Citizen Based Taxation—What You Need To Know

Expats are America’s global front-line ambassadors. Everyday, their actions and attitudes help shape others’ perceptions of the U.S. and Americans.

They are also the 21st century pioneers, forging opportunities and lives away from our shores and in the wider world.

However far from the U.S. they venture though, they remain in the strange situation of having to file taxes twice, in the country where they live, as well as to the U.S. This is because the U.S. operates a citizenship based taxation system.

What is citizenship based taxation?

Citizenship based taxation means that all U.S. citizens (including anyone with the right to U.S. citizenship) as well as green card holders are required to file and pay U.S. taxes on their worldwide income.

The key thing to understand about citizenship based taxation is that it doesn’t matter whether you live in the States or not; as a U.S. citizen (or green card holder) you are still obligated to file U.S. taxes.

Why does the U.S. have citizenship based taxation?

Citizenship based taxation started way back during the Civil War, as a disincentive for Americans to leave the country to avoid being drafted into the Northern army. When it was introduced, income tax was higher for expatriates than for Americans living in the States. Happily this is no longer the case!

What do other countries do?

Most countries only tax people living within their borders, and those who live abroad but receive income from back home. This is called residence based taxation, and only the U.S. and the African minnow Eritrea have citizenship rather than residence based taxation.

What does citizenship based taxation mean for expats?

Up until 2010, citizenship based taxation impacted very few expats: because the IRS had no way of knowing what foreign generated income expats may have, citizenship based taxation was unenforceable.

Following the 2008 financial crisis though, with a record national debt and deficit after the government bailed out the failing banks, the administration sought new ways to generate revenue. One of them was by enforcing citizenship based taxation.

The 2010 Foreign Account Tax Compliance Act (known as FATCA) compels foreign banks and other financial institutions (including investment firms) to report their American account holders to the IRS, including account balances and contact details. It achieves this by imposing a tax on those that don’t comply when they trade in U.S. financial markets. Along with a raft of new intergovernmental tax exchange agreements, the IRS now has a very good idea about U.S. expats’ finances, and where they live.

This means it is now able to enforce citizenship based taxation for the first time.

What can I do to avoid double taxation?

The main problem with America’s citizenship based taxation system for expats is that they find themselves filing two tax returns and potentially paying taxes on the same income twice.

While U.S. tax treaties typically don’t mitigate for this, there are a number of IRS exclusions including the Foreign Earned Income Exclusion and the Foreign Tax Credit that can be claimed that allow expats never to pay more tax than the higher of the two tax regimes to which they are subject. In most cases, these exclusions allow the expat not to pay any tax to the U.S., however expats still have to file a U.S. tax return to claim these exemptions. Expats should also note that which exemptions they choose to claim, depending on their circumstances (e.g. their income and country of residence), affects the amount of tax they’ll end up paying.

What happens if I didn’t know I had to file U.S. taxes?

Many expats have been caught off guard by finding out that they have to file U.S. taxes on their worldwide income from abroad. Fortunately there’s an amnesty program called the Streamlined Procedure that allows expats to catch up on their U.S. tax filing without paying any penalties. We strongly recommend that expats who need to catch up contact an expat tax expert to find out more about the Streamlined Procedure before the IRS gets in touch with them.

With clients in over 150 countries, Bright!Tax is a leading provider of US tax services to the estimated 9 million Americans living abroad. I’m responsible for client experience, communications, and branding. Since I joined, turnover has been growing at a rate of 80% per annum.

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4 comments on “Citizen Based Taxation—What You Need To Know

  • Or, do as 1759 victims of this racket did last quarter alone and
    How’s that coming from “an ambassador?”
    Very short sighted thinking indeed on the part of the usa.

  • We used to be the goodwill ambassadors. We wern’t allowed to remain that. Americans that live abroad now celebrate every person who renounces citizenship. It’s seen as an individual and powerful protest that something is wrong and is ignored no matter how much we do to bring change. We’ve given up and moved on for a life with equal opportunities as our neighbors.

    The USA should be ashamed that they have made the lives of so many hard working US citizens that live abroad a daily hell. Would you like it if your bank account cancelled your mortgage or a company won’t hire you or its too difficult to start a business, just because you are American. Our children born abroad will also be disadvantaged where we live until they give up US citizenship. $2,350 each!!!!!!

    Americans don’t care for Americans who live outside the USA. They and their families are punished instead of “building bridges” to the USA in terms of trade and relations.

    We will all have to take up a foreign citizenship at some point and become America’s ill will ambassadors fir the treatment and kick in the ass at the door when we leave. Great job America, other countries support their expats, yet you systematically tear yours to pieces.

    Only the USA does this to its citizens once they cross that border.

  • 2terrified2sleep

    It is ridiculous that the US cannot change its tax system to residence based taxation! Every person should be informed that if for any reason they want to live in another country, that they are nothing more than tax slaves to the US. This is very expensive since it involves hiring 2 accountants to sort through 2 different country’s very complicated tax codes. Why not just change to residence based taxation like the rest of the world is using?? And on top of that there is fatca to deal with! Why??

  • Expats are victims of American fiscal imperialism. Period. CBT was never really applied during the Civil War or after until the introduction of FATCA in 2010. From then on, it has been used to steal money from expats who already pay higher taxes in Canada, Germany, Sweden etc. than any homelander does. As a Vietnam era veteran who left the US over 40 years ago and had never earned a decent income, I recent having had to renounce my US citizenship to keep by bank accounts open and avoid losing most of what I had earned in over 40 years of hard work outside of the USA. 9 million expats, Accidental Americans etc. are being threatened and hounded by a greedy war-mongering nation that is currently the only industrialized nation steals from foreign tax jurisdictions. That’s what CBT/FATCA/FBAR etc. are about. Nothing more and nothing less.

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