As a self-employed freelancer who has the option to travel the world (otherwise known as a digital nomad), you get unlimited earning potential, ultimate work flexibility and your choice of office locations across the globe…but what about paying taxes to Uncle Sam? That’s right — working in Uruguay, Bali or Thailand doesn’t excuse you from paying your U.S. taxes.
If you’re new to the digital nomad life, paying taxes when working remotely can feel overwhelming. Do you get a tax break if you’re not living in the U.S.? Do traveling business expenses count as a write-off? Don’t worry, we’ve got you covered on everything you need to know to cover your taxes as a digital nomad. In this guide, we’ll walk you through how to pay U.S. taxes when you’re working abroad.
Understand the Foreign Income Exclusion
If you’re a U.S. citizen or resident alien, you’re subject to paying federal income tax on worldwide income. What qualifies as worldwide income? Any work you did while living in another country, such as Korea. Even if your employer is based in the U.S. and your income was deposited into a U.S. bank, the money you earned while physically in Korea is considered worldwide income.
While you are subject to paying income tax on worldwide income, here’s the good news: through the Foreign Earned Income Exclusion (FEIE), you may qualify to exclude up to $101,300 of your foreign earnings for 2017. On top of that, you may be eligible to exclude the value of meals and lodging provided by your employer from your income as well.
Know the FEIE Requirements
There are two major requirements to qualify for the Foreign Earned Income Exclusion:
1. You need to establish a “tax home” in at least one foreign country. The IRS considers your “tax home” to be the main place of your business or employment, and is looking for proof that your “abode” is truly outside the U.S. The easiest way to do this is to end your office lease, move out of your apartment, sell/rent your house, or sell your car. Essentially, anything that provides written proof that you indicate to live outside the country at least semi-permanently.
2. You’ll need to satisfy either the Physical Presence Test or the Bona Fide Residence Test. According to the IRS, you meet the Physical Presence Test if you are physically present in at least one foreign country for 330 full days during 12 months in a row. While the 12-month period needs to be consecutive, the 330 full days do not.
You can meet the requirements for the Bona Fide Residence Test if you are a bona fide resident in at least one foreign country for an uninterrupted period that includes one tax year. Note that just working in another country for a year doesn’t necessarily mean you’re a bona fide resident.
For instance, if you go to Berlin as a tourist or on a short business trip, you won’t establish a bona fide residence. But if you go to Berlin to work for an extended or indefinite period and set up a residence for you and your family, you probably will have established a bona fide residence. This remains true even if you intend to eventually return to the U.S.
You May Still Need to Pay Business Taxes
If you’re an independent contractor who receives a 1099-MISC from a client, you might still be subject to business taxes such as the self-employment tax, which is made up of Medicare and Social Security taxes.
A self-employed digital nomad is subject to paying higher self-employment taxes than someone who worked for an employer. This is due to the nature of Medicare and Social Security taxes: When you work for someone, the employer pays half of these taxes while you (the employee) are responsible for the other half. But when you’re self-employed, you’re considered both the employer and employee, so you need to pay all of these taxes.
For the 2017 tax year, the Social Security tax rate is 6.2 percent for both the employee and employer. If you’re self-employed, that means you’ll need to pay 12.4 percent. However, you only pay Social Security taxes on the first $127,000 of your earned income.
The Medicare tax rate is 1.45 percent for employees and employers, so as a self-employed digital nomad you’ll need to pay 2.9 percent. Unlike Social Security taxes, there’s no cap on earned income; you’ll need to pay that 2.9 percent no matter how much you make. (If you are a high earner, you’ll need to pay an additional Medicare tax of 0.9 percent on any income above $200,000, or over $250,000 if you’re married.)
How to Lower Your Taxes While Working Remotely
One thing you can do to reduce your self-employment taxes when working remotely is set up an LLC and elect to tax it as an S Corporation. By setting up your business this way, you can classify some of your earned income as salary and some as a distribution. While you’ll still need to pay the all of the self-employment tax on your salary, you’ll only need to pay the ordinary income tax on what’s classified as a distribution.
This can save you quite a bit of money! How much, exactly? Let’s say you set up your business as a standard LLC. If you took $70,000 out of the business, you would pay $10,710 in employment tax (15.3 percent). But if you took out $45,000 as a salary and $25,000 as distributions, you would pay only $6,885, saving you $3,825. You can use our handy tax calculator to see how much you could save on self-employment taxes by setting up your business to be taxed as an S Corp.
Want to learn more about how filing your LLC’s taxes as an S Corp can help you save on business taxes when you’re a digital nomad? Incfile can help walk you through the process and answer any questions you have. You can also find tons of great information on LLCs in our Help Center.