Moving Overseas? U.S. Tax Guidance For Expats And Digital Nomads
4 min read
Imagine the freedom of working from anywhere in the world, with just an internet connection and a trusty laptop. For many Americans, this dream is becoming a reality as the allure of lower taxes, improved quality of life, and better weather beckons. Before embarking on a global adventure, it’s essential to understand the intricate U.S. tax implications that come with an international move.
Hot Takes:
- File a tax return or risk losing significant U.S. tax breaks!
- Make the country your “home” to avoid tax issues.
- Self-employment and social security taxes don’t disappear; planning helps.
- State taxes don’t disappear, but one can escape them.
- Pay attention to foreign investments, estimated tax, special filings.
- Green card holders need extra care.
Americans venturing abroad soon realize that U.S. tax laws extend beyond borders, creating a complex web of obligations that follow them everywhere. To help navigate this complex landscape, today’s article delves into the world of the U.S. expatriate and what he must know about taxation. It’s a world in which I’ve been immersed for decades.
Foreign Earned Income & Housing: The Tax Breaks
Residing overseas doesn’t exempt individuals from reporting worldwide income to Uncle Sam. However, there are exclusions available that can significantly reduce one’s tax liability, but a tax return must be filed to claim them. The Foreign Earned Income Exclusion (FEIE) allows one to exclude work earnings, currently $126,500. for 2024. If specific requirements are met certain foreign housing costs can also be excluded (or deducted for the self-employed).
Understanding “Tax Home” And Qualification Tests
To qualify for the exclusions, one must establish a “tax home” in a foreign country. This is typically the primary place of business or employment, but it can also be where the individual regularly lives if the nature of the work is location-independent. Maintaining strong ties to the U.S. can complicate matters and potentially disqualify a claim for the exclusion benefits.
Additionally, the expat must meet either the bona fide resident test or the physical presence test. The bona fide resident test assesses whether the individual is truly a resident of a foreign country, examining actions and connections with the foreign location.
The physical presence test requires physical presence in a foreign country or countries for at least 330 days within a 12-month period. The days of presence need not be consecutive.
Expatriates meeting the bona fide resident test generally may spend more days in America than is permitted under the physical presence test. The typical digital nomad, however, cannot meet the bona fide resident test due to continuous relocation. In that case, careful counting of days and record-keeping are obviously critical.
Green Card Holders
Should a green card holder living in a foreign country claim the exclusion benefits? This is actually a difficult question to answer, even though many green card holders give little thought to the issue and willy-nilly claim the exclusions. This tricky area may impact the individual’s immigration status and have repercussions for retention of the green card.
Self-Employment & Social Security
Many expatriates are self-employed and are disappointed to learn the FEIE does not reduce self-employment tax. This is a 15.3% tax consisting of 2 taxes: Social Security (imposed at the rate of 12.4%) and Medicare (2.9% rate). While regular income tax liability will decrease because of the exclusion benefits for workers abroad, the self-employed expat is still responsible for self-employment taxes without considering the amounts excluded for FEIE or housing costs.
When employed overseas Social Security issues become complicated and depend on various factors. The issues need to be examined carefully and planning put in place to avoid later unpleasant surprises.
Navigating Estimated Taxes, Information Filings and Foreign Investments
Unlike in the U.S., foreign employers don’t withhold taxes from the expat’s salary, nor are any taxes withheld if one is self-employed. This means estimated tax payments must be made to the IRS throughout the year to avoid penalties.
Living overseas often triggers various tax information reporting requirements (and tax consequences) that are not common when living stateside. Owning foreign entities, receiving gifts or inheritances from foreigners, or holding foreign financial accounts are common examples that may require special reporting. Failing to comply can result in severe penalties.
While living abroad, unique investment opportunities may present themselves, but it’s essential to understand the U.S. tax implications before diving in. Certain investments, such as foreign mutual funds, foreign life insurance, or ETFs, can be subject to complex tax rules with harsh tax consequences.
State Tax Considerations
Expats can’t forget state taxes. Even if living overseas, some states may still consider the expat a resident for income tax purposes. Residency audits are on the rise and this upward trend will continue as increasing numbers of people are moving and relocating. The relevant state’s tax rules should be carefully examined before trying to break residency.
Embracing the Experience
Moving overseas is a transformative experience. Navigating the tax intricacies may seem daunting, but staying informed about tax responsibilities along the way will provide guidance and alleviate concerns.
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