Many U.S. citizens consider becoming digital nomads (working remotely while traveling in different countries). Some of them wrongly assume that, if they just travel from country to country, they will avoid the pinch of the taxman. In fact, the United States is one of the few countries that taxes its citizens on the basis of their citizenship and not on the basis of their place of residence. Below, we explain how digital nomads having a U.S. passport can legally reduce their tax burden.
U.S. citizens who meet three requirements are entitled to the so-called “foreign earned income exclusion”. The first requirement is having a foreign earned income which can briefly be described as income received for services performed in a foreign country. The second requirement is that the tax home of the individual concerned must be in a foreign country. The U.S. Internal Revenue Service (IRS) defines the term “tax home” as “the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home.” The third requirement is that the individual must: (i) uninterruptedly resides in a foreign country or countries for a period that includes an entire tax year; (ii) be a national or citizen of a country that concluded a double tax treaty with the United States and must reside in a foreign country or countries for an uninterrupted period that includes an entire tax year; or (iii) have physical presence in a foreign country or countries for at least 330 full days in the course of any period of 12 consecutive months.
U.S. citizens who meet the aforementioned three requirements are entitled to a foreign earned income exclusion amounting to USD 107,600 for 2020. Such U.S. citizens are also entitled to deduct or exclude certain housing-related amounts.
U.S. citizens living abroad will be subject to U.S. taxation on the income exceeding the foreign earned income exclusion. To avoid this, they can incorporate a non-US company which will pay them a salary not exceeding the amount of the foreign earned income exclusion. For example, if the foreign company earns USD 200,000 per year and pays USD 107,600 a salary to the U.S. citizen, the remainder of the company earnings (USD 92,400) can be tax deferred or reinvested, without the need to pay U.S. tax on them.