Thinking about taxes and tax residency is a crucial part of life for digital nomads and expats which many try their hardest to avoid thinking! Misunderstanding your obligations can lead to financial and legal complications. This guide provides a introduction and brief overview of tax residency and why it’s important to understand the basics.
What Is Tax Residency?
Tax residency determines the country or countries where you are legally required to pay taxes. It is separate from citizenship or physical residence and is often based on factors like time spent in a country, where is income earned, you’re Domicile and or significant personal ties to a particular place.
Why Is Tax Residency Important?
Understanding your tax residency is vital because it dictates where you must report income and potentially pay taxes. Failing to comply can lead to penalties, double taxation, legal trouble and even being stopped at the border. For digital nomads and expats frequently moving between countries, it’s essential to stay informed and know you’re tax obligations or plan around them.
What Is a Domicile and Why Is It Important?
Your domicile is your permanent legal home and may differ from your tax residency. For instance, you might reside temporarily in one country while maintaining your domicile in another. Domicile often determines inheritance taxes and other long-term financial obligations, making it an important factor in tax planning.
Quite often Digital Nomads just starting off will leave their ‘Domicile’ and tax residency as their home country. In the case of Australia this may allow them to retain their tax free threshold and other benefits.
You may not need to live their, like the place or even work in the country, but everyone needs somewhere to call home to appease the bureaucratic powers that be.
One very important consideration is that if you officially change your ‘Domicile’ and address, many financial institutions such as banks have started closing accounts for anyone not in the country!
Common Tax Residency Tests
Countries use various criteria to establish tax residency. The most common metrics include:
- 183-Day Rule: Many countries consider you a tax resident if you spend 183 days or more within their borders in a tax year. This is one of the motivations of a digital nomad to stay below this threshold
- Resides Test: Looks at where you maintain significant personal, financial, or employment ties, even if you spend less than 183 days in the country.
It’s essential to familiarise yourself with the specific residency tests in the countries you frequent as it does change country to country.
Notifying Authorities
To maintain compliance, it’s crucial to inform tax authorities and financial institutions of your current situation if you are no longer a tax resident or becoming a tax resident of a new country.
Under the Common Reporting Standard (CRS), financial institutions in over 100 countries exchange information about account holders to prevent tax evasion. This means your local tax department probably has a good idea of every bank account you have, the balances of each and a fair idea of your earnings. Staying transparent ensures you’re not flagged for non-compliance.
There is no hiding from the IRS or Tax office in the 21st century!
Tax Filing Obligations and Consequences
Filing taxes correctly is non-negotiable and something you just need to do. Tax evasion, even unintentionally, can result in severe fines, audits, or legal actions with enforcement actions that can cross borders. Depending on your circumstances, you may need to declare and file tax returns in multiple countries.
For example, U.S. citizens must file a tax return with the IRS annually, regardless of where they live or earn income. Other countries may also require you to file taxes on foreign income if you remain a resident under their laws.
If you are unable to lodge a tax return before the due date, it is highly advisable to request an extension or deferral.
Hire a Professional
Tax and especially international tax law is a very complex subject that requires a great deal of expertise to do correctly. It is strongly recommended you consult with a tax agent to discuss your situation and have a plan to ensure tax obligations are being met.
A good accountant can be expensive. A bad one or ignoring the topic can be several times more expensive!
Tax can be a headache, but knowing your obligations and having a proactive plan in place can prevent unnecessary stress and complications down the track