The Foreign Earned Income Exclusion for digital nomads raises many questions. If you are a US citizen, you owe taxes to the US even if you don’t live in the country anymore. Only the US and the African country of Eritrea apply this so called citizenship based taxation. In all other countries you can basically leave the country and stop paying taxes there. Although, you could already read in another article that Australia is also becoming stricter with regard to digital nomads. The Foreign Earned Income Exclusion (FEIE) is a way to help you save on US taxes.
What is the Foreign Earned Income Exclusion for digital nomads?
Based on the FEIE you can exempt up to $120.000 (income year 2023; indexed yearly) of professional income from income tax. In case you are self-employed, you will only get an exemption for your regular personal income tax but not for your self-employment tax (15,3%).
You can apply for the FEIE if you qualify based on the physical presence test or the bona fide residence test.
Physical presence test
You will qualify for the FEIE via the physical presence test if you meet some conditions.
The first condition is that you must have foreign earned income. This can be any professional income (e.g. salary, self-employment income, etc.). Pension or investment income (e.g. dividends, capital gains, rent, etc.) doesn’t qualify because it isn’t ‘earned’. The income should not necessarily come from a foreign source. You can receive income from US source (e.g. US employer) as long as you were abroad while earning the income.
Secondly, you must have your tax home in a foreign country. This means you cannot keep your main place of business in the US. Basically, you should perform your work from outside of the US. It’s important to note that you shouldn’t necessarily pay taxes abroad to benefit from the FEIE.
The third condition states that you need to be physical present in a foreign country or foreign countries at least 330 full days during any 12-month period. A full day is a period of 24 hours. When you are traveling, the time over international waters sometimes doesn’t count as spend in a foreign country. I would advise to keep track of your traveling in order to provide the necessary details if the Internal Revenue Service (IRS) would ask for it.
Bona fide residence test
Another way to qualify for the FEIE is the bona fide residence test.
The first condition is again that you must have foreign earned income. This condition is the same as under the physical presence test.
Also the second condition is the same. You must have your tax home in a foreign country.
The difference lies in the third condition. For the bona fide residence test, you need to have been a bona fide resident abroad for a full tax year (1 January – 31 December). This means having a long-term home (bought or rented) available abroad, foreign bank accounts, etc. The assessment of this condition is a grey area and thus not always very predictable.
Other attention points
If you qualify for the FEIE, you still need to file a tax return with the IRS. So, don’t forget about this in order to avoid penalties.
Apart from the FEIE, US tax laws provide in another benefit for US taxpayers. Namely, the Foreign Tax Credit. You can only apply one of them to your benefit. Therefore, you should always check which one would benefit you the most depending on your personal situation.
You can also have a look at the website of the IRS to find more information about the FEIE.
Foreign Earned Income Exclusion for digital nomads: conclusion
The Foreign Earned Income Exclusion for digital nomads is one way that US taxpayers can save on their taxes. You need to make sure though that you meet all the requirements to qualify.