More people are working from home these days, either as an employee or as an independent contractor (IC). There are clear differences in the tax planning for employees and ICs, but in the case of location independent work like this, there is one big question.
Where is Your Tax Residency?
People are on the move in these months after the pandemic shutdowns. Moving to bigger houses, smaller houses, to the city, to the country or completely out of the country. Your tax residency determines how much you pay in taxes so it’s an important question.
Let’s start by looking at domicile. The domicile is the place you live. If you leave for awhile to work or vacation, it’s the place to which you intend to return. You can only have one domicile, or tax home, at a time.
In order to change your domicile, you need to:
(1) Leave your prior domicile,
(2) Physically move into a new residence, and
(3) Have an intent to remain and make a home in your new residence.
If you work temporarily in a new area or move into a second home for a short period of time, you haven’t changed your domicile. You have to show that you have both left your prior home and that you have the intent to stay in your new home.
Let’s look at the tax impact of moves both within the US and from the US to another country, as a US citizen. What are your tax obligations?
Moving From State to State
If you’re moving from a high tax state to a lower or no tax state, your former home state may be reluctant to let you go. Some, like California, are downright next to impossible to leave unless you sever all ties.
In general, most states look at certain actions to determine whether you have shown the intent to make a home in the new location. They generally will look at:
- Amount of time you have spent in your former state versus the new,
- Location of your spouse and children,
- Where you have made your primary residence,
- Where your driver’s license and vehicles are registered,
- Where you professional licensed are issued,
- Where you are registered to vote,
- Your mailing address,
- Location of banks and investment accounts,
- Location of professional service providers (doctor, dentist, CPA, etc)
- Location of religious and community associations,
- Location of real property investments, and
- Location of work assignments.
Some states, like California, monitor social media to see what activities you’re attending and the location from where you post. There is no one rule that is true for every state. It will depend on both your former state of residence and your new state. One thing is for sure, though, it’s not a matter of just getting a post office box in a new state. You need to legitimately move and change addresses, accounts and the like in order to prove you have a new state domicile.
If you are an employee, you may also be subject to state tax from your employer’s location. Some states have already worked out how to handle an employee who lives in one state and works in another. Other states haven’t worked anything out and you’re likely in for a big fight.
Moving Outside the Country
If you thought it was hard to move from one state to another for tax purposes, just wait until you see what’s involved with moving outside the US.
The big difference with taxes when you live outside the US is “foreign earned income exclusion.” First of all, make sure you know your tax obligations in your new country of residence. In some cases, you may be jumping from the frying pan into the fire. Some countries have higher tax rates than the US. Make sure you understand what you’re getting into.
If you qualify, you can exclude up to $108,700 per person per year from US tax. For married filing jointly where both work, it would be double that amount on the return.
In order to qualify for this, the income must be earned income. It can’t be passive or clearly earned inside the US.
Plus, you need to either meet the physical presence or bonafide residence test.
The physical presence is an objective test. You must be physically present in a foreign country (or countries) for 330 full days during a 365 day period. If you have a day that is part US and part outside the US, it counts as a US day. It doesn’t need to be the entire year in question, but at least part of that year must be included. On the other hand, the bona fide residence test is more of a subjective test. You need to be able to prove that your domicile is outside the US. Generally that is done by having the appropriate residency visa for the foreign country. You’re not a tourist. You’re a resident. You don’t have the same restriction on day count, but it’s generally expected that you will spend less than 120 days in the year in the US. More than that, you need to have the intent to show that you will return. The US is not your home. Your other residence is your home.
Besides the foreign earned income exclusion, you also can get a foreign housing allowance. The amount you can take for this depends on a formula based on where you live outside the US and how much foreign earned income exclusion you have.
This is a deduction that is taken outside the regular itemized deductions.
This isn’t an automatic exclusion and deduction. You have to apply for them with the appropriate forms when you file your Form 1040, Individual Income Tax Return. Make sure you are working with experienced tax professionals who understand the foreign income exclusion, foreign housing allowance and foreign tax credits.
If you have a question regarding this, we can help. We have a separate department of accountant dedicated to helping digital nomads, expats and location independent taxpayers. Contact Us