The Difference Between Residency-Based Taxation and Citizenship-Based Taxation

Residency and Citizenship Based Taxation

How a country’s taxation system works makes all the difference in the world—something that many expats, and certainly 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.

What Is Residency-Based Taxation?

With residency-based taxation, a resident of the country is subject to taxation on their worldwide (local and worldwide) income. Nonresidents are only subject to taxation of income derived from the country. How a country defines a tax resident varies widely, though, and sometimes the tax rates differ for residents and nonresidents. So, when you move abroad, you’ll need to check with the local tax authority to find out exactly how resident status is acquired.

Countries that use residence-based taxation include Japan, Mexico, Canada, the UK, Australia, New Zealand, and most of the EU. A handful of other countries across Africa, Asia, and South America use similar systems.

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. In fact, the US is one of only two countries in the world that use this system—the other country is Eritrea. 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 taxes, you will still likely be required to file an annual informational return. Many expats are able to 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 have to file that as well. The thresholds for this requirement are met if you, at any point during the year, have more than $10,000 in all of your foreign bank accounts in total. 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 Residency-Based Taxation Affects Americans Abroad

While resident-based taxation is more common and less complex than the citizen-based taxation, it can complicate matters for Americans abroad. If a US expat moves to a country with residency-based taxation, and you become a tax resident of that country, you can face double taxation. Some measures to mitigate this include tax treaties, totalization agreements, and the Foreign Tax Credit, which is a dollar-for-dollar credit to your US tax liability based on taxes you paid to a foreign country.

Greenback Can Make Your Expat Taxes a Breeze

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. We’ve helped over 10,000 expats in situations like yours, so get started with Greenback today.

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