(Full disclosure: Dispatches is a satisfied client and recommends Doug and Specialized Tax Resolution Service. We receive no remuneration for this post about digital nomad taxes.)
During the just concluded tax season, I had the opportunity to work with a number of “digital nomads,” American citizens who express the very essence of entrepreneurship with a business model of “have laptop, will travel,” (although, given the age of most nomads, I doubt they recognize the name Paladin).
Most of these young entrepreneurs know they have a partner on their travels in the person of the Internal Revenue Service.
Hit the road, save on taxes Digital Nomads
The nomad’s best tax friend is the Physical Presence Test for the Foreign Earned Income Exclusion. If you remain outside the United States for 330 days of any 12-month period, you are able to exclude up to the Maximum Exclusion Amount ($108,700 in 2021) from your gross earnings. The exclusion only applies to earned income, for example wages or self-employment income, so your “passive” income of interest, dividends or capital gains is not excluded, but still, the exclusion is a terrific tax break.
As with most good things, the devil is in the details. Nomads will still be subject to self-employment tax on their self-employment income. If the nomad is a wage employee of a U.S. firm, she will continue to be subject to FICA withholding on her wages but can request the employer not withhold income tax on her wages if she expects her wages to be below the exclusion amount.
That Maximum Exclusion Amount is prorated for the portion of the current taxable year for which she qualifies. For example, a nomad who leaves the U.S. on 1 July 2021 and returns on 15 June 15 2022 meets the physical presence test for that 12-month period, but her maximum exclusion in 2021 is limited to $54,350 ($108,700 X 50 percent).
There is also an additional exclusion or deduction for foreign housing costs you incur.
The amount of the nomad’s housing costs in excess of 16 percent of her Maximum Exclusion Amount will also be excluded. The combination of the Housing exclusion and the Earned Income Exclusion cannot exceed the total foreign earned income.
State and local issues
Then there are the state and local income tax issues. Forty-one of the 50 states have some form of income tax on earned income. They generally – with some exceptions – tax their residents on worldwide income. The nomad who leaves the family home in, say, California, kisses mom goodbye, and takes off for an indefinite period will remain a California resident for tax purposes.
States generally want to see you establish residency somewhere else before they will accept that you have really left.
The retention of a valid state driver’s license or voter registration is generally enough to convince the State that you intend to return and are merely traveling. The tax collector can access those databases without leaving her desk. States such as California and many others love the phrase “temporary and transitory purpose.” That is the digital nomad’s residency plan, and it means the taxpayer’s domicile has not changed.
A little planning before departure can prevent an unpleasant state tax surprise a year or so down the road. Record keeping is an area that becomes a challenge for many nomads. Indeed, it is a challenge for many taxpayers. A contract coder can effectively work anywhere in the world, but she needs to develop good record keeping habits if she wants to deduct some of her travel expenses as business expenses.
For example, a nomad who is currently renting a home in Italy could travel to Indonesia to meet with a potential client and can deduct expenses, including round-trip airfare, lodging and meals. However, the business purpose of the trip must be carefully documented, and the three extra days’ lodging she spent enjoying the beaches in Bali cannot be deducted.
You still gotta file
The entrepreneurial nomad is yet another byproduct of the global gig economy. They are enjoying the enriching experiences of world travel while earning a living and perhaps building a business. Additionally, they are usually exempt from local income taxation and partially or completely exempt from U.S. taxation under the Foreign Earned Income Exclusion.
Just watch out for state income tax exposure.
Nomads have a winning lifestyle/business plan. Just remember to send back a postcard to the IRS in the form of your annual return.
About the author:
Doug Ralph is a certified public accountant and an expert in U.S. expat taxation. You can read his blog here.
Doug is based in New Mexico. You can reach him for tax advice at: [email protected]
Read more here on Dispatches about taxes and official requirements for expats.