THE FOREIGN EARNED INCOME EXCLUSION (FEIE) for US DIGITAL NOMADS.
The main title alone most likely has you thinking of what kind of “get rich quick” scam this is going to be about, right? Not this time! In fact, this isn’t about “earning” money at all. Because guess what, you already earned this! This is about how to leverage the laws of the Internal Revenue Service (IRS) to your advantage, which will allow you to make money back while traveling abroad that you NEVER would have received if you had been living in the US. And depending on your current tax situation (which we will dive into) this amount will most likely be a very significant amount. Still interested? Please read on…
This post is my attempt to help fellow location independent travelers and digital nomads better understand how to take full advantage of the Foreign Earned Income Exclusion for United States citizens. If you are not a US citizen this post will not be of much use to you. I wrote this article based on all of the frustration and confusion I constantly hear when speaking with fellow digital nomads surrounding this topic. Questions like: Do I qualify for the FEIE? If so, is it even worth filing for? Who can I speak to that I know I can count on that knows the laws inside and out? Will I get audited? There is so much information on this topic floating around, but it is very difficult to find something that is easy to understand and not written in some crazy IRS or CPA tax language that the average person won’t understand.
Now that I have had the chance to work with a knowledgable firm that has gone through and filed my 2016 taxes, I feel confident to write this article and share with other fellow digital nomads everything I have learned in the hope to help make it easy for everyone, and make back a lot of money from the previous year. But first…
*MY PERSONAL DISCLAIMER*
One very important thing I want everyone to know before reading further. Throughout my writing, I will be occasionally recommending products and services that I have both used and feel confident enough to recommend in the hopes of making your life easier. Make no doubt, these are “affiliate links” which means that if you click my link and purchase that particular product or service, I will make a small commission from that company. BUT, because you bought it from my site and not directly from that company, now 50% of every dollar made will go directly to the St. Jude Children’s Hospital which helps in defeating childhood cancer. You will not pay any more money for purchasing from my site than you would if you purchased directly from the company. It’s just a nice bonus knowing that you are now also helping a great cause. Thanks for your consideration when making this decision, it really means a lot to me!
So, if you are a citizen of the United States, you are responsible to file tax returns every year that you meet the income threshold to file, or have another situation that has an annual obligation. That does not mean you will owe tax, just that you need to file.
If you are one of the millions of Americans living and working abroad, you might be able to earn up to $101,300 USD in 2016 and pay nothing to the IRS in income tax. The foreign earned income exclusion (FEIE) exempts wages and self-employment income from U.S. federal taxation if you meet the requirements to qualify to file Form 2555 with your tax return. In addition, you can also exclude the amounts you pay for some of your housing expenses including rent and utilities if they exceed $16,208. This would only be required if you exceeded the $101,300 and needed an even bigger exemption (great problem to have, right!). To qualify for the exclusion your “tax home” must be in another country other than the USA. A tax home by IRS definition is the general area near your place of business or employment where you are permanently or indefinitely engaged to work. If you are not on an official assignment for your employer and choose to spend time traveling the world and working either locally or telecommuting you can still exclude up income as long as you have been outside the U.S for 330 days during any rolling 12 period. The income from all the countries would be added together and a single form 2555 would be prepared.
This exclusion is available to Americans abroad who are:
• _Working as a W2 employee, or self-employed;
• _Whose tax home is in a foreign country or countries;
• _And are either- o A U.S. citizen who is a bona fide resident of a foreign country, OR
– Physically present in a foreign country for at least 330 full days during any period of 12 consecutive months. (This is what the majority of the Digital Nomad community will be utilizing)
So let’s walk through a real time example of what it would look like for a typical Digital Nomad and how it will help you save a lot of money.
Let’s say on January 31, 2016 (remember 2016 is a leap year), you left the USA to fly to South America. And from then until June 15th you stayed in South America. You then decide to go back to the USA for two weeks in the summer to visit family. You stay a total of 14 days and then fly over to Europe to enjoy the rest of the summer there. From then until December 31st, you have remained traveling in other countries and have not returned to the USA. At this point, as long as you don’t go back to the USA until January 10th, 2017 (14 of those days you can classify as vacation) you would thereby qualify for the FEIE for 2016 as long as you use January 11, 2016- January 10, 2017 as your 12 month period. It really is that simple. You either qualify or you don’t, so my advice is to not overcomplicate or be scared of this. So now that we got your qualification officially approved, let’s move on to the next step.
Example #1 – W2 Employee
If you happen to be a W2 Employee in this situation, you have already been paying into the tax system from each paycheck, both for Federal and State. So Income Tax as well as Social Security and Medicare have already been accounted for. At the end of the year, if you were in the USA, you would typically work with your CPA (Certified Personal Accountant) or EA (Enrolled Agent) to find out if you have already paid enough and maybe even get some money back, or that you didn’t pay enough and possibly owe. BUT, because you weren’t living in the USA for almost all of 2016 (except for those 30 days in January and 14 days of vacation in June), you are now able to use the FEIE exemption against everything you paid in Income Tax over the year. So, let’s say on your W2 you see that you paid $20,000 in Federal Income Tax for the year already. You will now be able to claim that entire amount directly back to you. The only amount of money this would not fall under is how much you earned in January which would still be considered “US Earned” income. So, that’s about $20,000 or so back in your pocket that you would not have received simply by traveling for the year. You basically just got paid to work and travel the world! Now let’s celebrate…
Example #2 – Self Employed (1099)
In this example, you most likely have not paid ANY money yet to Federal or State, including any Income Tax, Social Security or Medicare. Now, for simplicity purposes specific to our situation, there is no way to get around not paying for your Social Security or Medicare (referred to as Self-Employment Tax) nor should you really want to get around that, as it will come back to you later in life. However, you would still owe for your Income Tax. BUT because you now qualify for the FEIE, you most likely will not have to pay ANY money to the government this year other than your Self-Employment Tax. There are certain situations that may still require you to pay some income tax back, depending on what your job specifics are, but the point to take away is that you would not have been able to take advantage of this without living abroad. Again, you just got paid to travel for the year! Go celebrate with your W2 buddies!
Please note. When it comes to your State taxes, each State is different, so it will obviously depend on where you are filing from. Some States are great, others are horrible. However, you would have to pay that amount regardless, so look at it as icing on the cake if you happen to live in one of the more “friendly” states. That said, there is also a very good chance you will be getting money back from the State as well. This is just another example of why having a knowledgeable international tax professional that knows the intricacies of all the States and their tax laws is vital.
So, the foreign earned income exclusion (FEIE) is voluntary and remains in effect for that year, and all subsequent years until you revoke it. As mentioned earlier, for Tax Year 2016 you may be able to exclude foreign earned income from U.S. tax up to $101,300. Remember if you are self employed and haven’t paid into the system yet, the FEIE does not eliminate the need to pay self-employment tax.
One last important thing to note. You would now qualify for a 2 month extension when filing for your taxes since you are filing from outside the USA. That means you have an automatic extension until June 15th to file, which helps buy a bit more time for you if you need it, just don’t wait until the last minute!
I hope that this post has helped you better understand how this process works and how you can really take advantage of this great opportunity. If you don’t, you are potentially leaving a lot of money on the table that could potentially help fund your travels. Here is a link to the firm that I used, and felt they did an excellent job with their patience and really took the time to help answer all of my questions and concerns. You can find them here at American Expat Tax Services. Again, there are other firms that offer similar services out there, this is just the one I felt comfortable working with and recommending to you. Thanks!