How Some Expats Pay Zero Income Tax

Why you need to familiarise yourself with global taxes regulations

Imagine a common scenario. You’re a US taxpayer, a freelancer living full-time in a country that doesn’t tax foreign-source income, like Panama.

You qualify for the Foreign Earned Income Exclusion (FEIE), which means you don’t pay US income tax on a certain amount of income. In addition to being a bona fide resident of Panama, you qualify because you do the actual work that earns the income from your home abroad.

But what about Panama? How do they treat your income for tax purposes?

The US and Panama—like other countries with territorial tax systems—use different “sourcing” ideas, and they don’t line up neatly. The critical question: is your freelance income “Panama-source” or “foreign-source” under Panama’s rules? If it’s Panama-source, you pay their income tax; if it’s foreign source, you don’t.

At first blush, you would appear to be liable for Panamanian taxes. Panama doesn’t characterize income as foreign source just because the client is overseas and pays you from abroad.  On paper at least, Panama approaches the matter just like the US: services performed within Panama create Panamanian-source income, which is subject to Panamanian tax.

But there’s an important nuance: Panama’s rules allow you to declare your income as foreign source even if you did the work in that country.

Panama defines taxable Panama-source income as the result of “operations that take place in Panama OR have effects in Panama.” Conversely, work that “has its effects abroad” can be treated as not Panama-source. If you’re in Panama but your clients are abroad and the services are “used” abroad, the income is usually treated as foreign source. In that case, you would be free of US income tax and Panamanian income tax. Break out the bubbly!

This can be tricky, however. If you’re a US freelancer sitting in Panama doing remote work for US clients, there are two defensible ways to characterize your tax situation:

1. Literal approach: Your income is taxable in Panama because the services are performed in Panama.
2. “Use/effects abroad” approach: Your income is foreign-source and not taxed in Panama if the benefit/use of your work is clearly outside Panama.

I’ll use myself as an example. I am a consulting analyst and writer for International Living, as well as several other publishers. I also have clients on my own account. If I were to move to Panama, and I:

• Write in Panama,
• Deliver content to foreign publishers,
• Have readers are outside Panama,
• Have no Panamanian audience,
• Have no Panamanian clients, and
• Engage in no Panama business operations beyond me sitting there typing,

then my income would be considered foreign source by the Panamanian tax authorities. The client is foreign. The market is foreign. The economic exploitation of the work happens abroad.

In a case like this, Panama would treat my work as “exported services.” Like many other countries, Panama deliberately encourages people to relocate there and export services to benefit from that income you spend within the country.

But there’s an important caveat. If you create a Panamanian company, which is very common, and you bill through it, or if you hired Panamanian staff, the tax authorities could treat it as Panamanian-source income, and therefore taxable.

The takeaway here is not to assume that everything is straightforward when it comes to managing your global tax affairs. Even if you think you’re right on top of the situation, you can miss important nuances that could cost you. That’s why I created my How to Pay Zero Tax Seminar to help you figure out how to get the best possible tax outcome!