As a US expat or a digital nomad you are a citizen of the world, right? But you still carry your beloved American passport. Well, Uncle Sam looks at the world the same way you do: When it comes to US expat taxes, it’s all for him.
The US is one of only two countries that tax their citizens on their worldwide income, not just on the income you make while you are physically present in the US or on income that comes from US sources. (The other country is Eritrea, in case you wonder.)
But there are some ways to reduce or even eliminate your expat tax burden when you live and work abroad.
Here are the top 5 things you should know about US expat taxes. For a more comprehensive and up-to-date guide, check out this Expat Tax Guide from actual accountants.
1. You still need to file a federal tax return
As I said above, the US taxes its citizens on their worldwide income. As an expat or nomad, you can probably exclude much or all of your income while working from abroad using the Foreign Earned Income Exclusion (FEIE).
FEIE is the only acronym I will throw at you here. It stands for Foreign Earned Income Exclusion. You will see that it is a very important tool when it comes to taxes for Americans abroad. It is probably the biggest tax savings for US expat taxes.
The FEIE means that you can exclude the income you earn while living and traveling abroad, up to a certain amount, if you spend more than 330 full days in foreign countries in a 12 month period. (This is a very simplified statement. The FEIE is complex and nuanced, so please learn more in my post about FEIE. The FEIE only applies to salary or other income you earn through work, not to investment or retirement income.)
Thanks to the FEIE you may not have to pay income tax. But you still have to file a tax return.
Why file a tax return if you don’t have to pay you may ask?
The FEIE has to be chosen. It is not just given to you without asking. That means the Exclusion doesn’t apply if you don’t file a tax return and claim it. If you don’t file your federal tax return and the IRS finds you later, you may even lose your right to use the FEIE and have to pay back taxes on your entire income.
Income tax is not all – There’s also self-employment tax
Many nomads are working for themselves as freelancers or running their own one-(wo)man business, maybe supported by virtual staff. The IRS sees that as self-employment, so you have to pay self-employment tax. Unlike income tax, you can’t get out of self-employment tax with the FEIE. A way to avoid that can be to incorporate a business abroad.
2. You may also need to file taxes in your state
As an American, you are a resident of a US state. Even if you haven’t really lived there for a long time. Your state is the last state where you lived before you started to travel. Most states require you to pay state income tax.
States differ at lot, most are easy but some can be tricky. If in doubt, it is better to file a state return declaring that you are residing living abroad than not filing at all.
Not all states allow you to exclude the income you make abroad. For example California doesn’t have a Foreign Earned Income Exclusion. That means that as a Californian you may have to pay state income tax even though you don’t have to pay federal income tax because of the FEIE.
Therefore it is important to figure out your state residency before you leave the US and possibly move to a cheaper state first. Some states like California can be very “sticky” and won’t let go easily of residents that they could tax.
3. If you have a foreign bank account you may have to disclose it
It’s not just expat taxes to think about. If you have one or more bank accounts in a foreign country, and you carry a high enough balance, the Feds want to know.
What is a high enough balance? If the value of all your non-US accounts together exceeds $10,000 at any time during the tax year you need to disclose that.
This is just a reporting requirement meant to prevent money laundering and doesn’t trigger taxes. But you should take it very seriously because penalties for not reporting can be pretty high.
Keep in mind that by now many foreign banks share information with the US. You want to report those accounts and not wait for the IRS to find them and fine you.
There are additional reporting requirements for other assets but the threshold for reporting those is higher. If you own property abroad, you should definitely look into this.
4. Obamacare may impact you – This is not an issue anymore from the 2019 tax year forward
The healthcare reform, also known as Obamacare, requires almost everyone to have health insurance or pay a penalty. Your insurance coverage has to comply with the healthcare reform requirements.
Unfortunately, International expat health insurance usually does not comply. And travel insurance is definitely not compliant. (Travel medical insurance can only be an add-on to regular health insurance, not a standalone. But that is a different topic for another time.)
You don’t have to pay the penalty if you qualify for the FEIE. Here’s that acronym again. You see why the FEIE is so important, not just for avoiding taxes, but also for avoiding penalties.
5. Keep track of your days in and out of the US
You saw that you can only exclude your foreign income and avoid the healthcare penalty if you qualify for the FEIE, meaning if you spend enough time in foreign countries. That’s a nice challenge to have as a nomad.
Counting days is crucial.
330 is the magic number for full days spent in a foreign country or countries. The travel days you arrive and leave the US, or even flying over US territory do not count as a full day abroad.
Plan your travel with this in mind. You don’t want to lose out on the biggest expat tax exemption that may cost you thousands of dollars because you spent a few days too many in the US. If you don’t meet the 330 full days abroad requirement, you lose the entire exclusion, not just a portion of it.
Keep travel itineraries/etickets, passports with stamps, any proof of your foreign whereabouts. Ideally, you have a simple spreadsheet or calendar that shows the travel dates and days in US, and the evidence to back up those dates.
Now, I know this is a lot to deal with. Don’t get overwhelmed with your US expat taxes and as a consequence do nothing. There can be serious fines and penalties down the road.
To learn more about US taxes for expats and nomads, check out my Quick Guide to US Taxes for Nomads – In Plain English. It is a bit outdated, but the general concepts still apply. For more up-to-date info from an expat accounting firm, see this overview of expat taxes.
