When you’re traveling the world as a digital nomad, you just want to focus on making the most of your time. Not everyone gets the opportunity to have flexible work arrangements, and you are one of the lucky few who get to mix business and pleasure wherever you want.
However, traveling the world while working can complicate your tax situation. Every country has its own tax system and you need to make sure that you stay on top of your financial situation.
Here are a few things a digital nomad should know about taxes.
1. Do I need to file taxes even if I’m a digital nomad?
Yes, all U.S. citizens and permanent residents (also known as Green Card holders) are taxed on their worldwide income. While most countries tax citizens and aliens based on their residency status, the United States has adopted a citizenship-based taxation system. That means you are required to file state and federal tax returns even if you earn all of your income abroad.
Your taxes also depend on your worker status. If you are directly employed by a company, whether based in the U.S. or not, then the standard income thresholds apply. For tax year 2021, a single taxpayer who earned at least $12,400 in gross income is required to file a tax return. However, if you are self-employed (i.e. a sole proprietor or an independent contractor), you need to report income above $400.
You may also be required to file a tax return in your host country for income earned during the duration of your stay. The usual criterion for determining foreign tax residency is physical presence and the length of stay. If you’re not sure about your tax status, consult a tax professional.
2. I forgot to file a U.S. tax return. What should I do?
American citizens who for various reasons have not filed a U.S. tax return can settle their tax liabilities with penalties forgiven. The IRS has a tax compliance program for expats and digital nomads called the Streamlined Foreign Offshore Procedures (SFOP).
To qualify for the SFOP, you must:
- Not have an abode in the United States
- Be physically outside the United States for at least 330 full days in one or more of the last three years you failed to file a tax return
- Prove that your failure to file a U.S. tax return stems from non-willful conduct
3. How can I avoid double taxation as a digital nomad?
If you stay in a foreign country long enough, you may be required to file two tax returns: one to the United States and one to your host country. It’s important to plan your trips properly to avoid double taxation.
Many tax professionals recommend staying in one country for no longer than six months to avoid having to file a foreign tax return, but the rules differ from country to country. If you desire to prolong your stay, you might want to consider a destination that offers low or zero local income taxes.
Some European countries such as Iceland and Estonia offer visas that allow digital nomads to stay for up to a year without having to pay income tax.
If you’re looking for a warm place to visit, tropical destinations like the Cayman Islands and Costa Rica have similar programs in place.
4. How can I save money on digital nomad taxes?
One of the best ways to minimize your tax liabilities is to take advantage of the Foreign Earned Income Exclusion or the Foreign Tax Credit.
The Foreign Earned Income Exclusion allows American taxpayers to exclude up to $108,700 (for tax year 2021) of foreign-earned income from federal tax if they work and live abroad.
Another option is to take a Foreign Tax Credit for foreign income taxes imposed on the same income. Digital nomads can claim an equivalent value in tax credit for every dollar of income tax paid to a foreign government.
To qualify for these programs, you need to pass the Physical Presence Test or the Bona Fide Residence test.
5. What other taxes do I need to pay?
If you are classified as self-employed, you will need to pay a 15.3% self-employment tax (for Social Security and Medicare) on your income on top of your regular income tax. The calculation for the self-employment tax happens before any tax breaks or exclusions.
6. How do I pay digital nomad taxes?
Filing taxes when you’re in the U.S. is already hard enough. If you’re based abroad, your tax situation can be rife with complications and difficulties. If you want to clarify your tax situation, it’s best to consult with an expert tax professional.
TFX (Taxes for Expats) has been preparing U.S. tax returns for American expats and digital nomads for over 25 years. Our team of experts can examine your case and recommend the best course of action to straighten out your tax liabilities. With the right advice, you can save thousands of dollars that could be put to better use.
