Welcome back to ESL Gypsy. This week, we’re covering an issue that most digital nomads don’t even want to think about- taxes. No one wants to pay them, but being in compliance with the law is an important part of what we do as freelance workers. A lot of messages have come in about living in Portugal and the tax benefits that digital nomads can enjoy while living and working here. The visa requirements for relocating to Portugal have been outlined in previous articles, but this week, we’re focusing on the Non-Habitual Residency status that may be available to foreigners who move to Portugal on the D-7/Type 1 visa. Just remember, this post is informational only and should not be considered legal advice. If you are serious about taking advantage of potential tax benefits related to living in Portugal, always consult with a tax attorney or certified accountant.
What is Non-Habitual Residency status?
Non-habitual resident (or NHR) allows expats to have their income exempt from Portuguese income tax or pay a reduced rate of income tax during the first ten years of residency in Portugal. This is especially attractive for retirees who draw a pension or social security income, as this income will be taxed in the United States, and not in Portugal- which has some incredibly high tax rates.
What type of income qualifies?
Unfortunately, not everything. Tax laws are never simple, and the rules surrounding NHR are no exception. In this article we want to focus on the NHR and how it impacts digital nomads- particularly those teaching online. If you are teaching online as a freelancer or independent contractor, which most teachers are, then you may not be totally exempt from Portuguese taxation under the NHR. The income must be foreign sourced. If you are a freelance teacher, then you are subject to Portuguese income tax under the NHR, as the income is considered to have originated in Portugal (regardless of where your clients are). It may still be eligible for preferential tax treatment at a rate of 20%. Let’s look at how to get to 0%…
Avoiding PT Tax on Your Freelance Income (S-Corp)
There is a straightforward solution that should allow your teaching income to qualify as tax exempt under the NHR. This involves creating your own US-based company. This will require segregating your business income from your personal income, such as by having a business bank account and tax ID number. ESL Gypsy has previously run articles on the benefits of running your online teaching business as an S-Corp and some of the steps involved. Many teachers don’t want to be bothered with the hassle, but there are some real benefits where the NHR is concerned. As a one person S-Corp, the money you’re paid becomes your total revenue. From this, you pay yourself a wage. The rest is business income from which you may deduct your expenses. At the end of the year, you issue yourself a Form W-2 (for your employment income) and a Form K-1 (for your business income). Now, your income is foreign sourced. Check out Part II and Part III of the S-Corp articles. If you are not an American, look into the rules in your home country for starting a limited company.
Paying Self-Employment Tax
There’s a wealth of information in the three-part series on starting an S-Corp, including the state fees, as well as state and federal taxes that are due when starting an S-Corp (such as unemployment insurance). Be aware of these obligations, as well as the requirement to pay self-employment tax in the United States. As a one person S-Corp, you will be wearing two hats so to speak- one as an employee and one as a business owner/employer. As an employee, you will be responsible for your share of self-employment tax (7.65%). As an employer, you will be responsible for the other 7.65%. This is the same 15.3% total that you are responsible for as a sole proprietor. Since you are paying yourself a wage that is lower than your total revenue, your self-employment tax obligation should actually be lower than what it would be if you were working as a sole proprietor in America. I’m personally quite happy to make my self-employment tax contributions. It means that I will be entitled to some social security in my old age, as well as Medicare.
Foreign Earned Income Exclusion
The USA allows US citizens living abroad to apply for the Foreign Earned Income Exclusion based on the bona fide residency test (are you a bona fide tax resident of another country) or the physical presence test (have you been outside the country for 330 days). This is not automatic. You must apply to have this income excluded. Like all applications, this may be rejected, exposing your income to US taxation. The wording of the NHR is tricky, so it’s best to speak with a tax professional who has experience in this highly specialized area of taxation. However, be aware of the potential benefit of having your income excluded from all income tax for a period of ten years.
What happens after the ten years are up?
All good things must come to an end. Unfortunately, this is true of NHR. After ten years, you are subject to the same tax laws as a Portuguese person. Remember that after six years in Portugal (five as a temporary resident and one as a permanent resident), you can apply for citizenship. With an EU passport, you can come back as often as you like. As long as you make your tax home somewhere else and spend less than 182 days in Portugal, you may avoid being subject to the high rates of taxation. Check out the recent article on getting your Type 1/D-7 visa. If you are able to achieve FIRE (and draw a very limited income), you may choose to remain in Portugal and pay the tax associated with the limited income you draw in retirement.
What are the normal tax rates in PT?
Very high. Like the US, Portugal has a progressive tax system. Those earning more, pay more. For those with a taxable income up to 7,091€, the tax rate is 14.5%. The highest tax bracket pays income tax at a rate of 48%. Earners enter this tax bracket when their taxable income exceeds 80,641€. For a complete list of tax rates in Portugal, check out Blevins Franks. This website also contains a wealth of info for those from the UK who are curious about NHR.
The NHR offers real tax benefits to those wishing to live and work as digital nomads. Like all good things, it takes a bit of work to get it set up and running properly. If you are interested in living and working abroad and achieving FIRE (financially independent retired early), look into NHR as a tool to help you along the way. The tax savings can represent significant investment to speed up your FIRE journey. Speak to an accountant or tax attorney who specializes in this area of taxation and can guide you as to the benefits and obligations in Portugal and your home country.