Citizens of the United States and foreign residents must pay taxes on their worldwide income no matter where they’re living. Nevertheless, citizens and digital nomads living overseas are afforded certain tax benefits for income earned in foreign countries.
The rationale is that those who are not present in the US and don’t have an opportunity to enjoy the advantages of the government’s taxation efforts should not have to share the same tax burden as people who live here permanently. The available tax breaks come in the shape of relatively simple exclusions and deductions which can be claimed on Internal Revenue Service Form 2555.
Nevertheless, a complicated test exists to determine who qualifies for these exclusions and deductions. The rules for filing income taxes are usually the same regardless if you’re in the United States or in a foreign nation. Your gross income, filing status, and age usually determine whether you must file an income tax return.
The Internal Revenue Service updates the minimum income requirements yearly. For purposes of determining whether or not there’s a filing requirement, gross income must also include any income that one plans to exclude under foreign earned income rules.
All of the same rules apply regarding due dates, extensions, and estimated taxes as well. The amounts reported on your US tax return must be expressed in US dollars. If you’re paid in a foreign currency, you must convert it into US dollars on your return.
The exchange rate which should be used is the prevailing rate at that time the income is received. This is still the method that the Internal Revenue Service prefers. In instances of receiving income weekly or monthly, the exchange rate on the date you receive your pay should be noted.
If you decide to mail in a paper return, it should be sent to the Austin, Texas service center for processing. Residents of US territories are usually required to file with their territory, not with the US.
Taxpayers can exclude up to $100,000 of earned income while overseas. This is where the rules become convoluted and difficult to apply. Your tax home in a foreign country. Your tax home is the general area of your place of work or employment, no matter where you maintain your family home.
The location of your tax home frequently depends upon whether your assignment is temporary or indefinite. Excluded from the definition of a foreign nation are Antarctica and any one of the US territories. In order to be able to qualify for the Foreign Earned Income Exclusion, the tax home must be in a foreign country. Generally, this is near your place of employment.
As a digital nomad, you may not live near where you work, as most of your work is done remotely. In this case, you would be considered itinerant and your tax home is wherever you are working.
Another factor to consider is if you are employed in the US, but are on assignment abroad. Whether your income qualifies for Foreign Earned Income Exclusion is whether your assignment abroad is temporary or indefinite. To be classed as temporary, your assignment abroad must be expected to last one year or less. For indefinite, it would be if your assignment abroad is to last one year or more.
You are not considered to be “on assignment” if you simply move to another country for personal reasons. In this instance, your tax home is the last place you lived prior to leaving the United States.
Further, to qualify for the Foreign Earned Income Exclusion, you must meet one of two criteria:
- Live and work outside the US for at least 330 days out of 365. This is the Physical Presence Test.
- Live and work in a foreign country (not international waters) from January 1 to December 31, an entire calendar year. This is the Bonafide Residence Test.
For the first item, all you need to do is live outside the US for most of a year. For the second item, you must live and work in a single foreign country. One year, you could leave the US in February and live in another country for the rest of the year and claim Foreign Earned Income Exclusion based on the first item. For the next year beginning on January 1st, you could claim the second item if you remain in that country for the entire year.
Another thing you need to qualify for the Foreign Earned Income Exclusion is income. That is, earned income. This is income earned from work. Income earned as dividends, royalties, or other types of unearned income is not allowed to be excluded.
If you have to travel into the United States on business, you cannot exclude that income. If you are living abroad in China, but have to fly to California to speak at a conference, the amount of money you earn at that conference cannot be excluded. However, if you were paid to Skype a presentation from your home in China to the conference in California, you would be able to add that amount to your exclusion total.
The IRS utilizes Form 2555 to establish how much of the Foreign Earned Income Exclusion you can deduct from your taxable income. It is a form with 50 items. Most items are straight-forward, plug in income, company, and other information from the normal 1040. At the end of the form, it tells you how much you can exclude and where to plug in the appropriate numbers on the 1040. If you are mailing your return in, be sure to include this document.
If you reside outside of the United States on Tax Day, typically April 15th, you are granted an automatic extension to June 15th, but you may also file an extension to have your documents filed with the IRS by October 15th.
Those worrying about double taxation, that is the foreign country you are living in levying taxes and then also paying taxes to the United States, there is no reason to worry. What you pay in taxes to the foreign country is counted against your US tax liability.
One word of warning, while it is possible to exclude foreign earned income on a federal 1040 form, each state may have different rules regarding what can and cannot be excluded from foreign income.
Thanks for reading!
PS – Online Expert Empire is how you efficiently create your first product and build your online business so you can live/work anywhere (coffee shop, home office, while traveling).
This is how I efficiently get moolah dropped in my account each Monday.
This is how I help you make your business more efficient with the support of awesome people who want to help you.
This is how you efficiently increase your blog’s rank on Google
