US citizens and permanent residents are taxed on worldwide income regardless of where they live or work. A US software developer working remotely from Bali, Portugal, or Mexico owes US income tax on every dollar they earn - even if they have not set foot in the US all year. The foreign earned income exclusion (FEIE) under §911 can shelter up to $132,900 of foreign-source earned income in 2026, but it does not eliminate self-employment tax, and most digital nomads are surprised to discover that their home state may still be collecting income tax on their "nomadic" income. Understanding all three layers - federal income tax, federal self-employment tax, and state income tax - is essential before deciding to work abroad.
Federal income tax: All worldwide income is taxable. The FEIE excludes up to $132,900 of foreign-source earned income (2026, indexed). The housing exclusion adds additional relief. Income above the exclusion is taxed at regular rates. Passive income (dividends, interest, capital gains) is NOT excludable under §911 regardless of where earned.
Self-employment tax: FEIE does NOT reduce self-employment tax. A freelancer who excludes $132,900 under §911 still owes 15.3% SE tax on net self-employment income up to the Social Security wage base, then 2.9% above that. IRC §1402(a)(11) specifically provides that the §911 exclusion does not reduce net earnings from self-employment for SE tax purposes.
State income tax: Many states tax residents even after they leave. A California domiciliary who moves abroad without properly establishing a new domicile continues to owe California income tax. Some states - notably California, New York, Virginia, and South Carolina - aggressively pursue former residents who did not clearly sever their state domicile ties.
To claim the FEIE under §911, a taxpayer must have a tax home in a foreign country AND meet either the physical presence test or the bona fide foreign residence test.
Physical presence test: Present in a foreign country or countries for at least 330 full days during any consecutive 12-month period. The 330 days do not need to be in the same calendar year - a taxpayer can use a 12-month period that straddles two tax years. Days in transit through the US are not US days. Days count when the taxpayer is in a foreign country at midnight.
Bona fide foreign residence test: A bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year. "Bona fide" requires establishing a genuine residence - not just being present. The IRS examines: intention to remain, establishment of a home, participation in community activities, and visa status. Most digital nomads who are constantly moving between countries do not establish bona fide foreign residence and must use the physical presence test.
This is the single most misunderstood aspect of FEIE planning. The FEIE can eliminate the income tax on $132,900 of self-employment income. But IRC §1402(a)(11) explicitly states that net earnings from self-employment are computed without regard to the §911 exclusion. A freelancer with $132,900 of net self-employment income who uses the FEIE to pay zero income tax still owes approximately $18,371 in SE tax (15.3% on the first $184,500 of SE income for 2026). There is no exclusion, exemption, or credit that eliminates SE tax for US citizens working abroad in most cases.
The exception: totalization agreements. The US has Social Security totalization agreements with about 30 countries. If the nomad is paying into a foreign social security system under a totalization agreement, they may be exempt from US SE tax on that income. But most popular nomad destinations - Thailand, Bali/Indonesia, Mexico, Portugal for non-NHR residents - either have no totalization agreement with the US or the agreement does not cover self-employed individuals working remotely.
Establishing a foreign domicile does not automatically terminate state income tax obligations. To stop owing a state's income tax, a digital nomad must: (1) establish a new domicile outside the state (either in another US state or abroad), AND (2) meet the state's specific requirements for severance of the old domicile. States with aggressive residency enforcement - California, New York, New Jersey, Virginia, Maryland - audit purported domicile changes. A California resident who moves to Thailand and maintains a California driver's license, California bank accounts, and regular returns to California may be treated as a California resident and owe California income tax at 13.3% on top of everything else.
Instead of the FEIE, nomads working in high-tax countries may benefit from the foreign tax credit under §901. The credit offsets US tax dollar-for-dollar with foreign income taxes paid. A nomad paying 30% income tax in Germany receives a credit against US tax equal to the German tax paid. In high-tax countries, the FTC often eliminates US tax entirely without using the FEIE. The FEIE and FTC cannot both be applied to the same income - the taxpayer must choose. The FTC is generally preferable in high-tax countries; the FEIE is generally preferable in low-tax or zero-tax countries.