What to Know About Taxes When Working Abroad

More people are becoming digital nomads, living and working in other countries. Here’s what you should know about US tax obligations if you work abroad.

Key takeaways:

• You still must file a tax return and pay any applicable taxes in the US when living and working abroad.
• You may qualify for the foreign earned income exclusion if you work in another country.
• Self-employed individuals still have to pay self-employment taxes, regardless of what was excluded from their income with the foreign earned income exclusion.
• Your tax home will be wherever you work if you have no regular residence or place of business.

In today’s world of virtual work, online influencers aren’t the only ones earning a living while traveling. More companies than ever have gone remote, so employees can work from anywhere they have an internet connection. More people are also joining the gig economy as self-employed workers, reaping the benefits of working while traveling in another state or even abroad.

There are nearly 60 million freelancers working in the US, and that trend will likely increase as we come to depend more on digital communications. Common industries for Americans working abroad include education, IT, marketing, advertising, and communications. 

If you are living and earning money overseas, there are specific domestic tax implications. The most important takeaway: you still have to file a tax return and pay taxes in the US no matter how long you’re living outside the country or where you’re working—if you meet the income thresholds outlined by the IRS. 

Here’s an overview of what international workers need to know.

The foreign earned income exclusion

In general, any foreign income is still taxed by the US government. However, the foreign earned income exclusion (FEIE) allows individuals to avoid paying US income tax. You can exclude foreign earnings from your income up to $108,700 in 2021. To claim the exclusion, you must be a resident of a foreign country for the entire year or be physically there for at least 330 full days within a 12-month period, starting or ending in the applicable tax year. This is known as the “physical presence test.” In contrast, the “bona fide residence test” requires that you have your home in a foreign country with strong ties there.

You can claim the FEIE with Form 2555, and remember that this tax break will not be automatically applied to your taxes. Even though you can reduce regular income tax with the FEIE, it will not reduce self-employment tax, according to the IRS. 

Individuals may also be able to claim the foreign housing deduction if they’re self-employed, which is an additional deduction from gross income for foreign housing expenses. This only applies, however, if your tax home is in a foreign country, discussed more in the next section.

Your tax home

A tax home is not considered foreign if your place of residence, or your “abode,” remains in the US, where you “keep closer familiar, economic, and personal ties,” as the IRS states. So, taxpayers only have a foreign tax home if they work in another country and expect to be there for an indefinite amount of time.

You can only qualify for the FEIE, the foreign housing exclusion, or the foreign housing deduction if your tax home is in a foreign country throughout the bona fide residence period or the period in which you are physically abroad. 

An important note about tax homes: if you do not have a regular or main place of business or don’t have a residence where you regularly live, the tax home will be wherever you work. This rule may apply to those who consider themselves “digital nomads.”

The foreign tax credit

Another IRS tax break is the foreign tax credit, which ensures that individuals aren’t taxed in both the foreign country where they work and the US. You can take a credit or an itemized deduction that equals the amount of qualified foreign taxes paid or accrued during the tax year. 

Usually, the credit is the better option. The tax you owe is reduced, and you can take the credit even if you don’t itemize on your tax return.

Self-employment tax

No matter where you work or live as a US citizen or resident, the self-employment tax rules are the same. This tax covers social security and Medicare on all self-employment earnings. If you make more than $400 as a self-employed worker, you must pay this tax, though nonresident aliens are excluded.

When calculating net self-employment earnings, you must include all income, even if all or a portion of your gross receipts were excluded with the FEIE. The IRS wants to know about every penny individuals made, no matter where they lived and worked, in USD. You still must make quarterly estimated tax payments throughout the year, too.

For 2021, the self-employment tax is 15.3% on the first $142,800 of net income: 12.4% for social security and 2.9% for Medicare.

Why work with a tax expert?

If you are self-employed and living and working abroad, these requirements can get complicated. A tax professional can help ensure you won’t face any penalties and take all the credits and deductions for which you qualify. And remember that even if you work and live abroad as a self-employed worker, you still have tax obligations back home.

Provident CPA and Business Advisors helps our clients pay the least amount of tax legally possible while assisting business owners as they implement comprehensive growth strategies. Contact our experienced team to learn more about our services.