How Accidental Americans Can Avoid Double Taxation

Every year, people around the world feel shocked to discover that the US considers them to be tax residents. Regardless of how long it’s been since they lived in the US — or sometimes, whether they’ve lived there at all — these “accidental Americans” still have US tax and reporting obligations. And if they’re a tax resident of another country, double taxation can occur.

If you fall into this camp, try not to panic (easier said than done, we know). There are a number of strategies accidental Americans can leverage to avoid double personal income taxes.

Below, we’ll walk you through some of the most effective options and share some additional information on who accidental Americans are, what their tax and reporting obligations include, how their income is taxed, and more.

Who is an accidental American?

The term “accidental American” refers to those who are legally United States citizens but don’t maintain strong ties to the country. Typically, these people fall into one of two categories:

1. People born in the US who now live in another country
2. Certain people born abroad to US citizen parents

In the first scenario, you are a US citizen because you were born within US territory, automatically granting you citizenship. No matter how little time you spend in the US after, you maintain that citizenship until you formally renounce it. There are very few exceptions — typically, only children of foreign heads of state or diplomats are excluded. 

In the second scenario, you become a US citizen because you were born to at least one US citizen parent abroad under certain conditions. Note that there are restrictions on citizenship based on a combination of factors, including:

• The parents’ marital status at birth
• Whether one parent or both were US citizens
• Whether the citizen parent is a mother or father
• The amount of time the citizen parent previously lived in the US

Are all accidental Americans subject to US taxes?

The US is one of the only countries in the world that has citizenship-based taxation. With citizenship-based tax systems, all citizens and permanent residents are subject to personal income taxes. As long as they meet the minimum income reporting thresholds, US citizens and permanent residents must file a federal tax return and possibly, pay taxes.

This is true regardless of how much time they spend in the US (if at all) and whether they maintain any ties on a financial or personal level in the US.

Taxation of income sourced in the US vs. abroad

US tax residents are subject to taxation on their worldwide income, which includes any income they’ve earned abroad. Generally, foreign income is taxed the same as domestic income at ordinary tax rates (except for non-resident aliens).

However, earning foreign income and paying foreign income taxes does make you eligible for certain tax breaks.

Compliance & reporting obligations for accidental Americans

As a US citizen (and therefore, tax resident), you must file a federal tax return (aka Form 1040) every year and if applicable, pay any taxes associated with it. Besides your personal taxes, however, you may need to file other reports or forms.

A couple of common disclosures for Americans abroad include the:

• Foreign Bank Account Report (FBAR): Required of American citizens and permanent residents with more than $10,000 across foreign financial accounts
• Statement of Specified Foreign Assets (aka Form 8938): Required of Americans with over $200,000 in foreign assets on the last day of the tax year or over $300,000 in foreign assets at any point in the tax year
  • Note: Americans living stateside may have to file this document as well, but for them, the threshold starts at just $50,000

The consequences for failing to file these forms when necessary can be steep. Those who don’t file an FBAR when required face a penalty of $10,000 to $100,000 (or 50% of the account’s value at the time you failed to file, if greater). Failing to file (or incorrectly filing) Form 8938 carries a potential fine of $10,000 to $60,000.

Strategies to avoid double taxation & penalties

Accidental Americans should plan to file outstanding tax returns as soon as they discover their tax and reporting requirements. Fortunately, this doesn’t necessarily mean you’ll need to pay a huge tax bill or face steep penalties. Here are some common strategies that can help you avoid double taxation as an accidental American.

Streamlined Filing Compliance Procedures

The Streamlined Filing Compliance Procedures is an Internal Revenue Service (IRS) amnesty program that allows Americans who fell behind on their tax returns to catch up without any additional fines or penalties. Americans abroad should apply specifically to the Streamlined Foreign Offshore Procedures.

To qualify, you must:

• Have a taxpayer identification number (i.e., Social Security Number). You may need to apply for a Social Security Number before you can file if you don’t already have one. 
• Not have previously been contacted by the IRS regarding back taxes
• Not have traveled to the US for more than 30 days in at least one of the three most recent tax years (Offshore program only)
• Certify that your previous incompliance was non-willful (aka due to misunderstanding or lack of awareness)

If you qualify, you’ll need to:

• File an FBAR report for the past six tax years 
• File tax returns for the past three delinquent years
• Pay any taxes associated with these returns
• Affix a statement explaining your previous noncompliance

After successfully submitting, you’ll be fully tax compliant.

Tax treaties & agreements between countries

Another possible option is to claim the benefits of a tax treaty between the US and the country in which you reside. The US has a number of different tax treaties with other nations designed to help dual residents avoid double taxation. This includes agreements with the UK, most European countries, China, Mexico, and more.

There is, unfortunately, a catch: Most of these tax treaties contain a savings clause. These clauses allow the US government to “save” (i.e., reserve) the right to tax Americans as if the treaty didn’t exist.

However, some parts of the treaty may be excluded from the savings clause — such as the provision that allows UK residents to withdraw a tax-free lump sum from their pension.

To claim the benefits of a double taxation treaty, you’ll need to file Form 8833.

Foreign tax credits & exclusions

Generally, the most effective way to avoid double taxation is by claiming a tax break. Two of the most popular options available to Americans abroad are:

The Foreign Tax Credit (FTC)

The FTC gives Americans dollar-for-dollar tax credits for any foreign income tax paid, which can be applied to their US tax bill. Because many other countries have higher income tax rates than the US, the FTC can often eliminate your US tax bill entirely. Often, you can even receive excess credits that you can use to pay future US tax bills.

To qualify for the FTC, the foreign taxes you’ve paid must be:

• Based on foreign income
• Levied by your country of residence
• Legal
• Charged to you specifically

You can claim the FTC by filing IRS Form 1116.

The Foreign Earned Income Exclusion (FEIE)

The FEIE, on the other hand, allows you to exclude a certain amount of your foreign-earned income from taxation. For tax year 2023, you can exclude up to $120,000. To be eligible for the FEIE, income must:

• Be earned (e.g. wages, salary, tips, bonuses, self-employment income, etc.) rather than unearned/passive (rental income, investments, trusts, etc.)
• Come from a non-US governmental source — foreign income earned while overseas in the armed forces or while working as a foreign diplomat, for example, would not be eligible

For individuals to qualify, they must pass one of two tests:

• The Physical Presence Test: For those who have been outside of the US for at least 330 days in a 365-day period
• The Bona Fide Residence Test: For those who can provide official documents (e.g. passports, residence cards) proving their status as a resident of a foreign country 

You can claim the FEIE by filing Form 2555.

Renouncing American citizenship as a way to avoid double taxation

Renouncing your citizenship is the only real way for Americans to be no longer subject to taxation by the US government. 

The IRS has a program called the Relief Procedures for Certain Former Citizens, specifically for Americans who have renounced their citizenship and have never filed a US tax return. Like the Streamlined Procedures mentioned above, this program helps accidental Americans avoid penalties associated with incompliance. It also provides relief from US tax law.

To qualify for this program, you must:

• Renounce or intend to renounce their US citizenship after 2010. 
• Never have intentionally neglected your US tax & reporting obligations
• Have a total tax liability of no more than $25,000 (after applying all tax breaks) for the current year plus the previous five tax years 
• Have less than $2 million in worldwide net assets

While renouncing your citizenship will relieve you of your US tax residence, it can come at a cost. Those who meet certain criteria may be considered covered expatriates, which brings an exit tax of up to 23.8% (unless they qualify for the Relief Procedures for Certain Former Citizens).

Other potential consequences include, among others:

• A $2,350 fee (US tax authorities are considering reducing this fee, but nothing has materialized just yet)
• Losing the right to enter, freely move within, & work in the US
• Complicating taxes associated with US-based properties & investments
• Losing the right to pass on citizenship to your children

If you decide to move ahead with the Relief Procedures for Certain Former Citizens Program, you must file:

• A dual-status federal tax return for the year of renunciation
• Tax returns & FBARs for the past five years

If successful, you will not only abandon your status as a US tax resident — you won’t face an exit tax.

Additional resources

1. U.S. citizens and resident aliens abroad
2. U.S. citizens and residents abroad – filing requirements
3. Frequently asked questions (FAQs) about international individual tax matters
4. U.S. Citizens and Resident Aliens Abroad – Where and When to File and Pay

References

1. Child Citizenship Act
2. Do you qualify to pass on citizenship?
3. Frequently asked questions (FAQs) about international individual tax matters
4. United States – Individual – Taxes on personal income
5. Renounce Citizenship – Fees
6. American living in Europe? It could soon be cheaper to renounce your US citizenship