How digital nomads can optimize tax obligations during international business growth

The rise of remote work has spawned a new class of professionals – digital nomads. These individuals blend work and travel, often across multiple countries.

For US expats working as digital nomads, tax optimization is essential to avoid financial pitfalls.

Let’s explore how digital nomads can effectively manage their taxes while expanding their businesses internationally.

Understanding the tax environment for digital nomads

What qualifies as a digital nomad?

Digital nomads can be freelancers, business owners, or employees of remote-first companies. To qualify as a digital nomad from a tax perspective, the individual must work while residing outside of their home country for a significant period.

However, even without a permanent residence, digital nomads are still subject to tax rules based on where they earn their income and their national tax obligations.

Common tax challenges for digital nomads

Digital nomads often face a variety of tax challenges, including double taxation, residency confusion, and conflicting rules in different jurisdictions. One of the biggest risks is being taxed in multiple countries – both where they earn their income and in their home country, such as the US

Other challenges include managing different tax residency rules, where a nomad could unintentionally become a tax resident of a country by overstaying the allowed time limits.

In addition, the nomad must understand the rules governing tax filings, reporting of foreign income, and the potential penalties for non-compliance.

The role of tax treaties in the taxation of digital nomads

The US has tax treaties with many countries to mitigate double taxation for expats. These treaties typically specify which country has the primary right of taxation and may provide relief through credits or deductions for taxes paid abroad.

While tax treaties provide significant relief, digital nomads need to research the specifics of treaties between the US and the countries in which they operate.

Strategies for tax optimization as a digital nomad

Use of Foreign Earned Income Exclusion

The Foreign Earned Income Exclusion (FEIE) is a powerful tool for digital nomads to reduce their taxable income in the United States.

The FEIE allows US citizens and resident aliens to exclude a certain amount of their foreign-earned income from US taxation. For 2024, the exclusion amount is up to $120,000, indexed annually for inflation.

Eligibility requirements:

• Your tax home must be in a foreign country.
• You must be physically present in a foreign country or countries for at least 330 full days during any 12-month period.

Use of Foreign Tax Credits (FTC)

Foreign Tax Credits (FTCs) allow digital nomads to reduce their US tax liability by offsetting taxes paid to foreign governments. An expat tax advisor can help navigate the complexities of FTCs to ensure compliance.

To claim the FTC, digital nomads must file Form 1116 with their US tax return. This form calculates the credit based on foreign taxes paid on income that is also subject to US taxation.

Step-by-step instructions:

1. Determine eligible foreign taxes. Determine which foreign taxes qualify for the credit.
2. Complete Form 1116. Accurately report foreign income and taxes paid.
3. Claim the credit. Reduce your US tax liability by the amount of the foreign tax credit.

Advantages of foreign tax credit use over exclusions

• FTCs can be carried back one year and forward up to ten years if not fully utilized in the current year.
• Unlike FEIE, FTCs have no income limitation, allowing higher earners to benefit.

Visas for digital nomads with tax benefits

Several countries have introduced digital nomad visas with favorable tax terms to attract remote workers. Here are some of the top options:

• Offers a digital nomad visa with a flat 20% tax rate and access to the European market.
• Through the Non-Habitual Resident (NHR) program, Portugal offers significant tax breaks for the first ten years of residency.
• Allows digital nomads to stay for up to one year with a fixed monthly income requirement, and benefit from competitive tax rates.

Common tax risks and how to avoid them

Understanding tax residency rules in multiple countries

Digital nomads may unintentionally trigger tax residency in multiple countries due to different tax laws that define residency based on time spent or business activity in a country.

How to determine your tax residency status

Tax residency is generally determined by the amount of time you spend in a particular country, with most countries using a threshold of 183 days in a calendar year. However, the rules vary widely, and some countries may consider other factors such as sources of income or permanent ties to the country.

For example, the United States requires its citizens to file taxes regardless of where they live, while other countries may only tax residents. It is important to understand the rules of any country where you spend significant time or do business.

Avoid inadvertent tax residency

To avoid becoming a tax resident in multiple countries, digital nomads should carefully track their travel dates and ensure they do not exceed the residency threshold in any given country unless they are prepared to deal with the tax consequences.

Maintain IRS and foreign compliance

US citizens are required to report foreign bank accounts and financial assets if their aggregate value exceeds $10,000 at any time during the year under the Foreign Bank Account Reporting (FBAR) rules.

In addition, the Foreign Account Tax Compliance Act (FATCA) requires additional disclosures of assets above certain thresholds. Failure to comply with FBAR and FATCA can result in significant penalties, so digital nomads must remain vigilant.

Penalties

Failure to report foreign accounts can result in penalties of up to $10,000 per violation, with willful violations resulting in higher fines and possible criminal charges.

How to build a sustainable financial future as a digital nomad

To ensure long-term financial stability, digital nomads should establish a robust and efficient financial structure that accommodates cross-border income and expenses. This often involves choosing the right banking institutions, managing currency exchanges, and setting up efficient payment systems.

Key steps include:

1. Opening international bank accounts to avoid costly wire transfer fees.
2. Using platforms that support multicurrency accounts for seamless transactions.
3. Automating bill payments and savings to maintain consistent financial health.

Top banking options for digital nomads:

• Wise (formerly TransferWise) – supports multi-currency transactions.
• Revolut – ideal for frequent international travelers.
• N26 – a European bank that offers fee-free transactions worldwide.

Planning to retire as a digital nomad

SEP IRAs and Roth IRAs are excellent choices for US expats:

• A SEP IRA allows self-employed digital nomads to make higher annual contributions than a traditional IRA.
• The Roth IRA is a valuable option if you expect to be in a higher tax bracket in retirement, as it allows for tax-free withdrawals.

Pension programs in your country of residence may also offer tax advantages, especially under certain tax treaties.

Using professional tax advice to plan for the long term

While establishing an efficient financial structure and planning for retirement are critical, professional tax advice remains the cornerstone of long-term financial success for digital nomads.

A tax professional can provide customized advice based on your unique situation, ensure full compliance, and identify opportunities for tax optimization.

Criteria for the selection of a tax advisor:

• Experience with expatriation and international tax law.
• Understanding of bilateral tax treaties.
• Proven track record of helping digital nomads navigate complex tax challenges.

“Consulting with a tax professional can help you avoid costly mistakes and take advantage of the most beneficial tax strategies,” notes CPA Mel Whitney.

Bottom line

Building a sustainable financial future as a digital nomad requires careful planning and a deep understanding of international tax laws.

By establishing an efficient financial structure, focusing on retirement planning, and seeking professional tax advice, digital nomads can enjoy their freedom while ensuring long-term financial success.

Be sure to regularly review your tax and financial strategy as your business and lifestyle evolve – and stay informed of changing tax regulations.