Understanding citizenship-based taxation: A guide for US expats
In the global landscape of taxation, most countries adopt a residency-based approach, taxing individuals based on where they live.
However, the United States stands out with its citizenship-based taxation system. This means that US citizens are taxed on their worldwide income, regardless of where they reside.
For American expatriates, this unique system introduces complexities in tax obligations, making it essential to understand the nuances of both taxation models.
Residency vs. citizenship-based taxation
What is residency-based taxation?
Residency-based taxation is a system where individuals are taxed based on their residency status within a country.
If you're considered a resident, you're liable to pay taxes on your global income in that country. Conversely, non-residents are typically taxed only on income sourced within that country.
Countries that employ residency-based taxation include:
- Canada
- United Kingdom
- Australia
- Germany
- Japan
- Mexico
- New Zealand
- Most European Union nations
In these countries, determining tax residency often depends on factors like the number of days spent in the country, permanent home availability, and personal and economic ties.
What is citizenship-based taxation?
Citizenship-based taxation is a system where a country taxes its citizens on their worldwide income, regardless of where they live or earn that income.
The United States is the most prominent example of this system.
Countries that tax based on citizenship:
- United States
- Eritrea
Key implications for US citizens:
-
Worldwide income reporting: US citizens must report all global income to the IRS, including wages, interest, dividends, and rental income.
-
Foreign Earned Income Exclusion (FEIE): If you qualify under the bona fide residence test or the physical presence test, you can exclude foreign earned income up to an inflation-adjusted annual limit. For tax year 2025, the maximum FEIE is $130,000 per qualifying person. For tax year 2026, it’s $132,900 per person. (You claim it on Form 2555.)
If you plan to use the FEIE, first calculate your days abroad to see whether you meet the physical presence threshold or should rely on bona fide residence. - Foreign Bank Account Reporting (FBAR): US persons must report foreign financial accounts exceeding $10,000 in aggregate at any time during the calendar year.
- Foreign Account Tax Compliance Act (FATCA): Some taxpayers must report “specified foreign financial assets” on Form 8938 once they exceed thresholds that depend on filing status and whether you live abroad. If you live abroad: single/MFS: >$200,000 on the last day or >$300,000 anytime; MFJ: >$400,000 on the last day or >$600,000 anytime.
Even if you pay tax where you live, you may still have US filing and reporting obligations. Whether you must file an income tax return depends on IRS filing thresholds and your situation, but many US expats still need to file. And while “double taxation” is a risk, many people end up owing no additional US income tax after tools like the FEIE, Foreign Tax Credit, and applicable tax treaty rules—though information reporting (like FBAR/Form 8938) can still apply.
How different tax systems affect US expatriates
For US expats, the citizenship-based taxation system can lead to complexities:
- Double taxation: There's a risk of being taxed by both the US and the country of residence on the same income.
- Foreign tax credits: To mitigate double taxation, the US offers credits for taxes paid to foreign governments.
- Exemptions and exclusions: Provisions like the FEIE and housing exclusions can reduce taxable income.
- Filing complexity: Navigating dual tax systems requires meticulous record-keeping and understanding of both jurisdictions' tax laws.
Understanding these implications is crucial for compliance and financial planning.
Conclusion
Citizenship-based taxation presents unique challenges for US expatriates, from potential double taxation to intricate reporting requirements.|
While mechanisms like the FEIE, foreign tax credits, and tax treaties offer relief, the complexities of navigating dual tax obligations remain.
It's imperative for US citizens living abroad to stay informed and seek professional tax advice to ensure compliance and optimize their tax situation.
FAQ
No, most countries tax based on residency, not citizenship. Only the US and Eritrea tax citizens on worldwide income regardless of residence.
No, some countries, like the United Arab Emirates and Monaco, do not impose personal income taxes.
Living abroad doesn't exempt US citizens from tax obligations. However, provisions like the FEIE and foreign tax credits can reduce or eliminate US tax liability.
Living abroad does not remove US tax rules. If you meet the IRS filing requirements, you must file a US tax return, and if you owe US tax after exclusions/credits, you must pay it. Many expats legally owe $0 after the FEIE/Foreign Tax Credit, but they may still need to file and may still have separate reporting duties (e.g., FBAR/Form 8938).
Green card holders are generally treated as US tax residents and taxed on worldwide income while they hold long-term resident status, so their US filing obligations can look similar to citizens’. If they end lawful permanent resident status (and meet the tax rules for ending US residence), different rules may apply.
In practice, only two countries are widely recognized as taxing most non-resident citizens on worldwide income simply because they’re citizens: the United States and Eritrea. A few other places have citizenship-connected rules in limited situations (not full “citizenship-based taxation” the way the US/Eritrea are). For example, Myanmar has imposed tax on certain nonresident citizens’ foreign salary income under changes effective in 2023.
