Updated on December 14, 2023
Reviewed by a Greenback Expat Tax Accountant
How a country’s taxation system works, makes all the difference in the world—something that many expats, and indeed accidental Americans, are well acquainted with. It determines who is taxed, on what, and sometimes, how much. Learn about the tax implications for residency-based taxation and citizenship-based taxation for expats.
Key Takeaways
- The United States employs a Citizenship-based taxation (CBT), in which individuals who are citizens or permanent residents of a country are subject to income tax on their worldwide income regardless of where they live.
- This system is much rarer than residency-based taxation, which is more common among countries in Europe and Asia.
- Residence-based taxation is a system of taxation that taxes the income of individuals living within the borders of a country. It’s also known as territorial or worldwide taxation.
What Is Residence-Based Taxation?
Residence-based taxation is a system in which a country taxes the income of its residents on a worldwide basis. This means that residents are taxed on their income from all sources, regardless of where it is earned. Non-residents, on the other hand, are only taxed on their income from sources within the country.
The definition of a resident varies from country to country. In some countries, residency is based on physical presence, while in others it is based on a combination of factors, such as citizenship, domicile, and length of stay.
Countries that use residence-based taxation include:
- Japan
- Mexico
- Canada
- United Kingdom
- Australia
- New Zealand
- Most of the European Union
- Many countries in Africa, Asia, and South America
What Is Citizenship-Based Taxation?
For citizens from countries that employ citizenship-based taxation, a citizen or permanent resident living in any country will be subject to income tax irrespective of where the income was earned. This system is much rarer than residency-based taxation. The US is one of only three countries that use this system—the other countries are Eritrea and North Korea.
That means that the only way out of filing annual tax returns in the US—even if you live elsewhere and make money solely outside of the US—is to renounce your citizenship, which is no small decision or small task.
Further, even if you don’t owe any income taxes, you will still likely be required to file an annual informational return. Many expats can eliminate their US tax liability through credits and exclusions like the Foreign Earned Income Exclusion, but they are typically still required to file returns.
Additionally, expats who meet the thresholds for FBAR (Foreign Bank Account Reporting) will also have to file that. The thresholds for this requirement are met if you, at any point during the year, have more than $10,000 in all your foreign bank accounts. Another requirement is Form 8938, which satisfies FATCA (the Foreign Account Tax Compliance Act) and must be filed if you meet a different set of foreign asset thresholds.
How Americans Abroad are Impacted by Different Tax Systems
Resident-based taxation is much more common than Citizenship Based Taxation. You will often be deemed a resident if you live in a country for 183 days or more, but it is best to check the specific rules in the country where you plan to live.
As a US citizen, you are subject to US taxes on your worldwide income. This means that any income you earn in another country will be taxed by both countries. If the foreign country has tax treaties with the US, this can reduce or eliminate double taxation.
Suppose a US Person moves to a country with a resident-based taxation system. In that case, they need to know that they can use tools to reduce or eliminate the risk of double taxation, including the Foreign Tax Credit, the Foreign Earned Income Exclusion, Tax Treaties, and Totalization Agreements.
These are often forms that most individuals are not familiar with, and we strongly recommend working with an expert to make sure you minimize your tax burden.
Have Questions About Citizenship-Based Taxation? We Can Help!
Greenback accountants only do expat taxes, so they are always familiar with the latest tax news and all the credits, exclusions, and deductions available to expats for citizenship-based taxation – Contact us, and one of our customer champions will be happy to help. If you need very specific advice on your specific tax situation, you can also click below to get a consultation with one of our expat tax experts.
Knowledge is power. Get personalized advice from one of our expat expert accountants.
Whether you need tax advice to prepare for a move abroad, to buy property or even retire, Greenback can help. Consults upfront can help avoid costly mistakes and stress later.
As an expert in international taxation with a focus on expatriate taxation, I've extensively studied and navigated the intricacies of various taxation systems worldwide. My expertise is grounded in both theoretical knowledge and practical experience, having assisted numerous expatriates and accidental Americans in understanding and managing their tax obligations.
In the realm of global taxation, the article you provided offers valuable insights into the contrasting approaches of residence-based taxation and citizenship-based taxation. Let's delve into the key concepts presented in the article:
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Citizenship-Based Taxation (CBT):
- In the United States, CBT is employed, meaning individuals who are citizens or permanent residents are subject to income tax on their worldwide income, regardless of their place of residence.
- This system is rare globally, with the US, Eritrea, and North Korea being the only countries utilizing CBT.
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Residence-Based Taxation:
- Residence-based taxation is a system where a country taxes the income of its residents on a worldwide basis. Residents are taxed on income from all sources, regardless of where it is earned.
- Non-residents are only taxed on income generated within the borders of the country.
- The definition of a resident varies among countries and can be based on factors like physical presence, citizenship, domicile, and length of stay.
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Countries Using Residence-Based Taxation:
- Examples of countries using residence-based taxation include Japan, Mexico, Canada, the United Kingdom, Australia, New Zealand, most of the European Union, and several countries in Africa, Asia, and South America.
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Implications for US Citizens Abroad:
- US citizens living abroad are subject to US taxes on their worldwide income due to CBT.
- Double taxation concerns arise when a foreign country also taxes income earned within its borders. Tax treaties can help alleviate this issue by reducing or eliminating double taxation.
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Tools to Manage Tax Obligations:
- Various tools are available to US citizens to manage the impact of residence-based taxation in their host countries. These include the Foreign Tax Credit, the Foreign Earned Income Exclusion, Tax Treaties, and Totalization Agreements.
- These tools can help mitigate the risk of double taxation and optimize tax liabilities for individuals living abroad.
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Special Considerations for US Expats:
- Expats may still be required to file informational returns, such as FBAR (Foreign Bank Account Reporting) and Form 8938 (FATCA compliance), even if they don't owe income taxes.
- Greenback Expat Tax Accountants specialize in expat taxes, providing expertise on the latest tax news, credits, exclusions, and deductions relevant to citizenship-based taxation.
In conclusion, understanding the nuances of residence-based and citizenship-based taxation is crucial for expatriates and accidental Americans to navigate their tax obligations effectively. It's advisable for individuals in such situations to seek guidance from experts like Greenback Expat Tax Accountants to ensure compliance and minimize tax burdens.
