If you have ever read a travel blog or ever googled ‘how to travel for free’ every single site will essentially tell you the same thing: ESL, couchsurf, house sit, WWOOF, save up miles, or some amalgamation of the above. None of those articles tell you anything you couldn’t just figure out on your own. This one will. Ultimately, the two most important questions are how do I fund travel and how do I find the time for it?
The question for me was do I give up a phenomenal job for a chance to roam the world, come back to nothing and start over? Most people don’t take advantage of the flexibility they have because of self-inflicted obligations or the perception of pressure or competition from others. I hope after reading this that you will see that you can have your pie and eat it too. In this context, what I mean is you can work remotely, travel simultaneously, and do it for free.
To understand how it works, whip out your W2, 1099, or other income tax documents and put your thinking caps on – we are going to be talking about taxes1. If you don’t have your tax documents handy, you can follow along with mine. If you don’t know what the heck a W2 is, I encourage you to pause and educate yourself. Taxes are the bane of existence itself, but if you learn a little about them you will respect their power. Doing so will allow you to bend them to your will. Bending them to your will could save you tens of thousands of dollars a year. No, that isn’t a typo. I said tens of thousands of dollars.
My gross income in 2015 after 401k, and other pre-tax deductions was $101,070.62[box 1]. Apply complex tax codes and my federal income tax withholding was a whopping $19,539.95[box 2]. That means 19.33% of my taxable income went to federal income taxes2
If you have your own tax documents, perform these calculations on your own.
Taxes tie into travel via two concepts that will allow me to reduce my percentage of federal tax from 19.33% to 0%. By reducing my federal tax obligations, I will increase my income by $19,539.95 allowing me to travel, buy a boat, or do whatever the hell I want! Now it’s important to note that you technically aren’t ‘travelling for free’ (come on, nothing in this world is free). What you are doing is increasing your income (reducing federal tax obligations) by enough to cover all of your travel expenses.
- The Foreign Earned Income Exclusion (the “FEIE”)
- The Foreign Housing Exclusion or Deduction (the “FHED”)
Foreign Earned Income Exclusion
The FEIE permits qualified taxpayers (I will call them remotes) to exclude income earned in foreign jurisdictions from U.S. tax. Remotes that have a prolonged absence from the United States, who are either U.S. citizens or U.S. resident aliens may be eligible to benefit from the FEIE. There are a number of rules governing the FEIE that we need to understand so you know how to maximize the benefits of the exclusion.
In general, U.S. citizens and U.S. resident aliens are subject to federal income tax on worldwide income. However, the FEIE allows qualified taxpayers to exclude from taxable income up to $100,800 of foreign earnings. Excluding or deducing income means that you lower your taxable gross income. Using my scenario, $101,070.62[box 1] on my W2 would become $270.62
The estimated tax in 2015 on $270.62 is $27.06 (a 99.9% decrease in taxes).
To qualify for the FEIE, a U.S. citizen taxpayer must
- establish a tax home in a foreign country or countries and
- satisfy either the Bona Fide Residence test or the Physical Presence test.
Your tax home is the general area of your main place of business or employment regardless of where you maintain your home. If you do not have a main place of business because of the nature of your work (travel for work for instance), your tax home may be the place where you live. To qualify for the FEIE, you need to ensure your tax home is in a foreign country or countries. You may not
- maintain a “regular or principal” place of employment or business in the United States, nor
- maintain a place of abode in the United States employment in any location.
If you are traveling for an extended period of time, it would be uncommon to maintain a principal place of employment or business in the United States (though founders of startups with fixed offices should pay close attention to these rules). The more difficult issue at hand is the place of abode. An abode is one’s primary place of residence or habitation. But, there is no objective rule to determine whether one’s previous U.S. residence remains a person’s abode while abroad. Instead, the IRS looks at the following facts and circumstances in making a tax home determination:
- Whether the taxpayer incurs duplicate living expenses
- Whether the taxpayer has abandoned the vicinity of his or her historical home
- Whether the taxpayer’s close family members reside at the claimed home
- Whether the taxpayer uses the claimed home frequently for his or her lodging
In addition to these factors, the IRS will generally presume that a trip was indefinite if a taxpayer plans to be abroad (and actually is abroad) for more than a year. If you plan to continue working abroad for beyond one year, then this presumption may be helpful. If you don’t and have doubts about whether you qualify this test (especially those with a connection to a start-up with a fixed office), then you should consult a tax advisor about your individual case before claiming the exclusion.
Bona Fide Residence Test
The Bona Fide Residence test requires a taxpayer to maintain a permanent residence abroad for an entire calendar year (among other things). Because most people are unlikely to satisfy this test, this post will focus on the Physical Presence test.
Physical Presence Test
The Physical Presence test requires a taxpayer to be present in a foreign country for 330 full calendar days within a continuous 12-month period. Days on which a taxpayer arrives in or departs from the United States do not count as days in foreign countries. For remotes who arrived in a foreign country on say on June 1, 2015, the first day of the 330-day count is June 2. It’s important to note this restriction does not apply for 330 consecutive days. For instance, if you are living abroad for a year, you can come back to the U.S. for a two week stint to see family and go back. As long as you can make 330 days out of 365, you can qualify.
As one might expect, there are detailed rules regarding which days qualify when the appropriate 12-month period begins and ends, but Remotes should be able to satisfy the Physical Presence test so long as they refrain from taking extensive trips back to the United States.
The FEIE permits a single (i.e., unmarried) taxpayer to exclude up to $100,800 of foreign earned income in 20153. However, this cap is reduced based on the number of days for which the taxpayer qualified as described above. The calculation for allocating the cap is somewhat complex, but a remote who leaves June 1 and does not return to the United States until May 31, the following year, would be eligible for a maximum exclusion in 2015 of approximately $68,000.
Assuming that a Remote earns the full $68,000 while abroad in 2015, the federal tax benefit of the FEIE would be approximately $10,000 in both this year and 2016.
Follow these Practices to Qualify
To maximize the benefit available under the FEIE, remotes should consider the following practices after consultation with their respective tax advisors:
- Restrict travel to the United States to less than 35 days during the remote
- Compile documentation and evidence that any office or residence in the United States has been abandoned. Examples of such documentation may include the cancellation or assignment of a previous lease agreement; a formal sublease agreement; written documentation (including emails) discussing the relinquishment of office space and the sale of any furnishings; mail-forwarding instructions to the U.S. Postal Service, indicating that mail should be sent care-of a third party; and similar documentation.
- If the establishment of a foreign tax home is in doubt, plan to work abroad for an additional few days, to extend the overall trip beyond a full year.
- Keep a precise log of all international travel. If more than 20 days are spent in or traveling to/from the U.S., take special care to count travel and layover days before booking any additional trips.
In addition, Remotes who are W2 employees should advise their employers to reduce the taxes that are withheld from paychecks. Independent contractors should adjust their estimated payments as appropriate.
FEIE and State Exclusions
In addition to applying the FEIE to federal taxes, most states allow taxpayers to claim the FEIE for state income tax purposes, leading to even greater savings. Notable states that do not permit use of the FEIE are California, Massachusetts, New Jersey, and Virginia. State laws vary in regards to FEIE, so do a quick read to see if you can claim this exclusion in your state.
Sadly, if you look at my W2[box 15] you can see that I call California home. That’s $7,046.15[box 17] I could have saved by living in a ‘less cheap’ state like Illinois.
There is too much diversity in state FEIE tax laws, so I encourage you to look up your state to see if it’s a state exclusion you can take.
Foreign Housing Exclusion or Deduction
If you’ve made it this far in the post then you probably forgot I said there were two concepts I was going to explain. If you make less than the maximum FEIE exclusion, don’t bother continuing unless you enjoy reading about taxes for fun. If you make more, let’s save some more money!
If your tax home is in another country(ies) and satisfy either the Bona Fide Residence test or the Physical Presence test, then you can also claim an exclusion or deduction from your gross income for your housing amount. Whether you claim the exclusion or the deduction depends on the source of your income. You can claim the exclusion if your income is ‘employer-provided’ and you can claim the deduction if your income is ‘self-employed.’
The actual calculation is a function of the maximum FEIE, your total housing expense, and the ‘base housing amount.’ If we use the June 1st – May 31st example above where the maximum FEIE exclusion was $68,000, then the housing deduction is
where x is the housing deduction or exclusion and y is your housing expenses for the year.
Let’s say you and your family spend $2,000 on housing (from June – December) then your deduction is
$3,120 for the 2015 tax year.
Housing expenses include ‘reasonable’ expenses actually paid or incurred for housing in a foreign country for you and your spouse/dependents. Housing does not include lavish or extravagant expenses, the cost of buying property, purchased furniture or accessories, or improvements to increase the property value.
A couple of other things to note:
- Don’t cheat the government. If you are writing off lodging and meals as a moving expense or from your gross income, you can’t exclude it a second time using FEHE.
- Eligible housing expenses must not exceed 30% of the maximum FEIE income ($68,000*.3 = $20,400). 30% may vary depending on the location in which you incur the housing expenses.
- Foreign housing expenses may not exceed your total foreign earned income for the year.
If you plan on taking this exclusion, you will need to work with you tax advisor as to whether you qualify and whether it would be better to write off the expenses as a moving expense or from your gross income (whichever will give you the biggest return).
1 I’m a full-time W2 employer. I don’t receive the 1099 tax form and I currently don’t have real-estate or dividend income so I don’t have any other income forms. If you do, everything I mention will still apply, just note your reported wages (after all deductions).
2 For you tax wizes who want to check my math, I know $19,539.95 isn’t the true amount I owed the IRS, but for simplicity sake, these are the values I will be using. I actually owed about $600 more in taxes because my company didn’t take enough out. Bastards.
3 The maximum exclusion in 2015 is $100,800, but taxpayers who spend only part of a calendar year abroad may exclude only a pro-rated portion of this cap. The maximum exclusion increase each year based on inflation.