It’s no surprise that remote work is on the rise - and here to stay.
The COVID-19 pandemic catapulted this shift, making remote work more important than ever. Businesses all around the world are adopting remote work as a long-term solution, reimagining the way we work to be more adaptable and resilient.
In fact, an estimated 32.6 million Americans, roughly 22% of the workforce, are expected to be working remotely by 2025, according to Upwork. This projection indicates a steady and ongoing trend toward remote work arrangements.
As this trend gathers pace, understanding the tax landscape for remote workers in the U.S. becomes crucial. This guide clears some of these complexities up by going over everything from the nuances of remote work, state taxes, and what it means to be an American digital nomad.
The Importance of Classification
Properly classifying workers as employees or independent contractors is an important part of remote work and taxes. Employees require income and payroll tax withholding, while independent contractors typically do not.
This involves assessing factors related to control, financial aspects, and the nature of the work relationship. If uncertain, Form SS-8 can be submitted to the IRS for clarification.
Once you've figured out how to classify your workers, it's important to follow through with your tax responsibilities. This means making sure you're withholding the right taxes for your employees.
Misclassification can land you in hot water, but there may be some relief if you have a good reason for the mistake. Remember, getting your worker classification right from the outset is a big deal to steer clear of tax headaches down the road.
Remote Work and State Taxes
With remote work becoming the norm, it's important to take into consideration what state you are taxed in, especially if you work remotely.
Let’s break down the basics of state taxes for those working across state lines!
What State Are You Taxed in If You Work Remotely?
When it comes to remote work, state taxes matter.
Each state in the U.S. has its own tax liabilities and tax laws, adding complexity to the situation. States have different rules for taxing remote work, such as how many days you work there or how much you earn.
Some states might even consider you a resident for tax purposes if you spent a significant amount of time working there remotely. These state-specific rules can be puzzling. You'll typically pay taxes in the state you live in unless it doesn't have local income taxes.
If you work in a different state, you'll generally need to fill out a nonresident tax form for that state. This form details your income and the taxes you paid and earned in the state where you worked.
Double Taxation
Working remotely sometimes means you're earning income in a state different from where your employer is located. This can lead to a situation where you have to follow the tax rules of multiple states when tax season rolls around.
It can be confusing and costly, potentially resulting in double taxation on the same income. To prevent double taxation on the same income, you can apply a tax credit. This allows you to offset the taxes paid in your nonresident state against your home state's tax liability, or vice versa if the nonresident state has higher taxes.
Convenience Rules
Certain states adhere to their own tax rules, such as the Convenience Rule.
The convenience rule is a key reason for double taxation and is followed by five states: Connecticut, Delaware, Nebraska, New York, and Pennsylvania.
This rule means that a state can tax your income if your employer is located there, even if you work from a different state remotely - unless your employer specifically asked you to work elsewhere. This is generally done at the convenience of the employer.
Imagine you worked for a New York company but worked from California last year. Both New York and California might want to tax your income, potentially leading to double taxation.
To avoid double taxation, some states defer to the state enforcing the convenience rule. Others establish agreements to clarify tax obligations for remote workers.
These agreements ensure you only pay taxes to your home state under specific conditions. It's essential to gather information tailored to your situation before filing your taxes.
To summarize, as remote work becomes more prevalent, understanding state and local taxes is crucial. Consulting tax professionals and staying informed about state tax laws can help remote workers comply with tax regulations, reduce tax burdens, and navigate this complex financial landscape effectively.
Digital Nomads
Did you know there are 17.3 million American workers who consider themselves digital nomads? This number has gone up by 2% since 2022 and has seen a huge 131% increase compared to the time before the pandemic, from 2019 to 2022.
It’s clear that the world of digital nomads is appealing, offering the freedom to work while traveling the globe. However, navigating the US’s approach to digital nomad taxes can be complex.
Let’s get into it.
U.S. Tax Obligations
Digital nomads who are U.S. citizens or Green Card holders must file a U.S. Federal Tax Return, regardless of where they live or work. This citizenship-based tax system means you're obligated to file taxes, but whether you owe taxes depends on various factors like your income.
Some digital nomads can rely on foreign tax credits to reduce or eliminate their U.S. tax liability.
State Income Tax Considerations
As a digital nomad, whether you have to file state taxes depends on your last state of residence and when you left. Typically, you file taxes for the portion of the year you lived in or earned income in that state.
But, in some states like California, New Mexico, South Carolina, and Virginia, they might still want you to pay taxes even after you leave. This can be based on things like having a driver's license, being registered to vote, or owning property there.
To avoid this, some digital nomads temporarily establish residency in a different state with less strict tax rules before going abroad.
Self-Employment Income Tax
Digital nomads who are self-employed in the U.S. usually have to pay the self-employment tax, which includes Social Security and Medicare contributions. This tax adds up to 15.3% of their income.
However, in certain countries with Totalization Agreements, you might be exempt from this U.S. tax and instead have to pay the foreign country's Social Security tax.
Taxation in Foreign Countries
Whether you pay taxes in your host country depends on its tax policies. Most countries employ residence-based taxation, taxing all income earned within their borders.
However, some adopt territorial taxation, taxing only income sourced within their territory. Digital nomads should understand the host country's tax rules.
Tax Benefits for Digital Nomads
Several tax benefits can ease the burden for digital nomads:
- Foreign Earned Income Tax Exclusion (FEIE): Allows exclusion of a portion of the foreign-earned income from U.S. taxation, with limits set annually (e.g., $120,000 in 2023).
- Foreign Housing Exclusion: This lets you deduct housing expenses alongside FEIE.
- Foreign Tax Credit: If you pay taxes to your host country, you can offset your U.S. tax liability with a credit.
The Physical Presence Test
To qualify for FEIE and related benefits, digital nomads must meet either the physical presence or bona fide residence test. The physical presence test requires spending more than 330 full days outside the U.S. within 12 months.
The Bona Fide Residence Test
This test demands that you maintain a foreign residence, live there for an entire calendar year, have no plans to return to the U.S. soon, and be a U.S. citizen or resident alien living in a country with a tax treaty.
Filing
Common tax forms for digital nomads include:
- IRS Form 1040: This is your main tax form. It tells the IRS how much you earned and how much tax you owe or are owed as a refund.
- Form 2555 (for FEIE, due with Form 1040): If you work in a foreign country, this form helps you exclude some of that income from U.S. taxation.
- Form 1116 (for Foreign Tax Credit, due with Form 1040): If you pay income tax to another country, this form lets you get a credit on your U.S. taxes to avoid double taxation.
- FinCEN Report 114 (FBAR): Use this form to report your foreign bank or financial accounts if they exceed a certain value. It helps the U.S. track foreign accounts.
- Form 8938 (due with Form 1040): If you have substantial money or assets in foreign accounts, this form ensures you report them to the IRS to prevent tax evasion.
As an American digital nomad, it’s important that you familiarize yourself with each of these forms. This will help you stay on the right side of the law.
Home Office Deduction
Now, let's get into home office deductions and how they impact your employee's taxes based on their employment status:
For Employees (W-2 Workers)
For those who are conventional employees and receive a W-2 form, recent changes in tax regulations have restricted your capacity to assert deductions for home office expenditures.
Generally, if you fall into the category of W-2 employees, you cannot request deductions for home office costs, regardless of the extent of your remote work.
This regulation is expected to persist until at least 2026. To put it plainly, possessing a home office won't directly reduce the taxable portion of your income if you are part of this group.
For Self-Employed and Freelancers (1099 Workers)
Self-employed individuals and freelancers, often identified by the 1099 forms they receive, have more flexibility when it comes to home office deductions. Here are two primary methods to consider:
The Easy Route (Simplified Method)
You have the option to choose a straightforward deduction of $5 for every square foot of your home office, up to a maximum of 300 square feet, which adds up to a total deduction of $1,500.
This method is easy to use and doesn't demand you to keep detailed records.
The Detailed Approach (Regular Method)
If you're willing to put in the effort to keep careful records, the regular method offers the potential for larger deductions.
Here's how it works:
You track all your home office expenses, like a portion of your rent or mortgage, insurance, utilities, maintenance, and even depreciation.
Then, you figure out what percentage of your entire home your office takes up and deduct the same percentage of these eligible costs. For example, if your home office uses up 10% of your home's space, you can deduct 10% of these expenses. But remember, there's a crucial condition: your workspace must be exclusively used for work-related tasks.
In other words, it cannot serve dual purposes, such as personal leisure. The IRS strictly enforces this requirement.
In summary, for remote workers, home office deductions can potentially reduce your tax liability. The simplified method offers a simple $5 per square foot deduction, up to $1,500. The regular method, while requiring more documentation, can result in more substantial savings.
Remember, your home office must be solely dedicated to work to qualify for these deductions. While it's an opportunity to save on taxes, it's essential to understand the rules and maintain accurate records to ensure compliance with tax regulations.
To make the most of these deductions, meticulous record-keeping is essential. This means keeping accurate records of expenses like receipts and invoices to prove these deductions if the tax authorities ever ask.
It's important to note that many people shy away from claiming these legitimate deductions due to the fear of tax audits. While audits can be intimidating, those eligible for these deductions shouldn't let this fear stop them from legally reducing their taxable income.
By doing so, they can keep more of their hard-earned money, which is a smart and responsible way to manage their taxes when working independently.
Consult a Tax Professional
Getting help from a tax professional is a wise decision, especially if your tax situation is tricky due to remote work in different states or countries. Tax rules can be complex, and these experts can guide you, find possible tax benefits, and ensure your tax paperwork is accurate and follows the rules.
Tax professionals know tax laws well, including the specific regulations that apply to remote workers. They understand not just federal but also state and international tax laws, so you won't miss any chances to lower your taxes.
They are skilled at spotting deductions, credits, and benefits that you might not notice on your own. By carefully examining your finances, they can help you use tax-saving opportunities that might save you more money than what you pay for their services.
When it comes to filing taxes, precision and following the rules are crucial. Tax professionals are experts at preparing tax returns with great attention to detail. This reduces the chances of mistakes or missing information that could lead to audits or fines.
For remote workers with complicated tax situations, this means you can be confident that your tax paperwork is accurate and legal.
While hiring a tax professional involves a cost, the potential savings and avoiding tax problems make their expertise a valuable investment. It allows you to focus on your work and life without worrying about taxes, knowing that a skilled expert is taking care of your tax matters.
Connect with Borderless
If you're an employer managing remote workers in the US, an employer of record like Borderless can be a great ally. We make handling taxes and payments for your remote team a breeze.
Here's how we can help:
Tax Compliance Made Easy
Borderless takes the headache out of understanding and following US tax rules for your remote workers. We ensure everything is done correctly and on time, so you don't have to worry about costly tax mistakes.
Swift Payments
Borderless makes sure your remote workers get paid quickly and reliably. This is vital for keeping your team happy and your business running smoothly, especially when you have team members in different places.
No Surprises, No Hidden Fees
Unlike some other services, Borderless won't hit you with unexpected upfront costs. Our transparent pricing lets you expand your remote workforce without financial surprises.
Tailored Benefits
Borderless knows that remote workers have diverse needs, so they offer custom benefits packages that fit each worker's location and situation.
Handy Mobile App
With the Borderless mobile app, your remote workers can easily manage their payments and invoices. It's convenient for them and makes your administrative tasks a breeze.
Go Global
Borderless helps you hire and manage remote teams in over 170 countries. This means you can tap into talent from around the world.
Legal Experts on Your Side
We have a team of legal experts who know the ins and outs of global regulations. They make sure your remote workers stay on the right side of the law.
All-in-One Management
Borderless offers a platform where you can handle everything related to your remote team, from contracts to payments. It's simple and convenient.
In short, Borderless is your partner for simplifying taxes and payments for your remote workers in the US. By trusting us with these tasks, you can focus on your business while ensuring your remote team is paid accurately and follows all tax and legal rules. It's a smart way to boost efficiency and reduce administrative hassles.
Interested in Learning More?
Check out our blog to learn more about the future of work, hiring US talent, managing a remote team, and much more.
Disclaimer: Borderless does not provide legal services or legal advice to anyone. This includes customers, contractors, employees, partners, and the general public. We are not lawyers or paralegals. Please read our full disclaimer here.
