The US tax code is a few thousand pages long—not something most digital nomads are eager to read through after a long day of work. Unfortunately, failing to understand the essentials can be as damaging to your finances as failing to use an accurate tax calculator when determining what you owe each year.
To help you avoid that
kind of costly trouble, here are five things to be aware of:
#1. (Almost) Everyone Needs
to File Federal Income Taxes
Digital nomads from the US
almost always have to file federal income taxes. The US is one of two
countries—the other being Eritrea—that has citizenship-based taxation. In
simple terms, that means all US citizens, regardless of where they reside, must
file taxes if their income exceeds the minimum threshold.
The minimum changes a bit
from year to year, but in 2022, it was $12,950 for those under 65. If you
earned more, you’ll need to file. You can do that by yourself, or with the help
of software or tax professionals.
#2. Not Everyone Needs
to File State Income Taxes
Although most digital nomads will have to file federal income taxes, not all of them will have to file state income taxes. That’s because not all states have income taxes.
More specifically, eight
states—Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and
Wyoming—have no income tax on earned wages, while New Hampshire only taxes
interest and dividends. If you reside in one of those states, you might not
have to pay.
Of course, taxes aren’t always that easy. Sometimes if you live in a state without income taxes but mostly work in one which has them, you may still be liable to pay.
#3. You’ll Probably Need
to Pay Self-Employment Taxes
While some digital nomads work for a company, the majority are self-employed as independent contractors. If you fall into the latter group and make over $400 per year, then you’re responsible for self-employment taxes.
These taxes are split into
12.4% for Social Security and 2.9% for Medicare, adding up to a total of 15.3%
of your income. Regardless of whether you pay these taxes once a year or in
quarterly payments, it’s recommended to put aside what you think you’ll owe to
avoid any unpleasant surprises.
#4. You Might be Able to
Exclude Foreign-Earned Income
If you’re eligible for the Foreign Earned Income Exclusion (FEIE), you can exclude up to $120,000 from your taxable income. The point of FEIE is to avoid double taxation, or being taxed in the US and your foreign country of residence.
To qualify, you’ll have to pass either the bonafide residence test or the physical presence test. Generally speaking, to pass the first, you’ll have to live abroad permanently without any immediate plans to return to the United States. For the second, you’ll have to be outside the US for 330 days out of any 12-month period.
#5. Additional Reporting
May Apply
Depending on your
financial situation, the IRS may require additional reporting. Two common ones
are the Foreign Bank Account Report (FBAR) and the Foreign Account Tax
Compliance Act (FATCA). Both involve reporting financial assets held in foreign
accounts.
Understanding some of the
basics of the US tax system is crucial for digital nomads who earn income while
living abroad. The five points outlined above are a great start, but be sure to
reach out to the experts for any detailed questions.
