U.S. Tax Considerations for the Digital Nomad Living Abroad
In today’s age of “digital nomads,” the idea of working remotely overseas continues to grow in popularity. New programs, such as Remote Year, have further facilitated overseas commuting by organizing year-long trips for employees and freelancers to live in multiple cities abroad. Participants, for example, travel in groups to live in multiple cities throughout Europe, Asia and South America, for one month each over a year period.
Working abroad presents a number of unique U.S. income tax issues and opportunities for the digital nomad. One main issue is qualification for the Foreign Earned Income Exclusion (“FEIE”), which allows U.S. citizens living abroad to exclude their foreign earned income from U.S. federal taxation. Another important issue is a digital nomad’s potential liability for state and local taxation even during their time living and working abroad.
Basics of the Foreign Earned Income Exclusion
Provided that an individual can satisfy either the bona fide residence test (substantive change in residence based on facts and circumstances) or the physical presence test (present in a foreign country for 330 full days during any period of 12 consecutive months) and is able to establish a tax home in a foreign country, such individual can exclude from income a portion of his or her foreign earned income.
Foreign earned income is generally pay for personal services performed overseas, such as wages, salaries, or professional fees. It does not include passive income items, such as dividends, royalties, rent, pensions, and capital gains.
The foreign earned income exclusion amount is adjusted annually for inflation. For tax year 2017, the maximum exclusion amount is $102,100 per qualifying person. The IRS just recently announced that the maximum exclusion amount is increased for the 2018 tax year to $103,900.
What is a Tax Home?
In order for an individual to qualify for the foreign earned income exclusion, his or her “tax home” must be in a foreign country. The general rule is that a “tax home” is located in the vicinity of the taxpayer’s regular or principal (if more than one regular) place of business or employment, regardless of where you maintain your family home.
Your tax home is the place where you are “permanently” or “indefinitely” engaged to work as an employee or self-employed individual. If you do not have a regular or principal place of business because of the nature of your work, your tax home may be the place where you regularly live. If you have neither (no regular place of business or living), then you may be considered an “itinerant” and your tax home would considered wherever you work.
If you have a permanent place of employment in the U.S. but then are put on assignment abroad, the location of your tax home depends greatly on whether your assignment is temporary (precluding the FEIE) or indefinite (allowing the FEIE). If you expect your employment away from home in a single location to last, and it does last, for 1 year or less, it is temporary unless facts and circumstances indicate otherwise. If you expect it to last for more than 1 year, it is indefinite. Courts generally consider employees not to be on assignment, however, if they choose to move and work remotely from abroad simply for personal reasons, i.e., if the employer does not require the taxpayer to live and work remotely abroad nor benefit from such an arrangement. In such case, the taxpayer’s pre-move place of business can be considered his or her tax home, regardless of the length of stay abroad.
The “tax home” rule is subject to an important overriding exception – an individual is not considered to have a tax home in a foreign country for any period during which the individual’s “abode” is in the United States. “Abode” has been variously defined as one’s home, habitation, residence, domicile, or place of dwelling. Thus, in contrast to “tax home,” “abode” has a domestic rather than vocational meaning. The location of your abode often will depend on where you maintain your economic, family, and personal ties.
Tax Home, Abode and the Digital Nomad
In the case of the digital nomad working abroad, assuming the individual satisfies the bona fide residence test or physical presence test (often the latter test is satisfied so an inquiry into the former is not necessary), the critical issues then become the “tax home” and “no abode in the U.S.” requirements.
The claim of a tax home abroad is arguably strengthened if the taxpayer stays in a single location abroad for more than a year and it is shown, for instance, that the move was employer-motivated and not solely for personal reasons. Alternatively, taxpayers who are permanently on the move throughout their career (e.g., freelancers) may be able to argue that they are “itinerant” workers whose tax home follows them to wherever they work.
The claim of “no abode in the U.S.” is generally strengthened to the extent the taxpayer can show that they have weakened their economic, family, and personal ties to the United States and strengthened such ties abroad. The strength of a digital nomad’s position will depend on the particular facts and circumstances.
If you’d like to read more about the topic of the foreign earned income exclusion as it relates to the digital nomad, you are welcome to read our 3-part series published last year in Wolters Kluwer’s Global Tax Weekly publication: Part I, Part II, and Part III.
State and Local Tax Considerations
Generally, states impose tax only on individuals who are “residents” of the state. Most states use some definition of “domicile” to determine if a taxpayer is a resident. In general, for state tax purposes, an individual may have many residences, or physical dwellings in which he resides, but will have only one domicile, or that permanent residence to which he or she intends to return.
If you move out of your state of residence and it is for a short time only, your domicile normally does not change. A short time can be anywhere from a month or two or up to a year or more. To make a change in domicile permanent, you must combine the acts of making a change in domicile along with the intent to change your domicile. In many states, the requirements for breaking residency are fairly strict and require not only that one move out of the state but also sever other ties they have with the state. Such ties include selling property owned in the state, closing bank accounts, and even relinquishing a state issued driver’s licenses.
For digital nomad employees working abroad for only a year and then returning to their state of residence, it may prove challenging to show an intent to change your domicile in many states. Each state has its own particular rules, so it is important to understand these rules and how they apply to your particular facts.
Tax Structuring for Digital Nomad Entrepreneurs
For digital nomad entrepreneurs, structuring your business adds additional layers of U.S. tax considerations, especially with the new rules set out in the Republican tax reform (the “Tax Cuts and Jobs Act” or “TCJA”).
As an example, doing business in the U.S. through an S corporation can be a great planning technique for minimizing self-employment taxes. However, when using an S corporation, some optimization may be needed. On the one hand, you may want to reduce salary amounts paid from the company in order to minimize self-employment taxes, but on the other hand, you may want to increase salary amounts paid so as not to limit the scope of the new 20% deduction under the TCJA.
For those conducting business outside the U.S. via a foreign entity, consideration should be given to the new outbound tax rules that stretch beyond the Subpart F rules that apply to controlled foreign corporations (“CFCs”), including the so-called global intangible low-taxed income (“GILTI”) rules.
In order to get it right, you should consult with a tax advisor who can weigh the various options depending on your particular circumstances.
By Ephraim Moss, Esq. & Joshua Ashman, CPA