Dateline: Tivat, Montenegro
When I was eleven or twelve years-old, my parents began talking about picking up our lives in the United States and transplanting everything to a different country. The idea was to move my father’s business, my family, everything to New Zealand – the country that my parents settled on after considering a few other options.
While my parents had a global mindset, they had never considered the idea of flag theory – a concept introduced by W.G. Hill in the 80s and 90s that described the life of a perpetual traveler. Rather than pick up and move to one new location, under flag theory, a perpetual traveler could separate all of their affairs by setting up a company in one location, banking in another and then living as a tourist in all of the places that they visited.
Because of the favorable treatment of tourists abroad, perpetual travelers (PTs) could essentially live “nowhere” and garner numerous tax and lifestyle benefits.
But when I was twelve years old, the only way my parents wanted or knew how to go abroad was to move their entire life from Point A to Point B. In the end, they didn’t take the leap, but if they had wanted to, my parents’ generation was perfectly poised to enjoy the benefits of flag theory.
Fast forward to 2005 and I discovered as a twenty-year-old businessman that I could live and work anywhere I wanted to go. I could take my VoIP phone and work from the beach in the Caribbean or from a quaint cafe in Europe. I could travel the world.
These days, people refer to this as the digital nomad lifestyle, and some still use the older term of the perpetual traveler. Millions of people have quit their jobs, set up a remote work agreement, or opened a location independent business and now work from anywhere.
But even as more and more people adopt the digital nomad lifestyle, many of the benefits of flag theory itself have been lost. The difference compared to my parents’ generation when you could live “nowhere” and easily enjoy a tax-free lifestyle is staggering. And things have changed a lot even since 2005 when I began traveling. Just in the last few years, the rules of the game have changed dramatically.
The bottom line is that it is getting harder and harder to live “nowhere” and still enjoy the tax benefits of perpetual travel.
Still, all over the internet, the modern perpetual traveler continues to ask the question, “How do I pay taxes as a digital nomad?” and “Where do I pay taxes if I have no permanent home?”
Today, living like a tourist – living nowhere – comes with a few big challenges. In this article, we will go over the obstacles that modern perpetual travelers face, as well as how to overcome them and avoid the “Nomad Tax Trap.”
Home is Where You Pay Your Taxes
The biggest source of confusion that people deal with when they’re figuring out where they are responsible to pay taxes is determining their actual tax home. This is one of those situations where people from the US are in one bucket and everyone else is in another.
If you’re a US citizen, you actually have an advantage because, if you meet the physical presence test by spending 330 days out of a 365-day period in a foreign country or countries, then you can take the Foreign Earned Income Exclusion (FEIE).
Under the FEIE, the US doesn’t ask you to prove where your new tax residence is as long as you spend enough time outside of the United States to prove that it is no longer your home. That doesn’t necessarily mean that you’re going to pay zero tax, there are other things involved, but you can still live nomadically and qualify for the exclusion.
The other benefit is that you can claim the exclusion and still report the United States as your tax residence because there is no way to fully get out of filing and paying taxes in the US. If you are a US citizen, the United States will always be your tax residence. This can be beneficial when setting up a foreign bank account as banks will want to know where you pay taxes before accepting you as a client.
Banks do not want clients who are bouncing all over the world, but because US citizens are permanent tax residents of the US, they can travel as much as they like and still report the US as their tax home.
But what about the Australians, the Canadians, the Brits, the New Zealanders, and people from everywhere else in the world with a residential form of taxation? If someone from Australia were to tell the bank that they pay tax in Australia when they don’t actually do so anymore, the bank is not going to accept them.
Citizens of countries with residence-based taxation who want to travel and save on taxes must find a new tax home.
This home will help them both create credibility with banks and other organizations as well as reduce their tax burden. However, determining where your new tax home is located can be a complicated issue.
I remember sitting in the boardroom of a Shangri La hotel a couple of years ago with people who had flown in from all around the world to meet with our team. One of the big things people were talking about was the idea that if you spent fewer than 183 days in a country, they wouldn’t tax you.
This is a big misconception that has confused many people.
Many digital nomads will spend eight months of the year traveling around the world, going from country to country, hotel to hotel and from Airbnb to Airbnb, and then they come home for four months.
While every situation is different, if you’re spending four months in your home country and two weeks at a time in 16 other countries, your case isn’t as strong as you may think. People believe that their government simply says that all they have to do is spend 182 days or less in their home country and they’re off the hook.
But this is a fallacy.
Each country has their own domicile tests to determine your official tax home and many countries are beefing up the enforcement of these tests as the nomad lifestyle becomes more common. In Australia, for example, the “days test” is just one of four different tests that help them determine whether or not their citizens are also tax residents. The Australian taxation office also wants to know where you have the most connections.
If you spend just under six months of the year at home to satisfy the “days test” and then split the next six between 16 different countries, are you really as connected to those countries as you are to Australia? Where’s your apartment? Where do you keep your furniture? Where are you a member of the chamber of commerce?
If I go to Australia as a bonafide tourist, then the days test is probably the most important test for me because I have stronger connections elsewhere. If I spend less than 183 days in the country, I’m likely safe as long as my intentions are clear that I’m not trying to move to Australia.
But if you grew up in Australia and the government naturally presumes that you are residing there and you have a home there and contribute to a superannuation there and you keep your bank accounts there and continue to use the system in one way or another… the government is going to claim that you are a tax resident of Australia.
You have too many connections there to claim otherwise.
This is what has changed. It is not so much that the law itself has changed but that, as more of these cases are presented, the interpretation of the law has become more uniform and the application of the law more cemented and enforceable. It’s not enough to leave. You need to migrate the center of your life somewhere else too.
This is an issue for citizens of numerous countries who were once residents of their home country but left to explore the world while making a living. I mainly work with folks from English-speaking countries like Australia, Canada ,New Zealand, the UK, Ireland, and others, but this is also happening in other EU countries and even in some odd places like Colombia.
Many folks from these countries did not believe that they owed any taxes. But as more and more people have made the jump to a nomadic lifestyle, governments have paid more attention and these folks are now hearing from them. Because they never met all of the requirements to become a tax non-resident in their home country, they now owe thousands in back taxes.
They did not realize that leaving their home country was not enough to avoid paying tax.
This is the nomad tax trap!
I follow these cases and the biggest thing that I have seen in the rulings is that the court wants to know where you live. Where is your center of life? Do you have a home somewhere else? Do you have an apartment lease? Have you set up a tax residence in another country? Do you have some type of connection to another country?
The folks who have been unable to show proof of any of these things are the ones who have had to pay back taxes to their home countries. In many cases, this blow can be quite devastating. So, know before you go: home is where you pay your taxes. If you’re going to avoid paying taxes in your home country, then you have to show them that you have a new home.
Making Your “Story” Straight
All of this leads to an important lesson: to live a nomadic lifestyle and enjoy the corresponding tax benefits, you have to be able to explain to others exactly what you’re doing. To keep both the tax people and the banks happy, you need to create a life for yourself.
A story that makes sense.
Not a fake story.
Not a made up fairy tale that allows you to dodge taxes.
This is not encouragement to lie or avoid reporting your income. We encourage our customers and readers to stay within the limits of the law and report their income.
This isn’t about “getting your story straight,” it’s about legitimately creating a straight story. A lifestyle that allows you to enjoy all the benefits of going where you’re treated best. To do that, you’ll need to make clear, intentional decisions about the life story you are creating.
This is even more true today than it was just a decade ago.
It began with the introduction of FATCA for US persons in 2010, but the universal need for a real offshore story has come about in just the past few years with the creation of the Common Reporting Standard, or CRS.
In an effort to prevent tax evasion, many governments around the world have joined together and accepted the CRS as an informational standard regarding the free and automatic exchange of information regarding bank accounts. This allows them to ensure that you are properly reporting your income.
Governments and banks have always wanted to know what you’re doing and how you’re doing it. Under the new reporting standards, they can now demand to know. So, if you are going to legally and effectively reduce your taxes, you need to create an international structure – a story about how your taxes, business, and personal life all work together – that demonstrates why you can enjoy your specific nomad tax situation.
Create a Real Home
If you really don’t want to pay taxes in your home country, you need to make a clean break. You need to set up a home somewhere else – both a tax residence and a physical, permanent residence. You need to create a base somewhere else that both banks and governments can see and understand is your real home.
The little tricks that have worked in the past are not going to work anymore. Saying that you live in Panama when you’ve never been there isn’t going to work. Saying that you’ve left your country without having a second residence won’t work, either.
At the very least, you need to fill out the forms to become tax non-resident and obtain a determination letter from the government acknowledging that you have left. But this still may not be enough. Getting a second residency and having a lease or home in another country is increasingly more important.
Now, this is not tax advice because every situation is different, and so is every country. But, generally, having a base that you can call home will help you explain to banks and tax officers what you are doing and demonstrate a “center of life” where you live and manage your affairs for a significant part of each year, even if you do not spend all of your time there.
Many of the entrepreneurs that I talk to tell me that having a base helps them be more productive, too. They have a space to work from. They have a place to store their clothes. And they are not constantly going from one hotel to the next.
The base is important for productivity and operational reasons, but it is also increasingly important because people want to know where you live. They want to know where you pay tax. But just because you are liable to pay tax somewhere doesn’t mean that you do pay tax. Maybe the rate is zero in your new tax home, or maybe you are exempt from paying taxes because your income is offshore.
Either way, having a base is increasingly important.
Maybe you have an apartment or even buy one and that helps you get a residence permit and then the residence permit helps you get citizenship. There are lots of different things that can play off of one another here.
A base gives you the benefit of being able to say, “This is where I live!” and then you can travel from that base. You can live the nomadic lifestyle and then go back to your base. You can visit your home country and then return to your base. A base can make various parts of the digital nomad tax situation and life much easier.
Policy makers may dislike that people are looking for ways to avoid paying 50% tax rates, and groups like the Organisation for Economic Co-operation and Development (OECD) may be closing some of the exits and making it harder for people to claim that they don’t live anywhere, but there are still plenty of ways to go offshore and reduce your taxes through a Nomad Capitalist lifestyle.
Having a base that you can call home is a key component for many seeking to live the Nomad Capitalist life.
Keep Out of the Nomad Tax Trap
The world is changing. The idea of just dragging a suitcase around from country to country is going to be harder and harder. What works now is much different than what worked in the 80’s.
That may mean that, once you’ve left your home country and gone through the required process to legally exit the system, the government could still make it difficult for you to prove that you are no longer a tax resident.
Above all, what you don’t want to do is become the person who says “I don’t live anywhere!”
Banks don’t like that.
Governments don’t like that.
And with stepped up enforcement, you don’t want to fall into the trap of believing that all that matters is the number of days you spend in any given country. In 2019 and beyond, that’s just no longer the case. You’re going to need to clearly explain what you’re doing to more people.
Though it is frustrating, it can be done if you have the right plan. There’s no universal strategy because each country and situation is different. The best thing is to get one-on-one help to create a plan based on where you’re from, where you’re living, what you’re doing with your business, where you’re banking, and how much time you want to spend in your home country.
It is worth the time to structure things correctly because you don’t want to get caught up in an audit situation where, five years down the road, you thought you didn’t owe anything but your government comes in and you have to pay thousands in back taxes.
With a holistic, offshore plan for both your personal tax and your business tax, you can make it clear that you are no longer a tax resident of your home country and avoid falling into the nomad tax trap.