Today’s blog post won’t necessarily address a will, trust, or common estate planning question for most of you, but it is still a useful topic. That topic is federal taxes and the potential tax savings from living abroad in a tax haven.
If you do most of your work remotely, and/or you can continue to do so without physical contact with your clients, there is the potential to benefit financially by living in a tax haven. The I.R.S. allows U.S. citizens or resident aliens of the U.S. to exclude $95,100 of their foreign earned income ( for 2012) if they are physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months. The I.R.S. also allows U.S. citizens the $95,100 foreign earned income deduction if that U.S. citizen is a bona fide resident of the foreign country or countries, for an uninterrupted period that includes the entire tax year.
Foreign earned income consists of wages, bonuses, commissions (excluding those made by the U.S. government or U.S. agencies). Foreign earned income does NOT include capital gains, pensions, dividends, alimony, social security or annuities, to name a few. (There are also tax deductions that may be available based on housing expenses in the foreign country).
So here’s where the tax benefit comes in. You could move to a tax haven, such as Monoco or Andorra, which have no income tax. In that situation, you would would pay no tax on that first $95,100. This saves you about 28% on that amount and likely lowers your bracket on the remaining amount. As an example, lets assume you make $130,000. If you satisfy the residency requirements listed above, that means no tax on the first $95,100 and leaves $35,100 that could be taxed by the US government. But you could likely make some housing deductions, and you would end up reporting even less, and that would probably drop you down into the 15% tax bracket — which might work out to somewhere around $5,000 in taxes, depending on the housing deductions. Now compare that to paying 28% (federally) on the $130,000 — or $36,400 in taxes — if you were living in the United States. A few years of that $30,000 savings can really add up to extra retirement wealth.
So if you have a passion for traveling/living abroad, and can make a living working and living in a tax haven, it could save you significant money in the form of taxes on foreign earned income.
Of course in these situations, you still need to file a tax return with the I.R.S., using the foreign earned income form (2555/2555-EZ).
Talk to a tax attorney or accountant for specifics on your situation because your particular situation and the country that you live in can have a significant effect on your taxes — ie. this is not legal advice, nor should it be construed as such.
Nick Wroblewski is a Chicago Estate Planning Attorney. Prior to becoming a lawyer he received a Economics degree from Illinois State University and worked in banking for almost 3 years. He enjoys reading, trading options, and anything economics related.