Have you ever wanted to travel the world for a year? Well, if you do, you can take advantage of some really big foreign tax benefits. U.S. citizens are taxed on their worldwide income. However, if you are overseas for a year or longer, you can generally take full advantage of some of the most eye-opening tax benefits available to individuals: the overseas tax benefits.
In fact, you could save so much coin from these rules that it could pay for your international travel! Who knew that travelling the world could save you money? So, get out your map and start dreaming of where you might go. Here are three tax benefits of spending a year abroad:
Be Outside The U.S. For 1 Year
To take advantage of these foreign tax benefits, you have to meet the “physical presence test” of being outside the U.S. for 330 out of 360 days (e.g. about 11 out of 12 months). Importantly, you don’t have to be in any one particular place – you can travel. Check out IRS Publication 54 to determine if the “physical presence test” applies to your situation.
(Note: You can also qualify under the “bona fide resident” test, but for taxpayers taking a year abroad, the “physical presence test” is generally easier).
1. Your foreign earned income can be excluded
If you earn any income while you are overseas, you can exclude over $100,000 of it from U.S. taxes. This means you don’t pay U.S. income taxes, and you also don’t pay social security taxes on that income.
The only trick is that the income has to be “earned” (i.e. paid in exchange for goods or services you provided, like a salary or a small business. Investment income doesn’t qualify). And you have to earn it while you are physically overseas.
There are all kinds of income a traveler might earn, which can be excluded. For example, if you are a digital nomad working on the internet for a U.S. company or U.S. clients, you can travel overseas and exclude your income from U.S. taxes (subject to limits)… just keep working while you are travelling.
Income from scholarships and fellowships can generally also be excluded. As can royalties you earn from a book you wrote. You can even exclude up to 30% of rental income, if you perform personal services in connection with the rent.
This tax rule clearly hasn’t kept up with the reality of working remotely on the internet!
The nitty-gritty rules around the foreign income exclusion are rather complicated. There are lots of rules, clarifications, complications, and some exceptions. In addition to meeting the “physical presence test”, you also need to have a foreign “tax home”. You can learn all about how it applies to your situation in IRS Publication 54.
2. Your foreign housing costs can also be tax-free
If you have housing costs, such as rent, while you travel abroad for a year, you can reduce your taxable income by the amount of those housing expenses. This is truly exceptional, because the IRS generally doesn’t allow rental deductions, except as a business expense. However, if you travel abroad for a year, and rent out a villa in Tuscany for a couple of months along the way, you could potentially use it to reduce your taxable income!
There’s one major catch (there’s always a catch). You must have foreign earned income in order to do this. In other words, if you travel the world and have no income while you travel, then you cannot use your foreign housing expenses to reduce your taxes.
There are two separate mechanisms available, depending on whether your foreign income is from salary or from self-employment: a foreign housing exclusion (for salary employees) and a foreign housing deduction (for self-employed individuals). They both subject to limitations.
You can only use housing expenses that are over a certain amount (about $16,000), and under a certain limit (generally about $30,000). I’m not going to go into the details of how to calculate these limits in this blog post, but you can read all about them in IRS Publication 54.
3. You aren’t required to buy U.S. health insurance.
Under the Affordable Care Act (aka Obamacare), U.S. citizens are required to purchase some rather comprehensive and expensive health insurance – even if you are young and healthy, and even if you prefer to self-insure.
However, if you spend a year abroad, you are excused from the health insurance mandate. Not only can you avoid paying thousands of dollars per month for expensive U.S. insurance, but you also won’t get hit with a penalty on your tax return for lacking coverage.
That’s good, because U.S. health insurance plans have little or no coverage overseas anyway. In fact, most plans are worthless if you are outside of the U.S.
If you travel the world for a year, and you want to have health insurance, you can still get basic travel/medivac insurance that will cover unexpected hospital bills. And it will cost just a fraction of what your U.S. health insurance costs.
For our family’s year abroad, I got worldwide health insurance for about $1,600 total for the year. It pays for up to $300,000 of emergency hospital bills, including medical evacuation costs. That goes a looooong way in most countries. For otherwise healthy individuals, this is all you really need.
Consult Your Accountant
These foreign tax benefits are huge. You can easily save tens of thousands of dollars in taxes – enough even to pay for your foreign travels!
But, these are also some of the more complicated among the IRS individual tax rules. There are many exceptions, caveats, and complications that may impact your particular situation, which I am unable to cover in this short blog post. I personally don’t recommend trying this at home, without consulting a professional who is familiar with these rules. However, for those with the wherewithal to tackle them, the foreign tax rules offer some truly spectacular advantages.