Disclaimer: this article is not financial or tax-based advice and should not be taken as such. I’m just sharing with you things I learned while researching taxes and other financial matters.
For most of my life, taxes were a complete mystery. That was fine because I never needed to worry about them. I was either employed by others or made too little on my own, so doing them myself or using a piece of software usually sufficed. Then, as my income rose over time, I simply hired an accountant to solve this problem. In both cases, I was successfully shielded from needing to understand this important part of any business.
Until now. Late last year, I partnered with another entrepreneur on a new business. For this company, we decided to incorporate it not in US—where we’re both from—but in another country, mostly because of better legal protection and lower taxes. This was a wise decision. This decision also prompted me to finally understand taxes on a much higher level.
In the simplest sense, taxes are a way for governments to take a cut of the action. It’s a form of exchange. Governments provide basic services such as police and paved roads so that you can get to work and build businesses and, in exchange, you give them a percentage of your salary or profits.
There are all kinds of different taxes, and to complicate things even further, the specific cut the government will get depends on the entity that’s being taxed.
Individuals are taxed differently from corporations. Different corporate structures are also taxed differently. So, if you’re operating as an individual, you will pay taxes at a particular rate, and if you’re a corporation, you will pay taxes under a different rate.
To complicate things further, each country, state, and other jurisdictions have specific tax rates. In America, individuals are taxed on a sliding rate that varies anywhere from as little as 10% to as high as 39%. The American tax rate for corporations is a fixed 39.1%, making it one of the highest in the world.
Most companies typically don’t pay those rates because as a business you have perks like deductions and credits, which allow you to lower your taxable income by “deducing” things like business expenses and other items, things that aren’t available to individuals or employees.
Taxes get more interesting (and complicated) when you become a global citizen. Usually, moving overseas exempts you from paying taxes in your former country. For example, if you’re a Canadian citizen and move to China, you no longer need to pay Canadian authorities a part of your income, regardless where that income is coming from. (Although depending on your status in China, you may be liable to pay taxes there.)
If a country stops taxing you when you move out, the country implements something called a “residence-based taxation.” Only the residents of the country are taxed. Germany is an example of a country with residence-based taxation. Anyone who’s a resident of Germany—regardless whether they’re a citizen or not—is liable to pay taxes in Germany. This means if you move abroad, you no longer need to pay taxes there.
Many countries around the world are like this. Canadian residents citizens only need to pay taxes if they live in Canada. Danish residents and citizens only need to pay taxes if they live in Denmark. If they move abroad—or remain abroad for the majority of the year (usually more than six months, but depends on the country), they’re essentially exempt from paying taxes in that country while still remaining to be the country’s citizens.
Another type of taxation is called “territorial-based taxation.” In countries that implement this system, you have to pay taxes only on the income that originates from inside the country. So, if you’re living in a country like Georgia (Republic of Georgia, not the US state)—a country with territorial-based taxation—you’ll only have to pay taxes if the source of your income is inside Georgia.
Territorial-based taxation is great because you can leave a country with residence-based taxation that taxes everyone who lives there and move to a country that only taxes local income. It’s specifically advantageous to nomadic entrepreneurs who most of their income from customers in other countries and, thus, don’t need to pay taxes on this income.
Finally, there are also countries that don’t have any income taxes whatsoever like Dubai or Bahamas. It doesn’t matter if you’re a citizen or a resident. It also doesn’t matter whether your income comes from inside the country or outside. No taxes means no taxes.
Unfortunately, the only people that can’t take advantage of the different tax systems abroad are American citizens. America is the only country in the world which taxes its citizens (and permanent residents) on their worldwide income—regardless if they reside in America or somewhere else. Americans must file their taxes every year even if they’ve been living abroad for the last decade (or more). That’s because American tax system is based on something called “citizenship-based taxation.” As long as you’re an American citizen, you must file your taxes yearly.
Fortunately, being nomadic offers many advantages even to American citizens. The first is the double-taxation treaties. American tax authorities (like most other countries) perfectly understand the fact that other countries may tax you because you’re living and work there. Thus, the amount that you pay elsewhere is used to offset your tax obligation in America. For example, if you’re living and working in Denmark (a country with resident-based taxation) and paying taxes there, that money you pay to Denmark’s tax authorities is used to offset the money may need to pay American tax authorities. That makes sense, otherwise, you’d be paying taxes twice on the same income.
For American citizens, the other nice perk of living abroad is that you’re granted with huge exemption that reduces your taxable income. As an American taxpayer, you’re granted an exclusion (the first $100,000+, it’s adjusted yearly for inflation) if you’re not living in America. So, if you’re not present in the US for around eleven months out of the year, you can use this exclusion to reduce your overall tax bill.
While it’s certainly not the same as not needing to pay any taxes when you move out, it greatly reduces your tax bill if you’re traveling around the world and not really living in America. There’s little reason to pay for things like government services when you’re not in the country to take advantage of them. That partly explains why lots of American location-independent nomads limit how much time they spend in America to less than a month per year.
All of these different taxation systems are options that you can leverage once you unchain yourself and embrace the freedom to live and work anywhere in the world. Once you’re not tied to a particular country, you’re free to live in a low tax country or even in a country without any taxes.
The holy grail of legally lowering your taxes is by mixing and matching the right countries and their requirements for becoming a tax resident. Although American citizens must file (and possibly pay) their taxes regardless where in the world they are, living outside the country can significantly reduce your the amount of taxes you’ll need to pay to Uncle Sam.
Things get really interesting when you get into more advanced stuff such as forming a foreign company and becoming an employee of that company. This allows you to do even more interesting tax and legal optimizations.
What was once a boring and mundane topic, taxes and legal planning are gradually becoming an integral part of my overall nomadic strategy as I’m traveling around the world and looking at countries with not only a pleasant quality of living but also ones that aren’t burdened with high taxes and ineffective legal frameworks. After all, taxes are important. And while you don’t need to become a tax attorney, having a basic understanding of different tax systems will help a great deal. Or, as one wise man once eloquently said: “In this world, nothing can be said to be certain, except death and taxes.”