Nobody likes to pay taxes. But taxes are necessary so that our country can function and continually improve. Your taxes go towards things like road construction, public schools, health facilities, public safety and social welfare systems. These things are essential for a happy and safe life in the United States.
But what if you’re a citizen of the US, but you weren’t in the US? What if you’re a digital nomad, and save for a quick trip to say hello to the fam at the holidays and pick up your favorite candy/cheeseburger/shampoo/whateveritis, you were other places? What if you never drove on the roads, you didn’t use the healthcare system, and you didn’t need the services of the public servants? You shouldn’t still be responsible for these things, right?
The IRS agrees, and there is a provision in the tax code that allows you to exclude a portion of your income from federal taxation, should you meet certain requirements. I’m going to do my best to explain this in laymen's terms, but the usual jargon applies: this is in no way specific tax advice-it is a very broad overview. If after reading this blog you think, ‘hey, that could be me’, I highly advise you to consult a tax professional.
So, how does this Foreign Earned Income Exclusion (FEIE) actually work?
You’re allowed to exclude up to a certain amount ($120,000 for 2023, $126,500 for 2024) of income earned while outside of United States from federal income taxes if you were either a Bona Fide Resident of another country ~or~ you were Physically Present in another country for 330/365 rolling days ~and~ your Tax Home was not considered to be in the United States. Let’s dissect.
First, this only applies to federal taxes. Sure, there are states that have their own provisions, but for the purpose of this blog, let’s think on a federal level. Qualifying for the FEIE does not exempt you from paying into the social welfare systems, i.e. Social Security (SS) and Medicare (MC). You’ll still be responsible for this portion of your tax. For employed (W2) individuals, the rate for SS is 6.2% of the first $147,000 of wages (2022), and MC is 1.45% of all wages, with an additional .9% on wages over $200,000 (2018). If you’re self employed, the self employment tax rates are 12.4% and 2.9%, respectively. Note there are other funny rules that go along with this, but they are irrelevant for the purposes of this blog
Now that we got that outta the way, let’s talk about the ways you can qualify. First, you can be a Bona Fide Resident of another country. This means you were a resident of another country for an uninterrupted period that includes a tax year. Stayed in one spot that wasn’t the US? This is your test. This one is funny in that you need to qualify in a calendar year, meaning Jan 1-Dec 31, but once you have, you can take partial years, both before and after your qualifying year. There’s a lot to be said about intention, period of assignment, etc, so just living somewhere for a year does not automatically qualify you. Please, consult a tax pro or do your own research before filing for the FEIE under the bona fide resident test.
Say you’re like most digital nomads though, and you have trouble sitting still. You like to move from place to place, country to country, never settling down anywhere long enough to be considered anything but a transient. Well, there’s a provision for us too, but there are some more hoops. First, you have to be physically present outside of the United States for 330/365 rolling days. WTF are rolling days, you ask? Rolling days just means that unlike the bona fide resident test, you don’t have to look at a calendar year to qualify. Just find a consecutive 365 period in which you spent 35 days or less in the US. Then proceed to step 2.
Step 2 takes a look at your “tax home”. For these purposes, this is not your domicile (home), more your work environment and nature of assignment. What is the relationship between your work and travel? Do you have a brick and mortar office in the States, and a boss the expects your butt back in your cube immediately after your travel? If so, you’re going to have a hard time convincing the IRS that your tax home was outside of the US. On the flip side, if you are self employed, your office is where you are, be that the US, Mexico, Europe, Bali, or the deepest depths of Thailand. Again, if this sounds like you, do some more research. Talk to a tax pro. See if you have a case for filing for the FEIE and saving yourself some money.
The last and very important point that I want to make is you aren’t automatically qualified or disqualified for the FEIE just based on the points above, they merely suss out how strong of a case you have to present to the IRS. The IRS will ultimately determine whether or not you qualify for the FEIE, and simply receiving your FEIE refund is not a guarantee that you’re in the clear. The IRS has 7 years to look back at your return and ask more questions if they wish. If they determine you did not in fact qualify for the FEIE you will be responsible for the taxes as well as interest and penalties.
Have questions? Feel free to request more information.