Citizenship-Based Taxation versus Residency-Based Taxation

Citizenship-Based Taxation versus Residency-Based Taxation

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

  • Citizenship-based taxation (CBT), is a system of taxation 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. The United States employs this system.
  • 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?

With residence-based taxation, a country’s resident is subject to taxation on their worldwide (local and global) income. Non-residents 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 non-residents. So, when you move abroad, you’ll need to check with the local tax authority to know precisely 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. 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. 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.

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? 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 for citizenship-based taxation.

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.

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