Mastering Foreign Income: A Guide for Digital Nomads and Expats
As someone who is location independent, you will likely have either heard of or be interested in foreign income.
For those reading who are US citizens living and working abroad, chances are that you’ve come across the term “foreign earned income exclusion,” or “FEIE.” But what exactly is it, and how can it benefit global freelancers, digital nomads and expats working outside of your home country?
So we are all on the same page, foreign income and foreign earned income are the same thing (foreign earned income is just the U.S. version).
In this guide we explain the basics of foreign income, how to apply for the exclusion, and how it can help you to avoid double taxation.
What Is Foreign Income?
Unsurprisingly, foreign earned income is the money you earn for work performed in a foreign country. As indicated earlier, it is typically a US term, and if you are from a country outside the US it is usually just referred to as “foreign income.”
It includes salaries, wages, bonuses, and professional fees that you earn while you are abroad. For example, if you own a US LLC (a Limited Liability Company incorporated in the US) and you perform the work or services from a different country, this counts as foreign earned income.
Similarly, if you work remotely in a different country but are employed by a US company your earnings are also considered to be foreign earned income, since the work was carried out abroad.
For digital nomads, global entrepreneurs and expats, understanding foreign earned income is key to managing taxes and maximising financial benefits.
Examples of Foreign Earned Income
There are a number of different types of earnings that are considered foreign income. Here’s a quick summary:
Salaries and Wages: Payments from an employer for work completed while living abroad.
Self-Employment Income: Earnings from freelance work, consulting, or running a business in another country.
Professional Fees: Payments for services like speaking engagements, contract work, or artistic performances abroad.
Tax Implications of Foreign Income
Navigating taxes can be tricky, but understanding a few key concepts will help you avoid double taxation and leverage tax benefits.
Key Concepts
1. Tax Residency
Tax residency determines where you owe taxes. Each country has its own rules, usually based on how many days you spend there, your connections to the country, and the nature of your stay (check out our tax residency blog). Knowing your tax residency status is crucial for understanding your tax obligations.
2. Double Taxation Agreements (DTAs)
DTAs are treaties between two countries that prevent you from being taxed on the same income twice. These agreements outline which country gets to tax your income and provide ways to avoid double taxation.
In a nutshell, if the income is foreign-earned and there is a double taxation treaty in place, the country where the income is earned will collect the tax. This can be very beneficial for expats and digital nomads if the country where the income is earned has preferential tax rates.
For example, if you own a US LLC and are living and working in Portugal (which has a DTA with the USA), you will pay tax in Portugal, but not in the US. Since Portugal has lower tax rates than the US, it is a popular location for many remote workers.
Under certain visas, different types of income such as dividends, distributions or capital gains may be exempt in the country in which they are earned, meaning that no tax or minimal tax may be payable.
3. Foreign Tax Credits
If you pay taxes on your overseas income in the country where you work, you might be eligible for foreign tax credits in your home country. These credits can reduce your tax liability, preventing you from being taxed twice on the same income.
Benefits of Foreign Income for Expats
Understanding and managing foreign income can bring several benefits to expatriates and international workers:
1. Tax Savings
Many countries offer exclusions or deductions for foreign income, reducing your taxable income and your overall tax burden. For instance, the US has the foreign earned income exemption, allowing you to exclude a portion of your foreign earned income from federal taxes.
You need to meet certain conditions to be eligible for the FEIE, such as being a US citizen (or green card holder) and being a resident in a foreign country for a full tax year..
2. Legal Compliance
Staying informed about the tax implications of foreign income ensures legal compliance with both your home country and the country where you work. This reduces the risk of penalties, fines, and legal issues related to tax evasion or non-compliance.
3. Financial Planning and Stability
Managing foreign income properly allows for better financial planning. Understanding your tax obligations and benefits helps you budget accurately, save on taxes, and invest wisely in your future.
4. Maximising Benefits and Allowances
Many countries offer specific benefits and deductions for expatriates, such as housing allowances, cost-of-living adjustments, and tax-free thresholds. These can further enhance your financial wellbeing.
How to Manage Foreign Income Effectively
Although applying for tax exclusions such as the FEIE is a smart decision for many expats and freelancers working overseas, managing foreign income is complex and there are many different factors to take into consideration.
Here is a quick introduction to help you get started:
1. Determine Your Tax Residency
Understand your tax residency status in both your home country and the country where you work. This affects your tax obligations and the benefits you can claim.
For example, to benefit from the FEIE you must be a US citizen (or a green card holder). You will also need to prove that you have set up residence in a foreign country, and you have no plans to move back to the US.
2. Understand Applicable DTAs
Research DTAs between your home country and the country where you work. These agreements provide crucial information on tax exemptions, credits, and which country has taxing rights over your income.
This ensures that you aren't unfairly taxed by both your home country and the country where you work.
3. Keep Detailed Records
Maintain accurate records of your foreign earned income, including payment details, contracts, and taxes paid abroad. These records are essential for filing accurate tax returns and claiming tax benefits.
4. File the Necessary Tax Forms
Ensure you file the correct tax forms in both your home country and the country where you work. This may include self-assessment returns, declarations of foreign income, and applications for tax credits or exclusions.
In the case of the FEIE, it’s important to note that just because you fulfill the requirements you are not automatically exempt. You need to file Form 2555 in order to claim the FEIE.
5. Consult a Professional
International tax laws can be complex. A tax professional specialising in expatriate taxes can help optimise your tax strategy, ensure compliance, and maximise the benefits of your foreign income.
Whether you're a digital nomad, freelancer, or expat, getting professional advice is essential to help you understand international taxation and make the most of living and working abroad.
Reach out to our team of lawyers and tax experts at admin@fresh-ops.co.uk to learn more about how we can help you navigate foreign income and improve your financial wellbeing.