Citizenship-Based Taxation vs. Residency-Based Taxation: What’s the Difference?
- Understanding the Two Tax Systems
- Key Differences Between Citizenship-Based and Residency-Based Taxation
- How Does Residency-Based Taxation Work?
- How Does Citizenship-Based Taxation Work for Americans?
- Why Does the U.S. Use Citizenship-Based Taxation?
- How Do I Avoid Double Taxation Under Citizenship-Based Taxation?
- What Else Do I Need to File as a U.S. Expat?
- Could the U.S. Switch to Residency-Based Taxation?
- How Greenback Helps You File Under Citizenship-Based Taxation
- Related Resources:
The difference between citizenship-based taxation and residency-based taxation determines whether you file taxes based on your passport or your physical location. According to IRS data, the United States is one of only two countries in the world using citizenship-based taxation (along with Eritrea), while over 190 countries use residency-based systems.
This fundamental difference explains why Americans must file U.S. taxes regardless of their location, while Canadian and British expats typically stop filing in their home countries after moving abroad. Your Canadian friend pays taxes where they live. You pay taxes based on your citizenship, regardless of where you live.
The key distinction: Citizenship-based taxation follows your passport. Residency-based taxation follows your physical location.
Understanding the Two Tax Systems
The fundamental difference between citizenship-based and residency-based taxation comes down to one question: What determines where you file taxes—your passport or your physical location?
- 1. Citizenship-Based Taxation (U.S. and Eritrea only): You file and potentially pay taxes to your country of citizenship regardless of where you live or earn income. Your passport determines your tax obligations.
Note: Some older sources mention North Korea, but it officially abolished direct taxation in 1974 and doesn’t enforce citizenship-based taxation in practice since citizens cannot freely work abroad.
- 2. Residency-Based Taxation (190+ countries): You file and pay taxes to the country where you live and maintain residency, regardless of your citizenship. Your physical location determines your tax obligations.
The practical difference: A Canadian living in France pays only French taxes. An American living in France pays French taxes AND must still file with the IRS.
Citizenship-Based Taxation Is Why U.S. Expats Still File.
Key Differences Between Citizenship-Based and Residency-Based Taxation
Here are the critical differences between how these two systems work:
| Factor | U.S. (Citizenship-Based) | Most Countries (Residency-Based) |
|---|---|---|
| Filing Trigger | U.S. citizenship or green card | Typically, only file where resident |
| Where You Live | Irrelevant for filing | Primary factor for filing |
| Worldwide Income | Must report all income globally | Only report if you’re a resident |
| Moving Abroad | Filing continues | Generally ends tax obligations |
| Dual Citizens | Must file in both countries | Usually, no reporting to home country |
| Typical Threshold | $13,850+ in 2025 (single) | 183+ days in country (typical) |
| Tax Treaties | Help reduce double taxation | Less commonly needed |
| Foreign Accounts | FBAR required at $10,000+ | Usually, no reporting to the home country |
How Does Residency-Based Taxation Work?
Under residency-based taxation, you pay taxes in the country where you actually live, regardless of your citizenship. This is how 190+ countries operate.
Common residency triggers: Physical presence (183+ days), permanent home, economic ties (income, assets, business), and family ties (where spouse/dependents live).
Real-world example:
Maria is a Canadian citizen who moved to Germany for work. Under residency-based taxation, she files and pays taxes only in Germany. Canada doesn’t require her to file Canadian taxes or report her German income. If she returns to Canada, she resumes Canadian tax filing.
Countries using residency-based taxation: Canada, the United Kingdom, Australia, Germany, France, Japan, Mexico, most of Europe, Asia, and South America.
How Does Citizenship-Based Taxation Work for Americans?
U.S. citizenship-based taxation means you’re taxed on your worldwide income, no matter where you live.
Who must file U.S. taxes abroad: U.S. citizens (including dual citizens), green card holders, and accidental Americans.
What you must report:
- All foreign-earned income (salary, wages, self-employment)
- Investment income (interest, dividends, capital gains)
- Rental income from foreign properties
- Foreign pensions and retirement accounts
- U.S.-source income
Real-world example:
James is a U.S. citizen who moved to Spain in 2010. He works for a Spanish company earning €65,000 annually. Under citizenship-based taxation, he is required to file U.S. taxes annually and report his Spanish salary to the IRS, despite also filing and paying taxes in Spain. He uses the FEIE to exclude his Spanish income from U.S. taxation, resulting in $0 U.S. tax owed. He must still file FBAR if his Spanish accounts exceed $10,000.
Why Does the U.S. Use Citizenship-Based Taxation?
The U.S. adopted citizenship-based taxation during the Civil War in 1864 to fund the war effort. It has remained unchanged for over 160 years.
Modern justifications:
- Anti-tax avoidance: Prevents wealthy individuals from moving money offshore
- Citizenship benefits: The Government argues that U.S. citizenship provides valuable benefits (passport protection, right to return) that justify filing obligations
- Political inertia: Changing requires Congressional action; no politician wants accusations of giving “tax breaks to the rich.”
Impact on ordinary expats:
The difference between citizenship-based and residency-based taxation affects ordinary expats (teachers, nurses, engineers, retirees) through dual filing complexity, professional tax costs, banking difficulties (foreign banks reject U.S. citizens due to FATCA), and anxiety about penalties.
How Do I Avoid Double Taxation Under Citizenship-Based Taxation?
Despite the differences between citizenship-based and residency-based taxation, the U.S. provides mechanisms to prevent double taxation:
Foreign Earned Income Exclusion (FEIE)
Exclude up to $130,000 of foreign earned income (2025 tax year) from U.S. taxation.
Who qualifies:
- Pass the Physical Presence Test (330+ days abroad in 12 months)
- OR pass the Bona Fide Residence Test (tax resident of a foreign country for the full year)
Example: Sarah lives in Thailand, earning $85,000 as a teacher. She excludes the entire amount using FEIE. U.S. tax owed: $0.
Foreign Tax Credit (FTC)
Claim dollar-for-dollar credits for foreign income taxes paid. Best for expats in high-tax countries (UK, France, Germany, Canada) or those earning over the FEIE limit.
Example: Mark lives in Germany and earns $120,000. Germany taxes him $42,000. He credits the $42,000 against his U.S. tax bill. U.S. tax owed: $0, with $24,000 in excess credits to carry forward.
Tax Treaties
The U.S. has tax treaties with over 60 countries, providing additional protections for pensions, Social Security, retirement accounts, and capital gains.
Which Strategy Should I Use?
| Your Situation | Best Strategy |
|---|---|
| Low-tax countries (UAE, Singapore, Hong Kong) | FEIE |
| High-tax country (UK, Germany, France, Canada) | Foreign Tax Credit |
| Income under $130,000 | FEIE (simpler) |
| Income over $130,000 | Foreign Tax Credit or combination |
| Self-employed | FEIE + plan for self-employment tax |
| Investment income | Foreign Tax Credit |
What Else Do I Need to File as a U.S. Expat?
Beyond your annual U.S. tax return, citizenship-based taxation creates additional filing requirements that don’t exist under residency-based systems:
- FBAR (Foreign Bank Account Report): Required if foreign accounts exceed $10,000 at any time during the year. Filed separately from tax return. Penalties for non-filing start at $10,000 per violation.
- FATCA (Form 8938): Required if foreign financial assets exceed $200,000+ for expats. Filed with your tax return. Broader than FBAR—includes stocks, partnerships, foreign business interests.
Other common forms:
- Form 5471: Foreign corporation ownership
- Form 8621: Foreign mutual funds
- Form 3520: Foreign gifts, inheritances, trusts
These requirements are unique to citizenship-based taxation. Under residency-based systems, you typically don’t report foreign accounts to your former home country.
Could the U.S. Switch to Residency-Based Taxation?
Several bills have been introduced in Congress proposing a switch to a residency-based taxation system, but none have gained traction. While reform efforts continue by organizations like Americans Citizens Abroad and Democrats Abroad, citizenship-based taxation remains the law for the foreseeable future.
The reality is that U.S. citizens must continue filing annual returns, regardless of where they live. The distinction between citizenship-based and residency-based taxation is unlikely to disappear anytime soon.
How Greenback Helps You File Under Citizenship-Based Taxation
The difference between citizenship-based and residency-based taxation remains unchanged, but we can make compliance easier.
We determine whether FEIE or Foreign Tax Credit saves you more, maximize your deductions, file FBAR and FATCA correctly, and help you catch up penalty-free if you’re behind.
You’ll have peace of mind knowing your taxes were done right under both U.S. citizenship-based taxation and your local residency-based system.
If you’re ready to be matched with a Greenback accountant, click the get started button below. For general questions, contact our Customer Champions.
Citizenship-Based Taxation Creates Ongoing U.S. Filing Obligations.
This article is for informational purposes only and does not constitute tax, legal, or accounting advice. Every expat’s situation is unique. Contact Greenback for personalized guidance on your specific tax situation.
Related Resources:
- Why Do I Have to Pay U.S. Taxes If I Live Abroad?
- U.S. Expat Taxes: The Complete Guide
- Foreign Earned Income Exclusion: How to Exclude $130,000
- Foreign Tax Credit Guide for U.S. Expats
- FBAR Filing Requirements: Complete Guide
- FATCA Form 8938: What You Need to Know
- Accidental American Taxes: What You Need to Know
- Dual Citizenship Taxes: Do I Pay Taxes in Both Countries?
- Streamlined Filing Procedures: How to Catch Up Penalty-Free
- Green Card Holder Taxes: What You Must File
