Living abroad can dramatically lower a U.S. citizen’s tax bill. By meeting the Foreign Earned Income Exclusion (FEIE) requirements, a digital nomad can shield roughly $106 000 of earned income from federal tax each year, and many states follow suit, resulting in savings of up to $30 000 annually.
How the FEIE works
- What it excludes: Up to $105,900 of foreign‑earned income (the 2019 amount, indexed for inflation each year) can be excluded from U.S. federal income tax. The exclusion is added to the standard deduction, effectively making that portion of earnings tax‑free.
- Who benefits: Any U.S. citizen or resident alien who earns income while physically present outside the United States and meets the residency test.
Physical‑presence test
- 330‑day rule: Within any rolling 365‑day period, you must be present in foreign countries for at least 330 days. The remaining 35 days can be spent in the United States.
- Foreign soil requirement: Days spent on international waters, on a yacht, or in a cruise that does not dock in a foreign country do not count toward the 330‑day total.
- No “tax home” needed: Unlike many other jurisdictions, the U.S. does not require you to establish a tax home abroad. As long as you satisfy the physical‑presence test, you are considered a foreign‑earned income earner.
Practical example
If you leave the U.S. on June 1 and return on May 31 of the following year, you must ensure that at least 330 of those days are spent on the land or territorial waters of foreign nations. Exceeding the 330‑day threshold allows you to exclude up to $106 k of income from federal tax.
State and local tax considerations
- Most states that levy income tax will mirror the federal exclusion, and many city taxes do the same. However, a few states (e.g., California, New York) may still claim tax liability unless you formally change your domicile.
Reducing self‑employment (Social Security & Medicare) taxes
- Foreign corporation option: To lower the 15.3 % self‑employment tax, you can operate your freelance or small‑business activities through a foreign corporation, provided you meet specific IRS criteria (e.g., bona‑fide foreign entity, proper payroll handling). This adds complexity and requires careful compliance.
Income above the exclusion
- If earnings exceed the $106 k limit, additional strategies—such as using offshore entities or structuring U.S. and foreign companies—can further reduce taxable income. These approaches are advanced and typically require professional tax advice.
Spousal filing
- A married couple can each claim the FEIE, potentially excluding $212 000 combined. Both spouses must individually satisfy the 330‑day physical‑presence test.
Risks and caveats
- Record‑keeping: Precise travel logs (dates, locations) are essential to prove the 330‑day count.
- Compliance: Failure to file Form 2555 (or Form 2555‑EZ) correctly can result in penalties and loss of the exclusion.
- State residency: Some states may still consider you a resident for tax purposes unless you take formal steps to relinquish domicile.
- Corporate requirements: Running a foreign corporation involves registration, reporting, and possible double‑taxation treaties; mishandling can trigger IRS scrutiny.
Bottom line
By spending the majority of a year abroad and meeting the physical‑presence test, U.S. citizens can legally exclude a substantial portion of their earnings from federal tax, dramatically reducing overall tax liability. Proper planning, meticulous documentation, and, when needed, professional guidance are crucial to maximize the benefit while staying compliant.
