Like many tax scenarios, it depends. Unlike most countries, the United States taxes its citizens on their worldwide income. For example, if you lived the digital nomad lifestyle and did some freelance work while you traveled internationally the Internal Revenue Service would still expect you to include that income on your tax return.
There is, however, the foreign earned income exclusion which may help you save a significant amount in taxes. The ruling allows a U.S. citizen, or resident alien, to shelter up to $107,600 (in 2020) from federal income tax provided that he or she:
- Maintains a tax home outside of the United States AND
- Was outside the United States for at least 330 full days
OR
- Was a bona fide resident of a foreign country for the entire tax year
It is important to note that the foreign earned income exclusion shields EARNED income such salaries, tips and commissions so income you receive from rents, capital gains, interest would be taxed normally. Any income earned as an independent contractor would also still be subject to self-employment tax.
Like a cherry on top of a sundae Americans abroad can also benefit from the foreign housing exclusion. Available if you are eligible to claim the foreign earned income exclusion, the foreign housing exclusion allows lodging costs to be tax-free provided that they are paid for with self-employment earnings or paid for by your employer. The foreign housing exclusion is typically limited to an annual maximum of 16% of the foreign earned income exclusion.
Keep in mind that these exclusions are not automatic and must be claimed on a filed federal tax return. As if things weren’t interesting enough with the federal tax rules, some states may not allow the foreign earned income exclusion. If you are a U.S. citizen planning to live outside of the country don’t let the sometimes confusing tax laws stop you. Enjoy the culture and opportunities abroad but prepare ahead so you avoid any surprises come tax time. Safe travels!