How to save thousands in Taxes using Geo-arbitrage | Ep 217

Download your Geo-Arbitrage Tax Guide here

David Mckeegan

What You'll Get Out Of Today's Show

  • The difference between foreign earned income exclusion and foreign tax credit and how to qualify for each, and how US citizens and tax residents can use them to save thousands of dollars every year.
  • How the foreign earned income exclusion can be used to step up the cost basis for long term investments through capital gains harvesting.
  • Reporting requirements for expats banking overseas and best practices to avoid many of the issues and make life easier.
  • Why expats should consider establishing residency in a zero-tax state before moving overseas and which state is the easiest to establish residency in.

Resources Mentioned In Today's Conversation

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Transcript Here


Speaker 1: You're listening to ChooseFI Radio. Your blueprint for financial independence lives here. If you're looking to unlock the secrets to financial independence and early retirement, you're in the right place. Stay tuned and join a community of like minded people who are getting all things and taking control of their lives in the pursuit of financial independence. ChooseFI, your home for financial independence online.

Jonathan: Hi everyone, we have a fun and informative episode for you today and I guess I should point out when Brad and I try to put together these episodes, we think about who is this serving and we recognize with any episode that it's not going to serve 100% of our audience, but I can prove out that there is a huge subsection of our audience that needs the information we're going to cover today. We're going to be talking about this Expat path to FI. We're going to really look at the advantages, the disadvantages, the tools, the tactics, the tax strategies that are available to you and to prove out how many people are pursuing this or looking into this currently. One of our largest cohort groups and the ChooseFI community from almost day one has been our expert group.

Jonathan: With nearly 5,000 members in it currently it's one of our most active groups and I think that part of it is that a lot of people either are currently in this Expat situation or anticipate at some point in the future looking at it as a viable option and parallel to that there are a ton of questions and it's hard to find good information. We held off on doing this episode for awhile until we found the right person to really help us address some of these questions and I'm very excited today to be able to go through this with you with David Mckeegan. He has a company that offers account services to Expats called and he's very active in our ChooseFI Expat group.

Jonathan: Based on conversations that we had with them offline, we knew this is information that is needed as a resource, as a perpetual resource for individuals that are just trying to figure out how do I start asking better questions? What are the questions I need to be considering and how do I implement this into my future plans? So to help me with this, I have my co-host Brad here with me today. How are you doing buddy?

Brad: Hey Jonathan, I'm doing quite well and yeah, this should be a fascinating episode. I think to your point, not only are there a significant number of people in our ChooseFI Expat group, but there are a lot of people thinking about Geoarbitrage as part of their fight journey. I think selfishly for me, this is something we may consider 10 years down the road. Knowing this information ahead of time might help inform us where we're going to move. It will be really interesting to hear David's story, how being an Expat has helped his path to FI and also to hear him talk more generally about the advantages, the disadvantages, the stumbling blocks, things we need to look out for. So this should be fascinating. And with that, David, welcome to ChooseFI.

David Mckeegan: Hey, thank you very much. Super excited to be here.

Jonathan: So let's take a look at your story. At what point did you start pursuing this Expat path to FI?

David Mckeegan: We became Expats before we started our path to FI. So in 2002, my wife and I were living in New York and we decided to pursue our MBAs and we moved over to Barcelona, Spain to do that. After our MBA program completed, we moved to London because that was where we could get jobs in finance and things like that at that point in time and we worked in London for about six years. Towards the end of that time we started thinking about starting our own business and we read The 4-Hour Workweek and some of these different stories that people have talked about. And for us what we wanted was to become location independent. So at the time nobody was really talking about becoming financial independent, but a lot of people were talking about using the internet and starting your own business as a way of becoming location independent.

David Mckeegan: We thought, "Hey, this sounds wonderful. We want to start a family. We want to be able to spend time with our kids, so to do that, we want to become location independent and that'll give us the flexibility to be wherever we are." That was our initial goal. Then through running our own business, and I've always been very interested in personal finance. We thought, "Hey, we need to make this sustainable. We need to make this something we can do forever." That's when we started thinking about how we could build up our assets, build up our income so that even with or without the business, we'd be financially independent.

Brad: So David, talk me through your employment journey here. You said you lived in London and you had finance jobs, but then you talked about running your own business. Now I know that today you have Greenback Expat Tax Services. Was that this first business, was that the business that helped launch you on ultimately this location independent dream or was there something else before that?

David Mckeegan: No, that was the business that we started about 10 years ago now and that's been our main business ever since. Just bit about our employment background. I worked for a bank right out of college. I was a history major, philosophy minor and wound up getting a bank job on a sales capacity. Part of my training at the bank, I went through the foundations and financial planning program which is like the CFP mini version. So I learned a bit there about personal finance and things like that that I'd never been exposed to before. Then after our MBAs, my wife was working for American Express and then Barclaycard in London and I was working on a leverage loan syndication debt for Bank of Scotland. And how did we come up with the idea to start the tax business?

David Mckeegan: Our accountant, who was based in New York when we were in London, really messed up our taxes one year to the point that we're getting $20,000 invoices from the IRS and we're like, "What do we do here? How do we manage this?" It took about eight months for us to sit down and work through all this stuff, understand all the rules and then contact the IRS and get it all straightened out.

Jonathan: So it turned out you did not owe $20,000 in taxes?

David Mckeegan: No we owed nothing.

Brad: Oh wow. Was it just reported incorrectly? Is that what ultimately happened? And do you remember what it was that your accountant screwed up so badly?

David Mckeegan: It was a combination of the foreign tax credit and the foreign earned income exclusion. So we should have been using the foreign tax credit. He tried to use the foreign earned income exclusion, but we didn't qualify for it that year because we were in the States too much at that point.

Jonathan: Okay. So this actually is the crux of the entire episode and it's a great transition as we talk about that. So I know as part of your story you said that you had managed to actually hit and achieve a 50% savings rate while living and working in London, which is objectively a very expensive city in which to live. You're not going to hit a 50% savings rate if you owe $20,000 to the IRS. Right? So I think that sets us up. Can we talk about both of those, the tax credit that you mentioned versus the foreign earned income exclusion and walk our audience through, what's the intent behind these? Because I guess the country that you live in currently is probably taxing you on your income, or at least they might, but also you have back home in theory, they're also taxing you as well.

David Mckeegan: Correct. So there's only three countries in the world that tax their citizens when they're outside of the country. The first one is the United States, the second one is Eritrea, and the third one is North Korea. Those are the only three countries that tax their citizens when they're out.

Jonathan: Oh, it's something we have in common with North Korea. Wow.

David Mckeegan: So in order to help protect people from double taxation, there's two main rules in Publication 54 and the first one is called the foreign tax credit. This one basically says that you get a tax credit dollar for dollar tax credit for any tax that you pay to a foreign government that's a legal tax. So if you're making unofficial payments to the police in a foreign country or something like that, that doesn't qualify as a tax. If you're paying into her Majesty's revenue and customs in the UK as part of your salary, that does count as a legal tax and you get a tax credit to offset your US taxes there. Now the foreign earned income exclusion is a little bit different. So this one you have to meet one of two tests. You have to be a bonafide resident of a foreign country and there's a number of different ways you prove that you're a bonafide resident.

David Mckeegan: It could be that you've been living there for over 12 months or over a calendar year. You've got bank accounts or own a house there, your family is set up there, things like that. Those all go towards proving you're a bonafide resident. The other way is called the physical presence test. Now the physical presence test says that you are physically present in a foreign country for 330 days in a 365 day period. So 24 hours inside a foreign country counts as one day travel time, time spent on offshore oil rigs or boats or things like that does not count as time spent inside a foreign country. If you meet that 330 day hurdle, then you can use the foreign earned income exclusion to exclude your earned income from US taxes. And for 2019, the amount that you can exclude is $105,900. That number is indexed to inflation. So it goes up by a little over a thousand dollars every year.

Brad: 105,900 is that for married filing joint? Is that single? How does that work?

David Mckeegan: That's for one individual. So if you're married filing jointly, it's doubled. It's almost 212,000 that you guys can earn as a couple. And that's before you take into account things like the standard deduction and other things you can do.

Brad: David, what's the interplay between the foreign tax credit and the foreign earned income exclusion? Is it, what's more advantageous for you? Are you looking at both? Talk me through how someone would approach that mentally.

David Mckeegan: You can use either, you can use both if your income's high enough. You can't use them on the same income. So if you only make $100,000 not that that's only, but if you make $100,000, you can use the foreign earned income exclusion to exclude the whole thing. If you live in a country that has a higher tax rate than the United States, let's say you live in Western Europe, you might be better off taking the foreign tax credit because if you're paying 40% to the UK government and let's say, then you're going to build up tax credits that you can use in the future to offset things like if you're paying into a foreign pension or something like that, you can use the foreign tax credit that you build up and you can save those credits for 10 years to offset any tax you'd have on your pension in the future.

Brad: All right, David, let's really talk through the example of you and your wife living in London. As part of living and working there, did you pay taxes to the UK government as if you were a resident? Did you file tax returns? Was everything normal as if you were a UK resident?

David Mckeegan: Yes, so we were on what in UK is called the pays you earn system, which basically means that the banks that we worked for took the tax out of our salaries, gave us the net amount and paid our tax for us.

Brad: Okay, gotcha. This is really detailed and precise info, so I just want to set up crazy...

Jonathan: I love it that my co-host is an accountant. This is great.

David Mckeegan: I can see the numbers raining down.

Brad: Yeah, this foreign tax credit thing, this really interests me especially when you said that there is a potential carry forward. Okay, I'm going to set up a hypothetical based on just back of the envelope numbers. I'm making up these tax rates, everyone, so please bear with me here. Let's just say hypothetically you guys earn $200,000 and for some reason the UK tax rate was a flat 40%. You would have paid $80,000 in taxes to the UK government. Again, in this hypothetical example, these are not real numbers. Those were actual taxes you paid to the UK and then when it came time to file your US tax return, you would report your income, but because in this hypothetical we're using the foreign tax credit, you would list that you paid $80,000 in foreign tax. Am I on track so far?

David Mckeegan: Yep. Exactly.

Brad: Okay. But what would also happen concurrently is you would calculate your US tax without that foreign tax credit, right? So you would actually put in all your income, pretend as if you were living in the US, you would come down to your actual tax liability for federal tax purposes and we're going to assume in this hypothetical that it is less than that 40% flat. Let's just say you came up with a number that you owed $30,000 in US tax. Because you paid that $80,000, you would list that as the foreign tax paid that would then wipe out your $30,000 US liability and the difference that 50,000 would actually be a carry forward in foreign tax credits for future years. And you said up to 10 years, is that pretty much spot on?

David Mckeegan: Yup. That's exactly how it works.

Brad: Awesome. Okay. That makes sense to me conceptually on how that foreign tax credit work. Jonathan, are you on board?

Jonathan: That was amazing. Those middle gymnastics? I'm blown away. You legitimately did not have notes to pull that off. So more power to you.

Brad: All right, so let's get into the foreign earned income exclusion. This is what I've heard of it. Now let's assume you're paying no foreign tax, right? So you have no foreign tax credit. Now can you talk the audience through how this would work on your US tax return? Because again, in this hypothetical and I know we'll talk through if there are countries where you're paying no foreign tax to them, but how would this work? So you have no foreign tax credits, so you're not looking at that scenario. So it's just, "Okay, I've got to file my US tax return. I made again this $200,000." What would that look like on the US tax return?

David Mckeegan: Why don't we look at two different scenarios? So the first one, we'll say somebody moves over to the Middle East as an oil contractor. And the reason I choose the middle East is because a lot of those countries don't have any income tax. So the person going over doesn't have to pay income tax to the country that they're going to be living in. If they earn call it $150,000, they're not paying any vocal tax on that money. Now you look at the US side, if they meet the physical presence test, if they're inside, that's the key point you have to remember. It's not 330 days outside the United States. It's 330 days inside a foreign country.

Jonathan: Well, can I specify, when you say a foreign country, is that the foreign country that you're filing these taxes and or rather not paying these taxes? Or is it any foreign country that's not the US?

Brad: Right. Cumulatively I guess that the question.

David Mckeegan: It's any foreign country that's not the US. So if you go and you get yourself a 12 month year rail pass, you can just ride the train around Europe for 12 months and it doesn't matter which country you're in as long as you're inside a foreign country.

Jonathan: Gotcha. Okay, thank you.

David Mckeegan: So we've got our guys living in the middle East. He's making 150K. He can exclude $105,900 of that right off the top using the foreign earned income exclusion. So know now his 150 is, let's call it 44 just for ease of math. If he's married filing jointly, then he can take another 24 is the standard deduction. And now his taxable income drops down to about $20,000. So he's earning 150 but his taxable income drops down to about $20,000.

Jonathan: Yeah that's huge. That is amazing.

Brad: So David has $20,000 of taxable income, but probably most of that will be in the 10% bracket. So we're looking at probably $2,000 in US federal tax on $150,000 of gross income in this scenario.

David Mckeegan: Well, it actually picks up in the tax bracket that you would have been in had you not used the exclusion.

Brad: Oh, that is interesting.

Jonathan: But just to be clear, that's a nuance that would not be the way you would expect to hear on any of the tax treatments that we get here in the States. That's interesting.

Brad: Oh, that's super interesting. All right, so you said you had two examples. That was the first one, let's hear the second.

David Mckeegan: Now let's take somebody who's self-employed. Let's say that the business is making $300,000 a year in profits that the owners can take a salary. In this case, let's say that it's a married couple. They're living in a country that doesn't charge them any income tax on their earnings. So if they weren't Americans, they could make this whole $300,000 completely tax free. But since they're us people, they have to file a tax return. If they themselves right, let's say they employ both spouses in the business, so all of a sudden they get to foreign earned income exclusions. So they can exclude just under $212,000 in income.

David Mckeegan: They can take $24,000 as their personal exemption. And if they set up a 401K for their business, let's say their business is established in the United States, they can set up a 401K and they can each foot $19,000 into their 401K. Let's say their company gives a 6% match, so they're each getting about a $12,000 company match. Now all of a sudden you're up to about $286,000 that is pretty much all tax free. The only thing you're going to have to pay is the social security tax, the self employment tax, which is 15.3%. So your effective tax rate becomes just over 11% and half of that's going to be paid by your business. So you're making almost $300,000 paying $32,000 in self employment tax between the individual and the company.

Jonathan: Well that's just awesome. Is there a list of these countries that don't tax. I mean I'm sure there is a list. Do you have a list of the countries you could provide for us that we can include in the show notes that have these favorable tax treatments for this type of strategy?

David Mckeegan: I don't actually have a list. I don't know if we've been asked for a list before.

Jonathan: How is that possible that no one has asked for a list?

David Mckeegan: I can tell you that Costa Rica, where I'm calling you from is one of those countries. So Costa Rica does not tax you on income that you earn outside of Costa Rica.

Jonathan: Wow. Okay. So to talk about your path to financial independence to tie what we know about how tax laws work and how if you have your own company and you and your spouse and married filing joint and you take advantage of the tax advantage treatments, you can see how you and your spouse have been able to supercharge your path to financial independence by knowing the rules as opposed to the beginning of your journey where you are just paying an extra 20K that was just owed by a basis of the fact that the accountant that you're working with simply didn't.

David Mckeegan: Exactly. And that's the thing that anybody living overseas really needs to pay attention to. It's the details in the tax rule that are going to make the difference in how much you're going to be charged in tax or not be charged in tax come the end of the year.

Jonathan: So what's cool about these types of strategies is you get through the 101 which is already cool and complex, but then when you get to the 201, because you're inside the financial independence community and because you've been looking at all the angles from all the different countries, you've had clients in all these different countries and you've seen all the different variations and you're intimately familiar with the tools that the Financial independence community is talking about. I know that you took this to the 201 and 301 level. Let's go ahead and talk about some other tactics that you can use when you start combining this foreign earned income exclusion along with capital gains and Roth conversions and all that stuff.

David Mckeegan: Sure. You mentioned the capital gains. The FI community is the only group I've ever heard use the term capital gain harvesting as opposed to capital loss harvesting. And it's a really interesting concept if you can get yourself into the zero capital gains basket. Now, one interesting thing that Expats can do is they can use their foreign earned income exclusion to exclude their salary and then they can use their standard deduction to harvest capital gains on their investment portfolio. So the way that would work is, let's say you have somebody making $75,000 a year who's living overseas.

David Mckeegan: The foreign earned income exclusion is $105,900. So that wipes out the tax on their entire $75,000 worth of income. They still have their standard deduction, which for an individual is $12,200 or for married filing jointly is twice that 24,400. So they can harvest all of their capital gains or a big chunk of their capital gains in the given year, increase the basis, and then have that increased basis going forward to avoid paying tax on capital gains on that money in the future.

Brad: David, I want to slow down and talk about this. We very recently did a case study looking at capital gains not really including the context of the foreign earned income exclusion. And so, what we basically were talking about is when you take a look at, for this case maybe you have a couple that's married filing joint. So they have up to $80,000 IN capital gains exclusion basically where you pay a 0% tax on capital gains up to that amount. And then when you stack that with the standard deduction, which I believe in the year 2020 is $24,800, that basically gives you wiggle room of up to, right around $105,000.

Brad: And if in doing so, you're blending your income and your capital gains, your effective tax on that would be 0% at the federal level. So it's clearly very powerful when you understand the rules here. But you're introducing a new tool to the toolbox with this foreign earned income exclusion. Can you clarify for our audience what's the interplay and how does that change the dynamic over the tools that somebody working here inside the States would have access to?

David Mckeegan: So you've got the $80,000 zero capital gains rate, and that's what most people are using to do their capital gains harvesting. What the Expat can do instead is use their standard deduction. So they can have a salary, like let's say it's married filing jointly. Both spouses earn $100,000, they can earn $200,000 a year, which would put them in the top capital gains rate zone, but they're going to exclude their income using the foreign earned income exclusion and then they're going to use their standard deduction to offset the tax on the capital gains harvesting.

Brad: So David, let's use a practical example here. What would this look like if you had a married couple, each of them working, making a six figure salary. So between the two of them, $200,000, how would this actually map out?

David Mckeegan: Sure. So let's say the couple, they each own $100,000 and they can each use the foreign earned income exclusion to pay zero tax to the US on that $200,000 worth of income. Now let's assume that they have a $200,000 portfolio that return 10%. So if they're doing capital gains harvesting, if they sell that entire portfolio, they're going to have a $20,000 worth of gain that normally you would have to pay some tax on. What this couple can do however is use their standard deduction to offset all of the tax that they would have to pay on that portfolio. So that's how they're doing the capital gains harvesting. They're selling the shares, they're not going to pay any tax because they're using their standard deduction to eliminate that tax. They buy that portfolio back and now they have a higher basis in their portfolio without having had to pay any tax at all.

Jonathan: Yeah. So let me interject here and lay man this thing, right? Because capital gains harvesting is something that breaks some people's minds, but it doesn't have to. First of all, you can relisten to the tax brackets that were just laid out. But at its most simple level, when we talk about the miracle of compounding interest, we're basically saying that when you're trying to save a million dollars to reach financial independence, $2 million to reach financial independence, you probably aren't going to get there just by putting in $1 at a time, $2 at a time. And rather we're hoping that you invest this money in common sense investing strategies and it grows at some rate over time. And we usually throw around 8% to do these calculations. But that means at some point your money is doing all the work for you working 24/7.

Jonathan: Now, if your money has doubled or tripled over a period of 20 or 30 or 40 years and your contributions are only 300,000 or 400,000 but that now has turned into a million or 1.2 or 2 million or whatever that difference is considered capital appreciation. It would be taxed as capital gains and you would then fall into whatever the capital appreciation, the capital gains, whatever those tax brackets are. The cool thing is that the way our tax system is set up is very favorable to individuals that have lower income. And so while your W-2 income may have been taxed at these marginal tax brackets, maybe 10%, 12%, 22%, 24%, 32%, 35%, 37%, you could be a millionaire, multimillionaire and depending on what your actual income was that year would actually determine this bracket that you find yourself and it could be as low as zero depending if you can get yourself inside these thresholds.

Jonathan: And certainly with the way that you're mentioning this foreign earned income exclusion, you could be at a 0% tax rate. So that means that your money could have appreciated hundreds of thousands of dollars and you're saying, "Hey, government tax me please. It's fine." And they're saying, "Okay, we will. Fine, we will, but your actual tax rate is zero." So you actually get to realize this money at a 0% tax rate and that my friends is what we call winning and it's why you should relisten to this segment and be very excited that you actually get to benefit from capital gains harvesting when the vast majority of the world not only doesn't know what it is but couldn't access it even if they did.

David Mckeegan: Yeah, exactly.

Brad: Yeah. Jonathan, very impressive there. I was pretty sure you were going to entirely go off the rails, but the only thing I could add to that is like you said at the very end there is realize it. So your tax, when you sell some of these appreciated assets. So that's where the nuance here is of determining what exactly you want to sell each year because you wouldn't be able to sell the entirety of it because then you would get into a higher bracket and that would not be 0% tax. So there is a tiny little bit of nuance, but yeah, otherwise completely spot on. That was awesome. So David, I want to actually ask you about the nuance since you're the expert here. So let's talk again about this capital gains harvesting. So in this scenario where we're talking about a single person who is making $150,000, they are using the foreign earned income exclusion.

David Mckeegan: Sure. So let's say that you're earning $125,000, you're working overseas, but you're working for a US company. They have a 401K. So you can max out your 401K in $19,500 and that leaves you with what would be taxable income of $105,500. You can exclude $105,900 using the foreign earned income exclusion. So right off the bat, you exclude all of your income through the 401K and through the foreign earned income exclusion. The only caveat is that you're going to have to pay the employee portion of the FICA taxes. So you're paying about 7% in tax on that, but that's still pretty good if you're earning $106,000 and you're maxing out your 401K. Even after all of that, you still have your standard deduction available to use for capital gains harvesting. So you can still sell a chunk of the assets in your portfolio that have gains, recognize that gain, increase the basis and not pay any money to the IRS.

Brad: But they clearly couldn't take a million dollars and sell it and realize longterm cap gains. They would be in the 0% up into that threshold that you said before.

David Mckeegan: Right. So if you had say, $30,000 invested and you get 10% gain over the course of a year, you'd be able to protect that entire gain.

Jonathan: Very cool.

Brad: Yeah, that's amazing. So right by protecting it, you're selling it and essentially rebuying a similar asset or...

Jonathan: You can buy the same.

Brad: Yeah, that's right. That's right because it's capital gain harvesting, you can rebuy the same and you're stepping up your basis in essence, right? You're buying it at the current fair market value. So that longterm capital gain is essentially gone. Like Jonathan said, you told the government, "Hey government tax me." And they said, "Okay, 0%."

David Mckeegan: Exactly.

Jonathan: And then same day or next day you're just saying, "I'll just go ahead and buy that again." Now people are listening to this and they're saying, "Well wait, wait, wait, wait, watch sale rules here. You're going to get in trouble." Right? And no, that's not the case. That is for tax loss harvesting. You are actually trying to incur a tax bill. You are saying, "Government tax me." And they're like, "You're good bro. You're good." That's the amazing piece of this. These work for you, even inside the States, you just don't have access to this foreign earned income exclusion. If you can create margin in your life, in terms of what your life costs versus what capital gains you're realizing, that's what gives you the space we talked about in episode 18 of our podcasts and 18 or the companion episode for that.

Jonathan: Now, what we're really talking about here is this really unique vehicle to create space in the tax code whenever you have space. There's other tools that we talked about in the financial independence community that come to mind like Roth Conversion Ladders. How would this play with the Roth Conversion Ladder?

David Mckeegan: The thing to remember with the foreign earned income exclusion is that it's only for earned income. Passive income does not qualify for this exclusion. So when you look at doing a Roth Conversion Ladder, what you're converting is not earned income. Let's say you take me as an example. I worked for about five years in New York City before I moved overseas. I had a 401K with the bank I was working with at the time. I rolled that to a traditional IRA. Now I move overseas, I start working for another company overseas taking the foreign earned income exclusion. I can't use the foreign earned income exclusion in a Roth Ladder, but what I can use is my standard deduction and start transferring that traditional IRA, which is all tax deferred money, so I haven't paid tax on that money. I can transfer that into a Roth IRA and use my standard deduction to not pay tax on it again, so I'm taking tax free money, not paying tax on it and putting it into a vehicle where it's going to grow tax free forever and I can take it out tax free in the future.

Jonathan: I love that this episode is both acting as a refresher for some of the more hardcore tax advantages of being on the path to financial independence, but also really focusing on how to serve this community of expats. We have a ChooseFI Expat group with close to 5,000 people and it was one of our most active groups early on and I think it grows so rapidly because of how hard it is to find this type of information and to have reliable sources and understand what the plan is. Once you have a few of these ideas locked down, then it's very easy to figure, "All right here's what I need to do to get there." But until you actually hear a framework for it, you can be very exposed and this is from a financial perspective in particular.

Jonathan: Now, I actually wanted to come back and talk about investments just because we've talked about capital gains harvesting that is relying on your investments, but expats that are investing outside the United States has some unique challenges in this regards. It's not just the tax treatment, it's how do you access some of the vehicles that we're talking about. You mentioned VTI, are you going through VPNs, this sort of thing. There are all sorts of friction to actually be able to get a solid investment strategy in place when you're doing this overseas. I'd love to get your perspective on this.

David Mckeegan: Sure. Expats have a much harder time banking and maintaining what we would call a normal financial life relative to people that live in the US. The government is very serious about making sure that people are not laundering money overseas or hiding it and shell companies and things like that. And they've instituted a couple laws that are designed to catch people out if they're doing this. The first one is FinCEN 114. That stands for the Financial Crimes Enforcement Center form 114. It's more commonly known as the FBAR or the Foreign Bank Account Report. If you're an expat and you opened bank accounts overseas, if they have over $10,000 in them combined at any time during the year, you have to report that bank account or all of your bank accounts to the US treasury.

David Mckeegan: One of the pieces of advice I give people when they're moving overseas is don't open a lot of bank accounts. It's just going to add hours of your time filling out this form for the government. If you need a bank account to pay your electric bill and your cable bill or whatever your bills are overseas, if you need an account to get paid into, yes, open a bank account, but try not to open too many bank accounts because you're just going to be keying in all the numbers and addresses and all this stuff on your FBAR each year.

Brad: And David, just to clarify there, so the issue isn't having multiple accounts, it's having $10,000 in total in all of those accounts at any one given time. Right? And then I guess you were saying, okay, you're going to have to file the FBAR and if you have multiple accounts then it's even just more owners to actually file it. Am I hearing you right?

Jonathan: I heard the opposite. I heard don't open multiple accounts.

David Mckeegan: Well, I think you're both right.

Jonathan: Yes, Brad, we get to both be right.

David Mckeegan: The way it works is if you have over $10,000 in all of your combined accounts, you have to report all of your combined accounts. A bunch of years ago when we were living in London, we had multiple accounts set up. We had a travel fund, we had a savings fund, just multiple different bank accounts. Now I can't close those accounts online actually I to go into a branch and I haven't bothered to get back to London to do that. So I've got one P in about seven different accounts that are joint accounts for both myself and my wife. Every year when I have to fill out this FBAR form, I have to list all of those accounts, both on mine and on my wife's FBAR, which takes me about an hour a year.

David Mckeegan: So if you want to save an hour of year and you have an extra hour to go do something you enjoy, rather than filling out government forms, don't open all the accounts. And the other caveat I'll say here for the FBAR is let's say you have a checking account and a savings account. You take $5,000 from your checking account and you transfer it to your savings account. Now according to the rules of the FinCEN 114 you have had $10,000 in your combined accounts for the year.

Jonathan: All right, now this is interesting. So the counterpoint to this would be, all right well if you're not going to have a bunch of foreign accounts, that means that you're going to have a bunch of us accounts whether they be online or physical branches, but I see some complications even there, especially based on the two factor authentication and everything else that I have to deal with currently. I feel like that gets more complicated as you're overseas as well.

David Mckeegan: It can do a lot of people ask like, "Where do you bank if you want to be an expat?" Personally we use a Schwab One International Account. We can buy and trade US mutual funds, ETFs, things like that. But we also have a debit card that we don't pay any foreign exchange or foreign ATM fees on that debit card. So that's our main day to day bank for that reason. The other good bank for expats is USAA. They do charge you for taking money out of foreign ATM, but they're used to working with people virtually and so they work pretty well in a virtual environment, especially with people overseas and things like that. And I know a lot of the listeners are probably in the military, so they're probably using USAA anyway.

Jonathan: Let's talk about the investment side scope. I know we mentioned VTSAX and VTI and some of these platforms. I know as you go overseas, probably some of these same antiterrorism, anti-laundering rules, they make investing more complicated. And while I think there's some aspect to... I think the question is, "Well, do I invest in the country that I'm in?" We hear about people saying, "Well, I can't access some of those. Here's what it looks like in my specific country." What does this look like for the expat that still as a citizen inside the United States and is trying to figure out how to navigate international banking laws.

David Mckeegan: There's a US law called FATCA, the Foreign Account Tax Compliance Act that makes banking outside the US very difficult for Americans. Basically the way the law works is it says all foreign bank accounts or foreign banks have to report US accounts to the Treasury Department. So imagine taking the 1099 program and rolling it out to every bank around the world and having all that information get reported back to the IRS. That's in place so it's going to be very difficult for people to open up accounts overseas because a lot of these banks just don't want to deal with Americans because of the extra reporting requirements. So it's going to be harder for people to set up overseas to maintain a normal banking life overseas.

Brad: So are there banks that you've found, I'm assuming maybe larger international banks that deal with FATCA and don't mind dealing with US residents?

David Mckeegan: They're becoming fewer and farther between and this is causing real problems for expats. People are having their mortgages called or unable to refinance mortgages because the bank doesn't want an American citizen to have a loan with them. Even companies like Fidelity, which we know as a US company for their overseas offices, they're closing accounts for Americans because of the FATCA rules.

Jonathan: So the many people that are listening to this saying, "Well what do I do? I do want to get access." Like what are best practices? What do you find that people are doing inside different expat groups and maybe groups outside of the ChooseFI group, how are they investing their money with some reliability into the accounts that we're all familiar with?

David Mckeegan: Well, what we hear most often is that people maintain accounts in the US. So if you have a Schwab account, you can set up the Schwab One International. If you've got a regular Vanguard account, like I haven't heard of Vanguard closing people's accounts, but it doesn't hurt. I've heard of people setting up and using things like mailbox forwarding or having the mail go to their parents' house, things like that just so they don't get flagged or caught out in this fat connect where companies are trying to make sure that they're not banking with people who are outside the country.

Jonathan: Yeah, fair enough. So this is something where you have these new laws that are in place that have very good purposes in mind, but they're not implemented consistently. And when they are, they're not very robust in terms of thinking of all the different situations and variations that are out there. So people that are relying on being able to access their funds and investing regularly, the key is just not to get flagged for something, not to get this warning letter where you don't have any control and they're saying, "Oh by the way, we're shutting down your accounts." And so to that end, one of the ways to do that is just to use some VPN or some other device when you're logging in just as a best practice.

David Mckeegan: Yeah, I've heard people do that. They use a VPN to log in, so it's showing a US address. If you run a business from overseas that's incorporated in the US you might need a VPN anyway just to access online banking and things like that. So yeah, people do that a lot. People have mailing addresses in the US for these things to make sure their statements go there. Those things make your life a lot easier anyway because if you're trying to get mail overseas from the US, it doesn't always get there. It's not always reliable. So we've used a mailbox service for, I don't know, six or seven years.

Jonathan: We talked about federal tax treatment. What does this look like at the state level? I guess I would imagine that if you're not paying a federal tax, then you're not a resident, so you wouldn't pay a state tax. Is that accurate?

David Mckeegan: Well, it depends on the state. So 44 of the States charges state tax and they all have slightly different rules. Now, some states are known for being much worse, meaning they're going to try and hold on to you as being domiciled in that state for tax purposes. So Virginia, where you guys are, New York, California are some of the worst. So you can get caught out for having a driver's license, having a library card, having bank accounts in that state. Things like that can cause a lot of problems for people. So if you're thinking about moving overseas, like if you haven't done it yet but you're thinking about doing it, you might want to think about trying to relocate to one of the zero tax states before you go and get residency there before you move outside of the country because that can greatly simplify your life.

David Mckeegan: Another hack that I've heard about is people go to South Dakota and they set up residency in South Dakota. Now South Dakota is trying to win all of the RVers in the United States. So you only have to spend one day a year in South Dakota in order to get residency. That's another one of these hacks. So if you guys decide you want to go overseas and live overseas, get yourself set up in South Dakota before you do it so that Virginia doesn't come knock and asking to see your salary going forward.

Brad: Laura, we're buying an RV.

Jonathan: Most expensive episode ever. This is amazing. I love this. All right, so we talked about federal taxes, talked about state taxes. I know I asked you for this crazy list and you're like, "No, I don't have a list." But are there a couple of countries that come to mind? I think in my mind like Costa Rica, because there's no tax treatment there. It's hugely beneficial and then the Middle East, I know Dubai is one of those that they don't tax you on your income there, which is massive, especially when you can double dip and get this foreign earned income exclusion. Anywhere else really stand in mind like any patterns that you see in terms of preferential tax treatments and other countries?

David Mckeegan: Well, not exactly a pattern, but a lot of countries, the way they work is you have to be there for 183 days before you become a tax resident. So if you flip that on its head and you say, "Well, I really like spending six months a year in Europe, I work online or I'm financially independent so I don't have to work anywhere." You could spend a couple months of the year in Europe, a couple of months of the year in the Caribbean or South America or something like that. You can move yourself around so that you avoid into that basket in any country now except the US.

Jonathan: Well, I know one thing that the many accountants struggled to work with expats because it's so complicated. There's so many different variables. There's different countries at play, there's different tax treatments at play. But this is what you and your wife are doing. You started a business dedicated towards this. Like what was the learning curve and what has been the biggest surprises after being on this journey for a bit?

David Mckeegan: We set up the business as expats. We didn't set it up as tax accountants. We've got a team of about 35, 40 accountants CPAs and IRS enrolled agents who work for us and work with our clients, preparing the tax returns for people. For us, we set it up as expats where, we had this massive problem with our taxes and we said, "All right, this is something that we can attack, something we can try and fix." And so that's the path we've taken in this business is just trying to get good information out to people, not using scare tactics, answering people's questions as best we can. When we're hiring accountants, we try and make sure that they can speak regular person English as opposed to just speak account knees.

Jonathan: That's my favorite type.

David Mckeegan: Which is harder than you'd think.

Jonathan: Awesome. All right, so let's just go and set it up here. If someone's listening to this, they either are planning this in their near future or they are a expat and they realize, "You know what? I don't want to do this alone anymore." What is the best way for someone to connect with you and your team?

David Mckeegan: Sure. Just head over to our website and we've got a excellent blog. It's huge. It's got a lot of information that was written by accountants and then translated into normal English you speak. And if you have questions, just reach out to us. We're happy to answer any questions.

Jonathan: Fantastic. All right, now most shows that would be the end of the episode, but David, on this show, we would love to give you the chance to tackle the Hot Seat. Are you ready for this?

David Mckeegan: Absolutely.

Speaker 1: In a world drawling and debt and rampant consumption, trapped by the chains of lifestyle inflation. These questions highlight the secrets of those who are broken free. Welcome to the ChooseFI Hot Seat.

Brad: Alright, David, question number one, what is your favorite blog, podcast or book of all times?

David Mckeegan: Okay. I've got two for you guys. The first one is a book called Antifragile by Nicholas Taleb and basically, it describes things that gain from disorder which is a very interesting concept. It's not really something that people think about or talk about very often. And the second one is a book called The End of Jobs by Taylor Pearson. It basically talks about how we're going through what I would call a de-industrial revolution. So the age of going to work for the big factory in your town is over and in the not too distant future, everyone's going to have their own little printer at home where they print their own shoes and they print their own, this and that, and it's de-industrializing. It's going back to a more individual set up. What I'd recommend for that book is to get audio book because Taylor reads the book himself and he adds a lot more to the book and the audio book.

Jonathan: Awesome. All right. A recommendation for an audio book, fantastic. Question number two, an inflection point in your life that was especially memorable or meaningful.

David Mckeegan: In 2008 as Lehman Brothers was going down, my wife and I were on a beach in Croatia. We had taken a couple of days off and we started thinking about and planning what we wanted our life to be like going forward. And this is where we decided we wanted to have a family, have kids. This is when we decided we were going to start a business and we actually started working out different ideas. We tried to write a list of a hundred different business ideas that we could start and run. So 2008 and Croatia is probably the most meaningful reflection point of my life.

Brad: That's awesome. So you're in the finance world and emits this global meltdown. You're looking at this as all right, it's pivot and opportunity. I love that.

David Mckeegan: Just a quick background on that comment. In 2007, the syndication debts that I was on, like I personally worked on a billion pounds worth of syndicated debt. In 2008, from January to June 30th, I did another billion pounds and then from July 1st until the end of the year, nothing, because the financial markets just closed up completely. So when we were thinking and talking about starting a business, the opportunity cost was zero. There was nothing going on in banking. It wasn't going to be interesting. You weren't going to get bonuses. So one of the exercises we do from time to time is think about what's the worst case scenario if I do something. And a lot of times your worst case scenario is the scenario you're in and it's not that hard to get back to that.

Jonathan: That's incredible. I love that. I love that and I love that you guys plan this out, this vision together back in 2008, so congratulations on all of your success. And I love how you were able to bring your passion for financial independence and this remarkable skillset that you've cultivated to help others. Question number three, your favorite life hack.

David Mckeegan: Geoarbitrage. Yeah, especially if you're starting a business and you're in the runway phase because you can maintain a much higher standard of living in some of these other places than you could in the US at a much lower dollar value. And that just gives you more time to get your business up and going and try and make it successful.

Brad: All right, question number four, your biggest financial mistake.

David Mckeegan: Back in about 2006 we bought a condo in New York City in Harlem that was meant to be a rental property. Now instead of viewing this as a rental property, we bought one that we could see ourselves living in, in the future if and when we ever had kids. And this thing was a money loser from the start. Fortunately, we got out once the economy recovered, we were able to sell it and came out with a very small gain.

Jonathan: All right, and question number five, the advice you would give your younger self?

David Mckeegan: I'm pretty happy with how things are turning out, but I wouldn't mind going back and just whispering in my ear to say, "It's going to work out. So enjoy the ride."

Brad: All right, we've got a bonus question for you. What was the purchase that you've made in, let's say, the last 12 months or so that has added the most value to your life?

David Mckeegan: This one's really easy, but I'm not sure it counts as being very FI. So we're in this little rural town in Costa Rica, the roads are not paved. We have potholes that could swallow a Volkswagen Beetle. So we bought a Kawasaki MULE, which is a side by side ATV. It's got six seatbelts, so all five of us can cruise around in this thing. It handles the bumps, it can cross rivers, it's amazing.

Jonathan: Hopefully it's larger than a Volkswagen.

David Mckeegan: Well it's got four wheel drive so it just comes up the other side.

Jonathan: Awesome man.

Brad: That's so cool.

Jonathan: David, one last question for you just because this is such a niche and I think there is so much interest and so many questions that we weren't able to get to. We have this pretty massive expat group that are pursuing financial independence and doing it all around the world. I know they would love to get effectively some one-on-one time. Would you be willing to do a webinar with the group, do some sort of live cast where you can take some Q&As and provide this community some additional information?

David Mckeegan: Yeah, absolutely. We can do a webinar or we can talk through the things we've talked about today and then have a big Q&A. We'll get a couple of the accountants on there as well to answer things live as we're going through.

Jonathan: Fantastic. We will work with the audience and with our team to get that date scheduled and we'll make an announcement on a future Friday roundup. You can find David at David, thanks again for coming on the show.

David Mckeegan: Oh my pleasure. Thanks for having me guys. I'm a big fan, like what you're doing.

Jonathan: All right, my friends, if you got value from today's episode and if you've been getting value from the episodes up to this point, just take one second and press the subscribe button on the platform you're listening to this on whether or not it be Apple, Stitcher, or YouTube. You can find us on your platform of choice, and if you're wanting to get started on your own path to financial independence, the easiest and simplest way to do that is just go to We've created an illustrated guide to FI which I think you will find incredibly valuable on your journey. All right, my friends, we'll see you next time as we continue to go down the road. Let's travel it.

Speaker 1: You've been listening to ChooseFI Radio podcast where we help middle class America build wealth, one life hack at a time.

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2 thoughts on “How to save thousands in Taxes using Geo-arbitrage | Ep 217”

  1. I have the same question. We reached our FI number 7 years ago and retired. Now we have a US Pension and traditional IRA. Since these income streams are from the US do either of these tax strategies help at all?

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