Digital nomads often earn income while traveling across different countries. Understanding how the IRS treats foreign income is crucial for tax compliance. The IRS rules can be complex, but knowing the basics helps digital nomads avoid penalties.
What qualifies as foreign income?
The IRS considers foreign income as any money earned outside the United States. This could include freelance payments, business revenue, or salary earned while physically residing in another country. Digital nomads must report this income to the IRS, even if earned abroad.
Foreign earned income exclusion (FEIE)
The Foreign Earned Income Exclusion (FEIE) allows eligible digital nomads to exclude a portion of their foreign income from U.S. taxes. To qualify, individuals must meet the Physical Presence Test or the Bona Fide Residence Test. The Physical Presence Test requires staying in a foreign country for at least 330 days within a 12-month period. The Bona Fide Residence Test applies if someone becomes a resident of another country for an uninterrupted period.
Self-employment tax obligations
Digital nomads who are self-employed must still pay self-employment taxes, even on foreign income. The IRS requires U.S. citizens and residents to contribute to Social Security and Medicare, regardless of where they earn their income. However, totalization agreements between the U.S. and certain countries may prevent double taxation for self-employed individuals.
Foreign tax credit
Digital nomads who pay income taxes to another country may qualify for the Foreign Tax Credit. This credit reduces the amount of U.S. tax owed by the amount paid to foreign tax authorities. This helps digital nomads avoid double taxation on their foreign earnings. It is essential to keep detailed records of all foreign income and taxes paid to qualify for this credit.
Digital nomads must maintain accurate records and consult tax professionals when necessary. Compliance with IRS requirements is critical to avoid penalties or other legal consequences. Understanding these rules can help make tax season smoother.