— Citizenship Lawyer (@ExpatriationLaw) March 26, 2017
The above tweet references a post by Virginia La Torre Jeker describing the “Foreign Earned Income Exclusion” found in Internal Revenue Code S. 911. Her description of the Foreign Earned Income Exclusion includes:
Section 911 of the US Internal Revenue Code permits a qualified individual to make an election in order to exclude certain amounts from his gross income. Generally, in order to qualify, the taxpayer is required to have a “tax home” in a foreign country and must meet either the so-called “bona fide residence” test or the “physical presence” test. He must file a tax return to claim the exclusion benefits. If an individual meets the qualification rules, he can exclude from gross income an “Exclusion Amount” related to “foreign earned income”. Foreign earned income includes amounts paid by the employer such as salary, bonuses, the cost of air tickets home, tuition costs for children and so on. Section 911 also permits an election to be made for exclusion from income for a “Housing Cost Amount”. The Housing Cost Amount relates to housing expenses provided by an employer for housing expenses incurred by the employee while living overseas.
Note that it is only “Foreign EARNED Income” that may be excluded. “Foreign EARNED Income” does not include “investment income”.In addition. one cannot claim the “Foreign Earned Income Exclusion” if one has an “abode” in the United States.
Digital Nomads and the “Foreign Earned Income Exclusion …
— Citizenship Lawyer (@ExpatriationLaw) April 10, 2017
“Digital Nomads” are entrepreneurs who run “location independent business”. Many “Digital Nomads” travel outside the United States with their laptops. Although they have a “presence” in other countries, they rarely stay long enough in any country to become “tax residents” of those other countries. They typically conduct their businesses through “non-U.S. AKA Foreign Corporations” and draw a salary from those “Foreign Corporations”. By drawing a salary from those “foreign corporations”, they ensure that their income is “foreign” AND they they avoid paying U.S.self employment taxes.
Now, let’s see how a U.S. citizen can avoid being subjected to income tax by ANY country while travelling the world. Here are the requirements for a U.S. citizen “Digital Nomad” to being taxed on any income in ANY country.
1. The Digital Nomad CANNOT have an “abode” in the United States.
2. The Digital Nomad CANNOT have any income earned from/in the United States (U.S. Source income).
3. The Digital Nomad must have a “tax home” outside the United States.
4. The Digital Nomad must avoid establishing “tax residence” in another nation or must avoid establishing “tax residence” in a country that has an “income tax”.
5. The Digital Nomad must have ONLY “Foreign EARNED income”. The Digital Nomad will commonly incorporate a company outside the United States. That “foreign corporation” will carry on the business activity and then pay the U.S. citizen as an employee (ensuring that the income is “foreign” and can be excluded under the “Foreign Earned Income Exclusion”).
6. The Digital Nomad must spend enough days outside the United States to meet the “physical presence” test (approximately 330 days per year outside the USA).
7. The Digital Nomad must file a U.S. tax return in order to be eligible to take the “Foreign Earned Income Exclusion”.
8. Assuming that the Digital Nomad is being paid through his or her “controlled foreign corporation”, the Digital Nomad must file IRS Form 5471 to meet the reporting requirements mandated by Internal Revenue Code Sections 6038 and 6046.
9. The Digital Nomad must be aware of Mr. FBAR and the consequences of having signing authority over Foreign bank accounts and other specified financial assets. Mr. FBAR may have to be filed and Form 8398 may have to be filed. For a description of many of the forms that may be mandatory for Americans abroad see here.
Warning!!! Points 1 – 9 are a gross oversimplification. There are a number of technicalities and you are encouraged to read Internal Revenue Code 911 and to read the IRS interpretation of the Foreign Earned Income Exclusion.
The future of the Foreign Earned Income Exclusion (“FEIE”)
Both American Citizens Abroad (“ACA”) and Republicans Overseas have proposed changes in the way that Americans abroad are subjected to U.S. taxation. Both organizations have (for different reasons) proposed either abolishing the Foreign Earned Income Exclusion.
The American Citizens Abroad proposal:
The FEIE would be abolished and citizenship taxation would continue. After five years, Americans abroad would be eligible to apply for residence based taxation. For American abroad who were NOT eligible to move to residence-based taxation, the repeal of the FEIE would/could be a major loss.
The Republicans Overseas proposal:
Republicans Overseas proposes moving to a system of “territorial taxation“. Under a system of “territorial taxation” foreign income earned by Americans abroad would no longer be subject to U.S. taxation. Hence, the FEIE would be unnecessary.