What is Citizenship-Based Taxation (US Tax Implications)

What is Citizenship-Based Taxation (US Tax Implications)

What is Citizenship-Based Taxation (CBT) 

The United States is one of only two countries that follows a citizenship-based income taxation model. What that means, is that the United States taxes US Person individuals based on the fact that they are a US person, and not the fact that they may reside in the United States. Of important note, is the fact that while it is referred to as citizenship-based taxation, it is not limited to citizens. Rather, it includes all US persons which can include US Citizens, Lawful Permanent Residents, and foreign nationals to meet the substantial presence test and therefore considered a resident.  Unsuspecting taxpayers who either reside overseas and have not filed taxes on their worldwide income — or reside in the United States and have not reported their foreign income, it may result in significant tax liabilities that they were not aware of or preparing for. Let’s look at the basics of what citizen-based taxation means.

Citizenship-Based Taxation Definition

The idea behind the Citizenship-Based Taxation model is the concept that a person is subject to tax on the income of the country they are a citizen of, whether or not they reside in the country — and whether or not the income they generate is sourced in that country. In other words, a taxpayer is forced to pay tax simply for the benefit of being a citizen of that country. The United States is one of only two countries that practices this type of tax system. Take for example a US Taxpayer who lives abroad. If the US Citizen abroad resides in a foreign country and earns all of their money from foreign sources, is it really fair for the United States to have the power to tax that individual — upwards of 37% — simply because they have US Citizen status? Making matters worse, is that even though it is referred to as Citizenship-based taxation, in fact, it refers to US persons and not just US citizens – which is why foreign nationals who are considered US residents can get swept up into the definition of CBT.  But, if a taxpayer has paid taxes overseas on foreign income then they can usually claim a foreign tax credit. Likewise, if the taxpayer resides overseas sufficient to meet either the bonafide residence test or physical presence test, then they should qualify for the foreign earned income exclusion –– which allows them to exclude upwards of 108,000 of annual income from US tax liability — along with a housing exclusion –– and married couples can each claim FEIE.

Citizenship-Based Foreign Asset Reporting

In addition to having to report worldwide income, taxpayers who fall under Citizenship-Based Taxation are often times required to disclose their global assets such as foreign accounts, assets, and investments to the US government on a host of different reporting forms. Some of the most common international information reporting forms include FBAR and FATCA.  While the failure to timely report these forms may result in significant fines and penalties, the US government has also created various offshore tax amnesty programs to assist taxpayers we get into compliance with offshore and overseas money.

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Golding & Golding specializes exclusively in international tax and specifically IRS offshore disclosure.

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