The second part of our US tax concept section is on the X patch tax provisions I alluded to earlier. I'm going to focus on the main way that expats and digital nomads alleviate US tax while living and working abroad, namely, the foreign earned income exclusion. We'll talk about the concept of citizenship based taxation. We'll go into some detail on the foreign earned income exclusion. We'll discuss some examples of how the exclusion works and touch on what you need to do to claim it, the reporting requirements and filing deadlines to keep in mind and just to note, all actionable information is included on your checklist which you can download and take notes on throughout the course. First, some of the definitions we covered in the previous section will come into play here.

The concept of citizenship based taxation is fundamental to understanding your ongoing US tax obligations as an expat or digital nomad. Because your US citizenship or green card means you'll continue to be considered a US person. And as such, you'll be subject to worldwide taxation and reporting in the US, no matter where you live or work and no long no matter how long you've lived outside the US. The US is unique in this regard, as you may or may not be aware, people from other countries don't often have this requirement to continue to report taxes based on their citizenship. However, there are methods by which us expats and digital nomads may reduce or eliminate the US tax on foreign source income. And that's what we're going to be discussing here.

The main method really, and the one that we're going to spend most of our time on is the foreign earned income exclusion, sometimes abbreviated as F, E, ie. You may have heard this discussed, and we're going to dive into exactly what it means and how it can apply to you. But first, let's look at each of the words there because they're all important. You firstly need to have foreign income. income is sourced as us versus foreign in a particular way, which we'll define for you. It needs to be earned income.

In other words, it can't be passive income. And finally, it's an exclusion from taxable income, which looks on your tax return in a particular way which we will define for you as well. What are the basics of the Foreign Earned Income Exclusion? Well, firstly, there are tests you need to meet to qualify for it. The tax home test is a fairly simple one. Generally, if you're no longer living in the US for at least a year, then your tax home is probably outside the US and you would meet this test.

So this is not one that tends to trip up most people if they're living outside the US for, again, at least a year in duration. And if they meet one of the other two tests, which we'll discuss in more detail. Secondly, for the foreign earned income to apply to you, you need to have earned income from when you were working physically outside the US. We'll talk more later about what constitutes a foreign source income, but it's generally as simple as that income you earn While you're working and you're physically located outside the US when that income was earned is generally all it takes to be considered for source. And finally, you need to qualify for the Foreign Earned Income Exclusion each year, meaning each tax year you need to determine if you've met one of the two tests, which we'll discuss next. So here are the two ways that you can qualify for the foreign earned income exclusion.

These tests have very specific definitions and you need to be very clear on which one you're qualifying under. In fact, a person might meet the requirements of both which is fine, but they still need to claim the foreign income exclusion under either a the physical presence test, or be the bona fide residence test. advisor satisfying either of these, you essentially automatically satisfy the first test, which is the tax home test we talked about. So again, that's really why the test is almost never a sticking point for people. These two tests do have stricter definitions. However, most digital nomads use the physical presence test or PPT.

This is because it is a straightforward test based on the number of days spent outside the US in a 12 month period. At a high level, if you keep your us days to less than 35 days per year, then you can qualify using this test. One note is the days don't all need to be in the same country. However, one area of caution for using this method is when you're counting your us days, a partial day in the US still counts. So when you're planning your trips back to the US, be sure to include Your arrival and departure days in your total when you're arriving at the 35 days. Finally, the 12 month period for the physical presence test can start or end on any day in the tax year.

It doesn't need to be from January 1 to December 31. So what this means is digital nomads who depart from the US midway through the year can still qualify for a partial year of the exclusion. Now let's look at our second test and kind of examine why it doesn't tend to work for most digital nomads. To qualify under the bona fide residence test, essentially you want to have as many factors as possible supporting your claim of being a bona fide or legitimate resident of a particular foreign country for a period that in cludes and this differs from the PPT test. The VFR test requires the dat period include an entire tax year from January to December. Generally claiming the bona fide residence test requires, at minimum, a permanent or long term right to live or work in that country that you are claiming to be a bona fide resident of.

So in addition to other factors, that's really the baseline that's required. And for that reason, this is not the test that we see most digital nomads claim. For example, if you're only in a country on a three month tourist visa or visa exemption, like many no digital nomads would use the BFR test is simply not going to work for you. However, for those people looking ahead to possibly settling down in another country longer term. One of the nice things about VFR is that it allows for you to spend More time back in the US, usually up to around four months is considered reasonable while maintaining your bona fide residence abroad. So it's certainly something to consider if and when you're settling down and creating more of a permanent home base outside the US.

Okay, so now we know how to qualify for the Effie. And in broad strokes what it does. Let's discuss a little more about the mechanics of it. If you qualify, you can exclude up to around $100,000 of foreign earned income per year. The exact amount is indexed for inflation, so it goes up by a few thousand dollars a year generally. I've given the amount there for 2018 which is $104,100.

If you and your spouse if you're married are both eligible. Then you can each claim it up to around $100,000 each. And just a reminder, only income earned from working is applicable. One note here for the self employed or freelancing digital nomads, the Foreign Earned Income Exclusion does not apply to self employment tax, which is a separate tax that's calculated distinctly from the regular federal income tax. We'll talk about this more in the next section. So for now, it's enough to know that if you're self employed, Fei he does not get you out of paying us tax altogether.

And also important to know, the Foreign Earned Income Exclusion isn't automatically granted. You have to claim it and the way you do that is by filing form 2555 with your tax return. Usually, this means you'll need some help preparing your taxes but you become a digital nomad. Even if you've always used Some of the commercially available or even free software in the past, the form 2555 simply isn't always well supported or well understood by some of these more broadly applicable programs. So it is a relatively niche area that you do want to get some specialized advice on. Now let's cover some of the common questions people tend to have related to the foreign earned income exclusion.

I often have people asking me if any of these factors will prevent them from claiming the FBI. And the simple answer is No, they won't. All of these are totally acceptable and in fact common amongst us digital nomads. As long as you're performing your work while you're standing on us or non US soil, and as long as you otherwise qualify for the foreign earned income exclusion, then the income is still foreign source. So your clients can be us client You can, if you're working as an employee work remotely for a US employer, they may still issue you a W two, that's perfectly acceptable. You can sell physical products into the US, for example, through Amazon FBA, you can get paid in US dollars into a US bank account.

You can keep using a US mailing address, a forwarding address, a friend's address, a peel box, virtual mailbox. All of these are fine. And in fact, you can structure your business through a US LLC. None of the above makes your otherwise foreign source income into us source income. It just doesn't work that way. So the main factor to consider is what is your physical location when you're earning that income?

And then do you qualify under one of the tests that we mentioned previously? Now let's look at two simple examples of how a digital nomads tax picture might look if they qualify for the foreign earned income exclusion. Example number one. Darcy the digital nomad earns $70,000 per year working remotely for her employer. So she's an employee, she's not subject to the self employment tax. And let's say she spends all of calendar year 2018 living and working outside the US.

So her income is 100% foreign source. She hasn't earned any of it while she's been physically located in the US. And because her qualification period is the same as the calendar year, then she's eligible for the full exclusion amount, which is again $104,100 in 2018. If Darcy doesn't have any other taxable income, then her US tax liability for 2018 is zero. but crucially, she does still need to file a tax return in order to claim it. One other thing to note, if you're an employee working for particularly a US employer is, if they issue you a W two, it may, they may have withheld US federal income tax throughout the year, in which case, it's not too late.

We just claimed for an income exclusion on your tax return and ask for that, withholding back as a refund. Now, one thing you can do going forward and I'll add this on your checklist is you can actually ask your employer to stop withholding the federal income tax. So you don't need to wait to get back as a refund. That's really the preferred approach. And there's a particular way that you need to ask them to do that. So that will again be on your action items.

In our second example, it gets slightly more complicated because our friend Sam here is a self employed digital nomad. He earns the same amount as Darcy but he earns it working for himself. And his artifacts are all the same. So he spends all of the year outside the US, his income is 100% foreign source. If he doesn't have any other taxable income, his us ordinary income tax rate is still zero. But because he's self employed, the self employment tax does apply to him.

We'll talk in more detail about self employment tax. But suffice it to say, Sam here is going to owe around 15% on his net earnings from self employment. So he still claims the foreign income exclusion the same way that Darcy does, but he also needs to file a Schedule C to report his business activity. And he needs to make the payment if he hasn't already made quarterly payments throughout the year. He's going to need to pay that all in April when he files his tax return. So you can see how things get just that bit more complicated when you're self employed.

But don't worry, we're going to take a deeper dive into that in our next section. For now, let's conclude with some dates to keep in mind, these will be in your checklist as well. When you're first starting out, just keep in mind that you'll need to track your trips back to the US. If you have self employment income, which many of you will have, then make note of the need to make quarterly estimated tax payments. The filing deadlines I've mentioned there are just for your reference. There is an automatic extension that's available for all persons who are residing outside of the US as of the April 15 deadline.

And then there's an additional extension which does require actually filing and applying for it, but it's available again for anyone who files form 4868 and requests it and then a note there on the quarterly payment deadlines for the self employment tax. If you do owe it, you're going to want to pay that by The quarterly deadlines of April 15, June 15, September 15 and January 15 of the following year. So again, that's our summary of the basics for us expats and digital nomads, the main provision that they would be looking to take advantage of being the foreign earned income exclusion. And for those self employed or freelancer, digital nomads Stay tuned. Our next section is really geared towards you. See you there.