This article is for anyone who lives and works offshore or in another country, or who is planning to do so. It’s for digital nomads, location independent workers or just plain expats who have chosen to live outside the US.
There can be a huge tax advantage, if you do it right.
Here’s how it works. The US govt allows qualifying US taxpayers to take a foreign earned income exclusion.
The income has to be earned income. That means it can’t be passive income like rental income or portfolio income like interest, dividends or capital gains. It is money you work for as an employee, worker or with your business.
If you qualify as a foreign resident during the year, you can take a foreign earned income exclusion of up to $105,900 per person per year. If you’re married, you could take $105,900 each. Additionally, you can get a housing allowance. This is based on a formula based on how much foreign earned income exclusion you have, how much your qualifying housing expenses are and where you live.
You will have to pay income tax to the foreign government in which you earned the income. However, this is where strategy comes into play. It’s often possible to earn income in a no or low income tax nation.
In order to be a foreign resident you need to either pass the physical presence test (330 days out of 365 days out of the US) or bonafide resident test. The bonafide resident test is subjective, not objective so there is no hard and fast number as to how many days you can be in the US. We usually assume it’s less than 120 days.
Obviously, there are a lot more rules to follow in order to take this amazing tax breaks. It’s surprisingly easy though, if the circumstances are right.
You can legally love a digital nomad lifestyle, traveling the world with your laptop and pay no taxes. Or you can live in another country, making money and never paying taxes.
And it’s all legal.
That’s how it works for the federal tax law. But there could be a problem.
There are some states that do not allow the foreign income tax exclusion:
You’ll want to sever your ties with those states. It’s pretty easy to do just by establishing another place of residence. But there are 4 states that are a problem.
If you currently live in California, South Carolina, New Mexico or Virginia and plan to move offshore, the state will consider you still a resident of that state.
Let’s say you currently living in Virginia and then move to Thailand to live and work. Virginia will still consider you a resident of the state. You still will be responsible to file a state tax return and pay tax in the state, even though you don’t live there and the IRS doesn’t think you have to pay tax.
Virginia, just like California, South Carolina and New Mexico, do not recognize a move outside the country. If you move from Virginia to another state, say West Virginia, fine. You’re no longer part of Virginia. But if you move from Virginia to another state, they still consider you a resident of Virginia.
The strategy here is to first move somewhere else and then move outside the country. As an example, if you live in California, move first to Nevada. Nevada is right next door and has no state income tax.
You will need to make this a legitimate move, though, and prove that the new location IS your residence. Some of the things that can prove residence include:
Your driver’s license
Your voter’s registration
Where your car(s) are registered
When your kids go to school
Where your religious organizations are that you belong to
Where you have membership in social organizations
If you live in a state other than one of the hard states to leave (California, South Carolina, New Mexico and Virginia), you don’t need to take this extra step. But if you do live in one of these difficult 4 states, go the extra mile. Otherwise you could find yourself on the hook for state taxes for years.
If you’re planning a move offshore or have already moved offshore and need to take a hard look at your own tax situation, you may need a personal tax consultation. For more information, Contact Us.