Unless you’re a tax accountant or lawyer, income taxes probably aren’t your favorite topic. To say taxes are confusing and time-consuming is a laughable understatement. No matter if you’re an employee, self-employed, or retired, taxes take a massive bite out of your paycheck, business profits, and investment earnings.
While taxes can be a downer, the more you understand about them, the more you can save by legally cutting your tax bill each year. In this post, I’ll answer seven tax-related questions that I recently received about working remotely, living abroad, and doing freelance work.
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7 Questions & Answers About Taxes
Here are some great questions from Money Girl readers, podcast listeners, and members of Laura's free Dominate Your Dollars Facebook group:
Tax Question #1
Rachel L. says, “I’m an American who’s been living in Canada for many years. How can Americans who live and work abroad avoid having to pay taxes in two different countries?”
Answer:
Rachel is one of the estimated 9 million Americans who live outside of the U.S. Whether you leave to work for an employer, do freelance work while globetrotting, or retire in another country, you can’t escape Uncle Sam’s tax system.
Unlike most countries, the U.S. taxes its citizens no matter where in the world you live. So, even if you never expect to move back, you still must file an annual tax return that includes all your worldwide income, as if you never left.
Unlike most countries, the U.S. taxes its citizens no matter where in the world you live.
Trying to hide your foreign income became more difficult after 2010, when the Foreign Account Tax Compliance Act (FATCA) was enacted. It requires all foreign financial institutions to report U.S. customers to the IRS. This leaves expats in danger of stiff back taxes and penalties if you don’t comply with U.S. tax laws.
However, the good news for U.S. expats is that you probably qualify for some nice tax breaks. To qualify, you must have a tax home in a foreign country and receive foreign earned income.
The biggest benefit when you live and work outside of the U.S. is the foreign earned income exclusion. It allows you to reduce your taxable income by up to $101,300 for 2016 per qualifying person. There are also foreign tax credits that may reduce or eliminate what you owe. You claim these benefits by submitting Form 2555 along with Form 1040.
Also note that you can still get a tax refund as an expat, but only if you continue filing annual tax returns. If you have foreign income and don’t file a U.S. tax return, you can’t claim any exclusions or credits, and are breaking the law.
As I mentioned, getting caught not paying U.S. taxes can result in high penalties. If your tax delinquency is at least $50,000, the State Department can even cancel your passport. So, don’t think you can fly under the IRS radar just because you’re no longer living in the U.S.
For much more information, check out Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad. And be sure to consult with an experienced tax accountant if you have any questions.
See also: How to Open an IRA—Understand Eligibility, Rollovers, and Early Retirement
Tax Question #2
Elisabeth B. says, “I’m an American in my early 20s, living and working full-time in Europe for the next few years. I have about $20,000 in my U.S. credit union in a mix of mutual funds, CDs, and savings accounts. I’m financially stable and wondering if my American money could be doing more for me. Can I open an IRA in the U.S. even though I’m earning income abroad?”
Answer:
Thanks for your question, Elisabeth, and congratulations for having a nice chunk of savings at such a young age. One of your top financial priorities should be to maintain a healthy cash reserve, known as an emergency fund.
Having a financial safety net is critical because it keeps you from going into debt if you have a large unexpected expense or hit a rough patch, like losing your job or business income.
Having a financial safety net is critical because it keeps you from going into debt if you have a large unexpected expense or hit a rough patch, like losing your job or business income. How much savings you need is different for everyone, but I recommend keeping at least 3 to 6 months’ worth of living expenses on hand.
Another good rule of thumb is to maintain at least 10% of your annual gross income in an emergency fund. For instance, if you earn $50,000, make a goal to accumulate a minimum of $5,000 in cash reserves.
But don’t be tempted to invest your emergency fund. Exposing it to any amount of risk means it could lose value the moment you need it. To have a healthy financial life you need different buckets of money, each with their own purposes.
The purpose of an emergency fund isn’t to earn money or grow, but to stay safe for future potential financial disasters. So, in general it should always sit tight in a high-yield, FDIC-insured savings account.
Once you’ve got some cash set aside or are saving to an emergency fund on a regular basis, it’s time to start another bucket of money that you want to grow for the future, such as a retirement account.
But is Elisabeth eligible for an IRA while living abroad? To qualify for any type of IRA, you must have some amount of taxable, earned income. As I previously mentioned, expats can typically exclude up to $101,300 of income from taxes, for 2016.
So, unless you choose not to take the foreign income exclusion or you earn over $101,300, you won’t qualify to make IRA contributions. However, you can still invest using U.S. dollar-based, taxable, brokerage accounts.
Also see: What’s the Difference Between a Roth 401k and a Roth IRA?
Tax Question #3
Miriam says, “What would be the consequences if I withheld federal and state taxes from my paycheck for a couple of months? How would I pay it back and would there be any penalties at the end of the year?”
Answer:
You can only claim an exemption from payroll income tax withholding if you had no tax liability last year, and don’t expect to owe any taxes for the current year. For instance, if you’re single, under age 65, and earned less than $10,350 in 2016, you don’t have to pay tax.
However, if you (or a spouse) earn less because you become unemployed for part of the year or lose side income, you can increase the number of allowances on your current W-4 to reduce your withholding to a minimum.
Problem is, if you don’t pay in enough tax during the year, you’ll have a tax liability on Tax Day of the following year. If you pay what’s owed by the deadline, which is typically April 15, there are no penalties. Just make sure you have enough savings to make up any potential tax shortfall.
Also see: How to Fill Out a W-4—Plus, 7 Reasons to Adjust Your Tax Withholding
Tax Question #4
Erica L. says, “Thanks for your podcast on tax deductions for a home business. I have two businesses that I run from home in the same office space. Can I account for both, or can you only take the home office deductions once?”
Answer:
Thanks for this great question, Erica. This is a great follow-up to my recent post and podcast #509, Work from a Home Office? Claim a Tax Deduction and Save Money. If you qualify for the home office deduction, you (or you and a spouse or roommate) can claim the same office space for two or more separate business activities.
Tax Question #5
John says, “I started working remotely for a company that’s out of state. Will I have to file a tax return for the state where the company is located?”
Answer:
In general, when you work remotely, you only need to pay income taxes in the state where you live, no matter where your employer is located.
In general, when you work remotely, you only need to pay income taxes in the state where you live, no matter where your employer is located. However, there are some states—such as Delaware, New York, New Jersey, Nebraska, Oregon, and Pennsylvania—with non-resident tax laws that require you to pay tax, in addition to your home state, unless you meet an exception.
So, if you receive a W-2 form at the end of the tax year that lists a state other than yours, you’ll need to file a non-resident tax return to the state listed. It’s a good idea to consult with a tax accountant to make sure you’re following the rules.
See also: 5 Ways to Pay a Tax Bill You Can't Afford
Tax Question #6
Adam says, “I’m self-employed and can work anywhere in the world with an internet connection. Can I claim the cost of my travel as a business expense?”
Answer:
When you’re self-employed and mobile, your home office essentially travels with you as you open a laptop or smartphone to work from a hotel or café. But that doesn’t mean you can deduct the cost of travel for every day that you work on your business from a remote location. You simply can’t deduct personal expenses.
You can only deduct the business portion of your travel expenses, such as staying in a city while you attend an industry conference, meetings with colleagues, or working with clients. If you plan to deduct all or a portion of an expense, keep the receipt and make notes to document its business significance.
Here are some common business-related travel expenses you might be able to deduct:
- Travel by airplane, train, bus, car, rental car, taxi, or rideshare between your home and your business destination
- Shipping and baggage fees
- Tolls and parking fees
- Meals and transportation to and from restaurants
- Hotels
- Entertainment
- Dry cleaning and laundry
- Tips
See Publication 463, Travel, Entertainment, Gift, and Car Expenses for more information.
Tax Question #7
Kevin W. says, “My son, Joseph, is a college freshman who was diagnosed with Autism at age 3 and was non-verbal. Now he’s a sports broadcaster for a local radio station on the air and wants to start writing about sports for their website. What types of expenses are tax deductible when you work from home or travel as a freelance writer or reporter?”
Answer:
Kevin, that’s fantastic! There are many expenses you can deduct when you start a business. In general, they must relate directly to the service you provide, and be what the IRS calls ordinary and necessary. Ordinary, as in common in your trade. And necessary means what’s helpful to generate revenue.
As I previously mentioned, you can’t deduct personal or family expenses. However, if something is partly personal and partly business, you can divide it appropriately and deduct the business portion.
For instance, if you travel for a blogging conference and then extend the trip for a vacation, you could deduct the portion of expenses spent just for the business. If you use your car for business, you can deduct expenses based on the mileage driven.
Here are some more expenses that may apply to freelance writers:
- Computer
- Printer
- Software for writing or bookkeeping
- Office supplies
- Website creation
- Website hosting
- Photography or graphic design services
- Subscriptions to trade publications
- Membership to industry associations
- Writing classes
- Conferences
- Marketing and promotion
- Business travel
This isn’t a complete list of all the potential business expenses that you can deduct. Check out Publication 535, Business Expenses for more information or consult with a qualified tax accountant to take advantage of every possible and legal deduction.
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