Why do people pay so much tax in the US? How do citizens and businesses stay in the game in the face of the government taking such a hefty slice of the pie?
The answer is that they look for legal ways to reduce their tax burden.
Yet, US citizens still have to run around in circles to catch a tax breaks. These include all sorts of tax credits, from the child tax credit to the earned income tax credit, all to lower their federal income tax and to get breaks on capital gains tax, amongst others.
People contribute to a health savings account, stash money away in retirement accounts to grow tax-free and hope they’re offered flexible spending accounts by their employers.
This might or might not even apply to your adjusted gross income and you can’t necessarily deduct all your contributions from your federal income taxes. However, you can completely avoid paying not just your federal taxes but all sorts of taxes in this tax system and you can do so legally.
If you’re interested in finding out how to win more freedom and mitigate, if not completely eliminate, your tax burden, then read on because you’re in the right place. Nomad Capitalist has a team of global experts located all over the globe who specialise in assisting individuals just like you. Check out our services page to see how we can help you achieve your goals.
So, here are the four ways you can legally avoid paying taxes on US income:
1. Live Outside the United States
One of the fastest and easiest ways to reduce your taxes is to live outside the United States for the vast majority of your time. This strategy falls under the Physical Presence Test for Foreign Earned Income Exclusion (FEIE). This test has been well covered and it’s a very common tax strategy for most expats.
According to the Internal Revenue Service (IRS), if you reside outside of the United States at least 330 days out of 365, you can exempt US$126,500 of taxable income from your annual taxes. The beauty of this strategy is that you can leave the US any time you want. Plus, even if you never live there again, you theoretically get to visit the US for one month.
One thing to be aware of is that the exemption specifically refers to time spent in a foreign country or countries. It’s not just about being out of the United States for 330 days; it’s about being in a foreign country or countries. What difference does that make? It comes down to the fact that international waters and air spaces do not count.
For example, if you work on a yacht, this time outside the US may not qualify for the FEIE. International waters do not count, so once you pass 35 days in international waters, you lose the exemption – even if you never go to the US.
In general, however, it’s easy to qualify for the Physical Presence Test. The only other thing to be aware of is if you’ve spent four weeks in the US and then had several long overseas flights. If the authorities ever looked at your time in international air space, they may conclude you spent eight or nine days flying over oceans or that you were on a cruise for 12 days on the ocean and have disqualified yourself without knowing.
So, while the Physical Presence Test is a simple and effective strategy for reducing your taxes, some planning is needed to ensure it works.
2. Live Nomadically to Benefit from Offshore Tax Incentives
Obtaining a second residency makes sense on so many levels and for so many purposes and reducing your US income tax is one such purpose.
This option to lower your taxes as a US citizen also involves leaving the US and living offshore. You can retain your US citizenship and choose to live in any combination of places, provided you do not trigger tax residence in more than one country.
As long as you spend 330 days a year outside the US, you can live in one place and be a tax resident of another. This allows you to leave the US and live in other countries to benefit from offshore tax incentives.
As long as you meet the US’ bona fide residence test to prove you have truly set up residence overseas, you can qualify for certain tax deductions. This allows you to benefit from location flexibility, low taxes and an easy return to the United States.
You must show the Internal Revenue Service (IRS) that you have been a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year.
3. Move to One of the US Territories
Another strategy to legally reduce your taxes is moving to a US territory like Puerto Rico. There are two different ways you can save on US income taxes by moving your life and business to Puerto Rico.
The first tax incentive is Act 20, also known as the Export Service Act. The act targets certain service businesses by offering incentives such as a low 4% export income tax and 0% tax on earnings and profits to those who choose to relocate and export their services from the island. You can see the full list of qualifying service businesses here.
Act 22, or the Individual Investors Act, on the other hand, specifically targets high-net-worth investors. The draw is zero per cent tax on interest, dividends and capital gains. The only catch is that you have to spend at least half the year (183 days) in Puerto Rico.
A lesser-known act is the International Financial Center Regulatory Act, or Act 273. Under this act, tax exemptions are made to businesses set up and engaged in eligible activities in Puerto Rico. To qualify, an international financial entity (IFE) must have an authorised capital stock of no less than US$5 million.
The entity must also employ at least four individuals and be careful here. Many people think they can qualify under Act 273 by hiring chefs, maids and chauffeurs and be fine. However, you should hire real employees who are engaged in a real business.
Puerto Rico isn’t the only US territory to offer tax incentives to businesses and investors that allow you to dramatically cut your taxes. The US Virgin Islands (USVI) also has a program but again there’s a physical presence requirement and you must demonstrate a closer connection to the USVI than to the United States. That invariably means actually moving there, lock, stock and barrel. You can’t try to maintain your life in the US and must show evidence you have assimilated into your new country, albeit a US territory.
Puerto Rico and the US Virgin Islands are attractive programs if you’re willing to actually live there.
The potential benefits of these programs are best suited to those who don’t simply want to settle for the FEIE. The FEIE only allows you to exempt up to US$126,500 in 2024 and taxes everything else you make, so the opportunity of 0-4% tax rates is attractive if your earnings justify it.
4. Renounce Your Citizenship
As a US citizen, you are deemed to be a tax resident of the US wherever you live around the world which means you have to report and pay your taxes to the IRS. However, renouncing your US citizenship eliminates all US taxes and IRS reporting obligations, leaving you free to explore the available low- and no-tax living options.
If you renounce, you don’t have to pay taxes or report on any of your overseas activities. Some people are required to pay an exit tax on all unrealised capital gains, like those from a business (which can be hard to value) to real estate, investments and other assets.
The exit tax is a hypothetical sale of your assets on the day before your renunciation of US citizenship. It applies to individuals with a net worth exceeding US$2 million, those who are not tax-compliant, and those who have exceeded the set income threshold for the past five years (US$201,000 for 2024).
The exit tax rate can be as high as 23.8%, but you will not be taxed again on any income or gains that have already been subject to US tax. For property, it’s deemed to be sold at its fair market value. However, the value of this deemed sale is reduced by an exclusion amount of US$866,000 in 2024.
Many people will not pay an exit tax and the good news is that you can still receive your government benefits and, in some cases, continue using US banks after renouncing.
The best news of all, however, is that if you renounce your citizenship, you’re done with US taxes forever. That means no more jumping through flaming IRS hoops or handing over half your income to the government each year.
Should You Keep Your US Citizenship?
So, with all that in mind, should you hold onto your US citizenship or renounce it? It really depends on your situation, but most of our clients at Nomad Capitalist benefit from expanding into the global market and cutting their taxes overseas.
It’s a big move and it’s not for everyone. But there are definitely certain cases where it makes sense for an individual to renounce their citizenship to get out from under the crushing burden of the US income tax.
There’s a lot to think about, and mistakes can be costly. If you’re planning on renouncing, you need a plan for what happens with your business, your banking, your investments and your taxes when you decide to leave.
That’s where Nomad Capitalist comes in. We help seven- and eight-figure entrepreneurs and investors create a bespoke strategy using our uniquely successful methods. We’ll help you to keep more of your own money, create new wealth faster and be protected from whatever happens in just three steps.
At Nomad Capitalist, we have a network of lawyers, estate agents, accountants and tax and company formation specialists based around the world. All that expertise and real-world experience come together when we create your holistic, bespoke action plan. Discover how we do things here.
