreign Corporations
- Filing deadline: With Form 1040 (for individuals).
- Who needs to file: US persons owning at least 10% of a foreign corporation. It includes beneficial owners, so the use of nominees or fancy structures won’t save you. It also includes officers and directors in companies where any US person owns more than 10%.
This is one of the worst tax forms the IRS imposes on Americans.
While it is mostly an informational return, in the case of a Controlled Foreign Corporation (CFC)—a corporation with more than 50% US shareholders—certain types of income may flow through to the US shareholders and be taxed on their personal tax return (called Subpart F Income).
Learning about and filling out the form is a real pain in the ass:
- The IRS estimates that, on average, it takes almost a full work week to prepare the form.
- They also estimate that—for someone already familiar with the relevant tax law—it will take about two work days to learn how to fill out the form correctly.
- Their estimate for the time required to keep the required records is more than another two work weeks.
The last point also shows why it helps very little to set up a foreign corporation (typically an IBC) in a tax haven with no local accounting requirements. You will still need to keep meticulous accounts for the IRS.
Since this form can be a nightmare, you might be tempted to stick your head in the sand and pretend that you don’t have to file it.
But that is a terrible idea.
- The IRS can—and will—impose up to $50,000 in “disclosure penalties” for each time you fail to file Form 5471 properly. Or file it incorrectly. Even if it results in no tax liability.
- The three-year statute of limitation on your tax return does not start ticking until you have filed Form 5471. That means your full tax returns remain open for audit indefinitely.
- If you are planning on giving up your US citizenship, the failure to file could render you a covered expatriate. I won’t go into details here, but just know that you definitely do not want that.
Given how complex the form is to complete, how much time is needed to understand it properly, etc., you should definitely get help from a qualified tax advisor if you’re required to file it. Most US-based tax advisors have no experience with this form, so definitely check with the companies I listed above.
Sadly, since the form is a real PITA—even for the pros—it will also cost you. Expect to pay around $500-$1000, even with a more affordable provider.
Considering the time required to do it yourself and the financial consequences of completing it incorrectly (up to $50,000), it is definitely still worth it.
But it also means you should only consider moving your business activity to a foreign corporation if it would save you a significant amount of tax—at least a few thousand dollars.
Frequently asked questions
So you still have some questions, huh?
Having the pleasure of dealing with the IRS is probably the least pleasant “benefit” of holding a US passport. It’s more than likely to make your head spin.
If you still have any questions, post them in the comments below. I’ll try my best to get definite answers to the most common questions and feature them here.
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