Changes in technology have evolved our standard “9 to 5” jobs to gigs that simply require a computer and internet connection. And with these technology changes, the way Americans work has changed, too. The number of Americans living and working abroad has multiplied in the last several years – 8 million Americans now live abroad.
These expatriates are commonly known as digital nomads, meaning “someone who is location independent and uses technology to perform their job.” Many of these digital nomads own businesses or work for companies that allow them to work outside an office environment. Because these nomads are not living within the United States, their tax obligations are more unique and complicated than an average taxpayer.
The primary reason expatriate taxes become so complicated is not surprising: location, location, location. Here are the basic tax law differences you need to know about when you prepare taxes for clients who live and work outside of the United States:
- U.S. citizens and green card holders that have income over the minimum filing requirement must report all worldwide income on their tax returns. This means any income they have earned anywhere in the world.
- Foreign Earned Income Exclusion: this exclusion allows taxpayers to pay zero U.S. income tax on $100,000 of income they earn outside the U.S. To use this exclusion, the taxpayer must spend 330 days outside of the US in a 12-month period. There is also a “bona fide residence test,” but that is a subjective test based on if the taxpayer has settled down in one country and intends to stay there indefinitely. Your client still must file a return and report all income earned, however.
- Foreign Tax Credit: the United States has tax treaties with over 60 countries in order to prevent double taxation. If you do still have to pay taxes to the country you are living or working in, then you can use this credit on the US return in order to take a credit or itemized deduction for those taxes.
- Social Security, Medicare, and Self-Employment: if the taxpayer is working for a company, then they won’t need to worry about withholding their Social Security and Medicare taxes. However, digital nomads that operate their own businesses will have to withhold these taxes and self-employment taxes. It is possible that the taxpayer can utilize the Social Security Totalization Treaty so they can participate in that country’s social insurance system and forego paying Social Security and Medicare taxes. Self-employment taxes do not fall under any treaty and will have to be paid by self-employed digital nomads on their income tax returns.
- Report of Foreign Bank and Financial Accounts (FBAR): If a U.S. taxpayer has a financial interest or signature authority over a foreign financial account (bank account, brokerage account, mutual fund, trust, etc.) that exceeds over $10,000 at any time during the calendar year, then a FBAR must be filed with the IRS.
- Form 8938: U.S. taxpayers with financial assets outside the U.S. that total more than the reporting threshold ($50,000 at the end of the calendar year) must report their assets to the IRS (the threshold varies based on filing status and whether or not the taxpayer lives in the U.S.).
After they begin working abroad, many taxpayers eventually choose to renounce their U.S. citizenship, often due to staggering U.S. tax obligations. The number of taxpayers trading in their passports has skyrocketed in the past several years. In 2015 alone, 4,279 Americans renounced their U.S. citizenship, up 20% from 2014. That is 18 times as many as in 2008, and the third year in a row that's set a new record. Once these expats renounce their citizenship, they cease their tax filing obligations to the United States.
If your client has moved abroad, then they will need to be aware of how their tax obligations have changed. This overview covers some of the basics that will help digital nomads, but with offshore companies and foreign investments, tax obligations of digital nomads can become far more complicated than this post can realistically cover. If your client’s situation exceeds the scope of these basic filing requirements, consider referring them to a tax attorney or another accountant that specialize in foreign filing requirements.
Interested in learning more about the Foreign Earned Income Exclusion and the Foreign Tax Credit? Check out How to Minimize US Taxes for Expatriates.