Dateline: Phnom Penh, Cambodia
We all know someone who has done it.
Here at Nomad Capitalist, I talk about the idea that you should “go where you’re treated best”. One of the key tenets of going where you’re treated best is lowering your taxes in any legal way possible.
In a world where governments are increasingly competing for business with lower and lower tax rates, it’s simply dumb to stay in one place and pay high taxes just because you were born there.
However, one method of legal tax reduction falls far short in my opinion: moving from a high-tax state to a low-tax or no-tax state. The concept of eliminating state tax is a fool’s errand in my opinion.
No doubt you have a friend or colleague who has vowed to never pay high taxes in California ever again, packing their bags for sunny, tax-free Nevada.
Or perhaps you know someone from high-tax New York City who relocated to Miami to avail themselves of Florida’s zero income tax laws.
There are currently seven US states with no state income tax; nine if you include those that only tax dividends. Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming allow income to be earned tax-free.
Don’t settle for the typical response
In my opinion, moving to another state in the United States – or another province in Canada – is not an effective way to reduce your taxes. Allow me to explain.
I recently helped an online business owner named Marcus save a lot of money. Marcus grew up outside of Los Angeles and eventually started his business in California, which was happy to pick his pocket for tens of thousands of dollars every year.
Finally, Marcus had enough. He was earning about $400,000 a year and paying $140,000 in federal taxes, and another $30,000 in state taxes payable to California.
Even after a slew of business tax deductions, he was paying more than 40% of his small businesses’ income to the IRS and California’s Franchise Tax Board.
So Marcus did what so many US citizens fed up with high state taxes do: he moved to Las Vegas. He even got an apartment right on the Las Vegas Strip.
While living in Las Vegas was fun for a while, Marcus missed California, but decided to stay in Nevada in order to save that $30,000 every year. After all, his business was growing and moving back to California would only cost him more and more in state taxes.
That’s when he called me.
Applying the Pareto principle
Like many successful entrepreneurs, Marcus tries to apply the Pareto principle to focus on what his business needs to grow. The Pareto principle is more commonly known as the 80/20 Rule and states that “roughly 80% of the effects come from 20% of the causes”.
In other words, 80% of your sales come from 20% of your clients, or conversely that 80% of complaints come from 20% of bad customers. The idea is that focusing on the most important aspects of business – or any other area of life – will yield the biggest gains, while focusing on any other areas will yield little.
Here Marcus was paying $170,000 in taxes every year, and his solution – like so many other Americans fed up with high taxes – was to uproot himself in order to save $30,000… a mere 18% of his tax burden.
If you’re considering moving from a high-tax state to a tax-free state, you’re likely missing out on a similar percentage of potential tax savings, because merely moving from one state to another does not reduce your obligations to pay federal tax to the IRS.
Nor does it relieve you of paying Social Security or Medicare tax, which for entrepreneurs totals 15.3% on the first $120,000 or so of income.
So how can you apply the 80/20 Rule to lower your taxes even further? Quite simply, by moving overseas.
Moving anywhere is a frustrating process that involves change. Growing up, my family moved between several suburbs of Cleveland, Ohio, and each time I lost contact with certain friends and had to get used to a new place.
If you’re going to deal with the frustration of moving in order to reduce your tax bill, why not really go for it? In many respects, moving is moving, whether it’s down the street or halfway around the world. You might as well pocket an extra million over the next few years for your trouble.
By moving outside of the United States for the majority of the year, you can exclude the first $102,100 in earnings from a job or business. If you’re married, your spouse can do the same.
If you’re running a business as Marcus was, you may be able to establish an offshore structure that allows you to also legally avoid Social Security tax and Medicare tax, as well as exempt even more income from tax.
Location, location, location
I’m simplifying concepts that can be rather complicated, and which can vary depending on a number of factors. People like Marcus come to me because I’ve done this myself and can work with my expat tax advisors to create a custom plan for them.
So while I can’t speak to your specific situation, I can say that in general, living outside of the United States can help you greatly reduce, if not even eliminate the taxes you owe.
Rather than reducing your tax bracket from 43% to 38%, you can reduce it from 43% to 1% as I did. It’s all legal and based on US tax code that offers tax relief to American expats.
If you can move to Miami, you can move to Panama.
If you can move to Seattle, you can move to Dublin.
If you can move to Alaska, perhaps Siberia would appeal to you.
Of course, moving to another country involves immigration matters that moving to another state doesn’t. However, US passport holders can visit some 167 countries without a visa, meaning you can leave the United States and claim tax benefits now, and figure out where you want to live later.
While you can choose to establish a new permanent home overseas, you can also choose to travel from country to country as a tourist and pay taxes nowhere.
I like to think of this as the US government paying for you to travel. Even with only $100,000 in annual earnings, the average US citizen would save about $29,000 a year by moving overseas. That’s far more than the few grand you’d save crossing into Nevada or Florida.
When you get into higher six- and seven-figure earnings, the savings become even more substantial. If you’re in business for yourself, imagine what you could do with all of that extra money every year by merely re-investing it back into the business.
In Marcus’ case, he decided to set up homes in both Panama and Thailand. By doing so, he was able to reduce his taxes to almost zero, giving him a six-figure sum to re-invest and double his money on.
Lower taxes and enjoy the good life
Before you move to another state, consider moving overseas. Having not spent so much as one day in the United States in several years, I can tell you that I don’t miss much, nor do I lack for anything.
You may miss the beaches, or skiing, or surfing, or California Gurls, but I promise you that plenty of other countries have beaches, slopes, waves, and hot girls.
In fact, not only can you keep a lot more of your own money by moving overseas, but you may be able to reduce your cost of living as well. While moving to Dublin might not yield much in the way of savings, moving to Bangkok will.
Heck, I know people who have gone from barely scraping by after taxes and living expenses, to pocketing 75% of their income after moving overseas.
Becoming an expat is a legal way to save on taxes and live an adventurous life of freedom, and it sure beats fighting tourists on the Strip.