Guess what...we pay no income taxes. Zero. Not one penny. State or federal. I'll let that sink in a bit for you...
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Are you mad? Curious? Excited to learn more? Hopefully all of the above. What you read above is true, though. We legally pay no income taxes at all. We keep every cent and spend it on whatever we want. There are two reasons for this. One reason can benefit anyone reading this and the other one requires some major changes being made to your work and/or personal life.
The Foreign Earned Income Exclusion Workaround (the more difficult one)
This is the part of the tax code that allows income earned abroad to be excluded from your federal (and usually state) income up to a certain level. That upper threshold is $101,300.00 for tax year 2016. Even better, that is per person. So a married couple could conceivably exclude $202,600 from their income. Amazingly enough, the IRS doesn't consider where you work or where your paycheck is deposited to determine your tax location. Nope, they use what they call your 'tax home'. This is your usual place of residence where you intend to stay for an indeterminate amount of time or to continually return to. So yes, we split our time between Mexico and Panama (mostly), but my wife works for a US company, headquartered in a US state, paid with US Dollars into an account at a US bank using our US PO Box as an address and yet the IRS considers our tax home to be outside the US and thus we qualify. When I learned that on the IRS website, I had to re-read it several times to make sure I understood how easy it was to change your tax location.
Now here is the hard part. You can't just leave the country, because what usually happens is your new country has an income tax and will want you to pay it. If you have a regular workplace where you have to show up (like an office or a factory) in that foreign country, you work there and all your income is subject to their tax laws as well as the tax laws of the US as well. To pay no income tax to ANY country, this is what we need do in order to keep it legal:
- Have a telecommuting or remote job that you do over the internet with the server located in the United States. The server location is important. For instance, in Mexico, the laws have been interpreted to say that the work location is determined by the location of the computer with the work being performed. If you work on local files (such as designing a website or graphics) directly on your laptop, they consider that "working" in Mexico. But if you were working remotely and connecting to a server in the US where all the files are, the "work" is being housed in the US, outside of their jurisdiction. This is a gray area and I know plenty of people who work on stuff locally. But it's one of those 'who is gonna know?' sort of things and a risk that some take. Not us. My wife works on a server in the basement of her law firm where the legal files reside and I do the same with my server in the cloud (which is in the US as well).
- DO NOT become a resident of your new country. Obviously, this means automatic tax coverage in your host country 9 times out of 10. Some treaties prevent double-taxation on some types of income, but if you life in a high-tax country (like Europe) then you're paying some high taxes when the difference is made up.
- DO NOT stay there more than 6 months at a time Most countries consider you a tax resident for income purposes if you are present more than 6 months at a time, even if you are technically a tourist. Either they will expect a tax return or you will have to do some border-hopping. We jump across a border every 6 months.
- Stay in the US no more than 35 days a year. For most people this one is tough if they have family they want to see a lot and that family isn't going to go to Ecuador every Sunday for brunch. Since you are taking the Exclusion instead of the Deduction (the deduction is used when you already have to pay taxes in another country), you must use the physical presence test to qualify for the Foreign Earned Income Exclusion. So your time in the US is restricted to less than 35 days per year to qualify under that test. Otherwise you cannot claim the Exclusion.
- You cannot have any plans to return to the US any time soon. Ok, settle down...you aren't giving up your citizenship or anything like that. But if you get audited and you just left your home in Boise, Idaho with everything where it has always been and it looks like you left the country ready to return at any minute, you are going to have a hell of a time proving to them you don't have plans to return home. Part of the tax home determination depends on whether your "assignment" abroad is temporary or indefinite. Do like us and sell all your stuff before you move and you've made it pretty clear.
I know. That's a lot to take in and anyone even considering this path would do very well to read the IRS website on the Foreign Earned Income Exclusion several times and research the laws of the country they are moving to. Some countries are easier to legally get away tax-free in than others. But we did it and haven't regretted it even one second!
But what if you aren't willing to or can't move? What if you have a job that will NEVER allow working remotely (and you told your husband buying a farm would be so liberating, eh)? The answer to those questions lie in Part 2 of this post with the secrets of retirement accounts and the stock market reducing your taxes!
Do you have what it takes to move to a foreign country to avoid taxes? Have you taken any steps to do so? Let us know in the comments below!