How can you save money on taxes as a digital nomad? Can you really save money by traveling around the world?
Living a digital nomad lifestyle can indeed help you save money on taxes.
This could mean traveling constantly from country to country, moving between two or three countries, or settling down in a low or zero tax country overseas. Your nomad lifestyle is going to look different from anyone else’s.
Still, everyone needs to follow the same basic first step — get out of your high tax country. After that, your next step is ultimately up to you. However, we’re going to give you some tips and tricks to keep in mind as you begin your nomad lifestyle and begin saving money by lowering your tax obligations.
This article is going to address both US and non-US citizens who are looking to avoid paying high taxes. We are going to explain digital nomad taxes and what you need to do to get a digital nomad tax deduction and how to avoid taxes as a digital nomad.
In this article, we’ll discuss:
- Avoiding tax as a US Citizen
- What is the Foreign Earned Income Exclusion?
- How do you qualify for the Foreign Earned Income Exclusion?
- How to avoid tax as a self-employed person
- How to avoid state taxes
- How to avoid taxes as a non-US citizen
- Where should you go to avoid taxes?
- How you can save money through an offshore company
AVOIDING TAX AS A US CITIZEN
Avoiding taxes as a US citizen is a bit more complicated than it is for citizens of any other country. The United States is one of only two countries in the world that practices citizenship-based taxation. This means that if you are a US citizen, you are subject to US tax regardless of where you reside. It doesn’t matter if you are currently living in the US. All US citizens and green card holders have to pay tax on their worldwide income.
As a US citizen, you can’t avoid taxes just by moving out of the US. However, there are still ways you can legally pay less on taxes by adopting a nomad lifestyle.
The US offers perfectly legal tax exclusions for people who live outside of the United States. By using these exclusions, you can move to a low-tax country or travel between countries as a digital nomad and significantly lower your tax obligation.
WHAT IS THE FOREIGN EARNED INCOME EXCLUSION?
The Foreign Earned Income Exclusion (FEIE) is a tax exemption in the United States that allows you to exclude just over $100,000 of foreign earned income from being subject to federal income tax. In 2021, the exclusion is $108,700. The exclusion is adjusted each year for inflation.
If you earn less than $108,700 in 2021 and qualify for the Foreign Earned Income Exclusion, you can completely eliminate your US tax bill. If you earn more than that, you’ll have to pay federal income tax on the excess.
Remember, to use the Foreign Earned Income Exclusion, you’ll need to file the correct form (Form 2555) with the IRS saying that you are claiming it. If you don’t do that, you won’t be able to claim it. Even if you don’t have to pay federal income tax to the US, you are still obligated to file with the IRS as long as you are a US citizen.
HOW DO YOU QUALIFY FOR THE FOREIGN EARNED INCOME EXCLUSION?
In order to qualify for the Foreign Earned Income Exclusion, you have to pass the physical presence or bona fide residence test. By living outside of the United States you can qualify for what is basically a digital nomad tax deduction.
To pass the physical presence test you have to spend a minimum of 330 days outside of the United States each year.
There are a few specifications you need to meet. For instance, the 330 days outside of the US must be spent on foreign soil, it doesn’t count if you’re spending them on a cruise ship. It also won’t count the days that you spend on an airplane. Days that you spend traveling into or out of the US are going to be counted as a day in the US and won’t count towards your 330 days on foreign soil.
It’s also going to be really important to track the days that you are on foreign soil. This 330-day value isn’t a suggestion, you have to meet it or you won’t qualify.
The bona fide residence test is based on whether you claim another country outside of the United States as your tax home. In this case, you need to become a tax resident of another country.
If you qualify for the FEIE through the bona fide residence test, you’ll be able to spend more time visiting the United States than you would if you qualified through the physical presence test. The bona fide residence test allows you to travel away from your tax home, you just have to make sure you spend more time in your new tax home than you do in the US.
HOW TO AVOID SELF-EMPLOYMENT TAX
The FEIE does not exempt you from having to pay self-employment tax such as Social Security and Medicare. Self-employment tax has to be paid on your entire profit including the income that was excluded from federal income tax by the FEIE.
Foreign employees don’t have to pay self-employment tax. That being said, you can avoid having to pay tax for Social Security and Medicare tax by creating a foreign company and hiring yourself as an employee.
You can then pay yourself an amount under the limit for the FEIE, and lower your US tax to zero.
HOW TO AVOID STATE TAXES
State taxes are easier to avoid than federal tax in the United States. State taxes are placed on those who live within that particular state. If you move out of a state and don’t plan to retire, the state you left will no longer tax you.
Most states recognize the FEIE, meaning if the federal government isn’t going to tax your foreign earned income, then the state government isn’t going to tax it either. However, California doesn’t recognize the Foreign Earned Income Exclusion.
Some states may try to keep you in their tax net, even if you are an ex-resident. If you are leaving one of these states, which includes California and Virginia, you might want to become domiciled in a different state before you leave the US.
As long as you are living in a US state, you are going to have to pay state tax. Many people want to get out of California because of the high taxes there, and they plan to move to a state with lower taxes. While this may lower their taxes a bit, they could lower their tax obligation to as low as zero if they left the US completely.
HOW TO AVOID TAXES AS A NON-US CITIZEN
Many people assume that as long as they are not US citizens they can leave their home country and be done paying taxes. This could be the case, but just to be safe, it’s important to take the steps necessary to ensure that once you leave your home country, you will no longer be a tax resident there.
There is a chance that even if you leave your home country, you could still be a tax resident. You want to take the appropriate steps to become a tax nonresident. Otherwise, you may end up owing back tax.
One way to become a nonresident is to establish residence somewhere else. You can obtain permanent residence in a low-tax country. It’s then a good idea to establish some ties to your new country of residence. You can do this by renting an apartment or joining a social club.
More western countries are imposing taxes on their citizens and expanding their tax net. If you still own property or have a business in your home country, you might still be obligated to pay tax in your home country. Because owning a business in your home country can subject you to tax there, you should consider incorporating offshore instead.
And while the United States (and Eritrea) are the only countries to impose a citizenship-based tax, other countries are always changing their tax laws. As long as you are a citizen of that country, you’ll be subject to whatever laws they put in place.
WHERE SHOULD YOU GO TO AVOID TAXES?
Most countries are only going to tax you if you qualify as a tax resident of that country. If you are visiting or living in that country for a very limited amount of time, you most likely won’t get caught in their tax net.
The rules for becoming a tax resident vary from country to country. Typically, you are going to be considered a tax resident if you live in the country for at least 6 months.
While it’s not true 100% of the time, you can often avoid becoming a tax resident if you don’t stay in a country for longer than 6 months out of a 12 month period.
One strategy to make sure you aren’t falling into any country’s tax net is to divide your year up between three countries. This way, you won’t be in one country long enough to fall under their tax obligations.
There are some countries, such as Panama, that only tax income earned within the country. This means you could live in Panama and pay zero income tax if you are incorporating and running your business in a different country.
Other countries have no income tax at all, such as the United Arab Emirates. You can avoid tax by moving to a zero-tax country, often called a tax-haven. Just remember this isn’t your only option.
SAVE MONEY THROUGH AN OFFSHORE COMPANY
Earlier we mentioned that having your business in your home country can keep you in your home country’s tax net. Because of this, you may want to look into starting or incorporating your business offshore.
By incorporating offshore, you can save money on taxes. Depending on how or where you structure your business, you could lower your tax to zero. Look into incorporating in low-tax or tax-neutral jurisdictions. Some of the cheapest countries to incorporate in are Belize and Seychelles. However, there aren’t your only, or best, options. Estonia also has an option to start up a corporation there and pay zero tax.
Having your business offshore is also a great way to protect your assets. If you keep your income source all in one country and something happens in that country, you could lose everything at once. If you source your outcome out of multiple places, you’ll still have some income if something were to happen to one source in one country.
Some countries have programs where you can get residence or even citizenship by starting a company there. These are often called Golden Visas or Entrepreneur Visas.
If you are incorporating overseas, you’ll need to decide where to keep your money. There are lots of amazing banks throughout the world. One of the easiest and least expensive places for your company to bank is in the United States. You can use a US bank for your offshore company, even if you aren’t a US citizen or resident — this won’t drag you into the US tax net.
Money that you earn while you are working outside of the United States is considered foreign earned income, even if you get paid in a US bank account. You also don’t have to pay taxes if you’re just moving your own money from a non-US bank account to a US bank account.
Additionally, as a US citizen, you are not required to do your banking within the United States. Banking overseas can help you to diversify your assets and many banks overseas have higher interest rates for term deposits.
Now you know how you can save money and avoid paying high taxes by living a digital nomad lifestyle. Digital nomad taxes are going to be less expensive than staying in a high-tax country. By going overseas, you can lower your taxes and live a much happier lifestyle.
You can avoid taxes legally by creating a plan for you and your business. Take advantage of tax exemptions for living overseas and avoid high-tax countries. Doing this will provide you with more personal and financial freedom.