Being an expat is enjoyable but the lifestyle comes with a couple of conundrums, notably considering taxes. These should be researched well in advance, and you should consult the local expat community and even professional services if uncertain.
The main issue is that digital nomadism is still largely undefined and, in some countries, also half-legal. Many people travel on a tourist visa and work on the go to avoid the hassle, but if you’re planning to relocate to a foreign country, you should research your options and set some goals.
Know Your State Taxes
No matter where you are, you’ll have to pay U.S. state taxes if you’re considered a resident. However, there are some exemptions.
You’re considered a resident if:
- You lived in the state for any duration during the tax year
- You have a permanent place of residence in the state
- Your immediate family lives in the state while you’re abroad
- You keep your voting rights, ID card, or driver’s license in the state
Do You Have Income in the State?
Income earned while working in the state is taxable in the said state. Keep in mind that other income (pension- and retirement income, various government benefits ) may also be taxable if you have state residency.
The states that don’t levy state income taxes are:
- Alaska
- Florida
- Nevada
- South Dakota
- Texas
- Washington State
- Wyoming
New Hampshire and Tennessee only apply income tax on dividend and interest income.
California, South Carolina, New Mexico, and Virginia (the “sticky states”) have a bit more rigorous rules, so make sure to look them up.
Unearned Income Versus Earned Income
Expats hoping to claim foreign-earned income exclusion must be relocated while earning their income. Income is any compensation received for professional services rendered.
There are two types of income: earned and unearned.
Earned income may include:
- Commissions
- Salaries
- Bonuses
- Tips
- Commissions
- Vacation pay
- Sick leave
- Severance pay
- Union strike benefits
- Disability benefits
- Self-employment income
- Non-Cash income
Unearned income may include:
- Alimony
- Annuities
- Capital gains
- Corporate dividends
- Gambling earnings
- Interest
- Unemployment
- Social Security
Understanding unearned income is critical in order to keep taxes in check.
Variable Income
There’s a third kind of income, namely, variable. There are many income types that adhere to specific regulations.
Per the IRS’ definition, variable income includes royalties, rents, scholarships and fellowships, and certain business profits.
Amounts not counted as foreign earned income include, per the same source:
- Reimbursements for expenses you incur on behalf of your employer under an accountable plan
- The value of meals and lodging furnished for the convenience of your employer that was not included in your income
- Pension or annuity payments including social security benefits
- Pay you receive as an employee of the U.S. government
- Amounts included in your income because of your employer's contributions to a nonexempt employee trust or to a nonqualified annuity contract
- Payments received after the end of the tax year following the tax year in which you performed the services that earned the income
(Source: irs.gov)
Expats operating within the entertainment industry (actors, singers, performers, etc.) are typically either paid directly for their services or through royalty earnings. Only royalties count as earned income if there is a copyright transfer involved.
Self-Employment Tax
If you are a self-employed U.S. citizen or resident, the rules for paying self-employment tax are generally the same whether you are living in the United States or abroad. You may be familiar with this with the freelancer boom that’s been going on.
Whether you’re standing in as a fractional executive or teaching abroad, you’re going to need to know about self-employment taxes if you’re freelancing.
The self-employment tax is a social security and Medicare tax on net earnings from self-employment. You must pay self-employment tax if your net earnings from self-employment are at least $400.
For 2022, the maximum amount of net earnings from self-employment that is subject to the social security portion of the tax is $147,000. All net earnings are subject to the Medicare portion of the tax. Additional Medicare Tax may apply if your net earnings from self-employment exceed a threshold amount (based on your filing status).
Exemption from Dual-Country Social Security and Medicare Taxes
As a general rule, self-employed expats who are subject to dual taxation will only be covered by the social security system of the country where they reside.
If your self-employment earnings should be exempt from foreign social security tax and subject only to U.S. self-employment tax, you should request a certificate of coverage from the U.S. SSA’s Office of Earnings and International Operations. The certificate will establish your exemption from the foreign social security tax.
Keeping Your Taxes in Check
With so many variables to consider, it’s critical to understand which income is considered earned and which — unearned.
Asking professionals for help can be beneficial, as once you know your options, you’ll be able to plan your retirement ahead.
Finally, rules may change over time, so keeping informed is critical.