What is Citizenship-Based Taxation?

If you’re an American living abroad, you may have already heard of the concept of “citizenship-based taxation.” If you haven’t, though, you’re not alone. 

Many US expats only find out about this unique tax system after they move overseas. It’s a concept all US citizens should familiarize themselves with, however, as it has major tax and financial planning implications.

We’ll dig in more below, but, briefly, citizenship-based taxation refers to a system in which all citizens are subject to worldwide taxes by their government. Because the US uses this taxation system, US citizens are obliged to file a US tax return annually – even if they don’t currently live in or earn income sourced from the US. 

As a result, Americans who haven’t lived in the States for years (or sometimes at all) are often on the hook for a US tax return and/or bill. Depending on the taxation system of the country they live in or earn income from, they may be subject to taxes by other governments as well.

Below, we’ll walk you through different taxation systems, how to determine your tax obligations, smart tax strategies for US expats, and more.

Countries that tax based on citizenship 

When we described citizenship-based taxation as a unique tax system earlier, we weren’t exaggerating. The United States and the East African nation of Eritrea are the only two countries that tax the worldwide income of all citizens and permanent residents regardless of where they live or where they earn money. In the US, though, there is a caveat — those who earn below a certain threshold are excused from having to file or pay federal taxes.

Minimum income threshold for filing taxes in 2023

So, what exactly is this threshold for tax year 2022 (aka the taxes you file in 2023)? The answer will vary according to several factors, such as your age, marital and filing status, employee classification, and more.¹

Single individuals

Age	Under 65	65+
Income (USD)	$12,950	$14,700

Heads of Household

Age	Under 65	65+
Income (USD)	$19,400	$21,150

Married individuals, filing jointly

Ages	Both Spouses Under 65	1 Spouse Under 65, 1 65+	Both Spouses 65+
Income (USD)	$25,900	$27,300	$28,700

Married individuals, filing separately

Ages	Any
Income (USD)	$5

Qualifying widows/widowers

Age	Under 65	65+
Income (USD)	$25,900	$27,300

Self-employed individuals

Ages	Any
Income (USD)	$400

Note: Depending on where they live and how long they plan to stay there, self-employed expats may need to pay US social security taxes as well.

In some cases, dependents may need to file a tax return, in which case filing becomes the parent’s responsibility.² Additionally, people who earn less than the income thresholds listed above may need to file as well, such as if they are subject to the Alternative Minimum Tax, or if they owe tax on an early distribution from a retirement plan.

Should I file a tax return even if I don’t have to?

There may be certain circumstances in which expats who fall below the mandatory filing thresholds don’t have to file, but would benefit from doing so anyway. This is especially true for those who plan to claim certain tax credits, such as the Child Tax Credit, First-Time Homebuyer Credit, Health Coverage Tax Credit, American Opportunity Credit, or an expat-specific tax credit (more on those in a bit).

How do other countries collect taxes?

You might be wondering: If the US and Eritrea are the only two countries that employ citizen-based taxation, what tax system does nearly every other country use? The two primary taxation systems around the world are:

Residence-based taxation

Residence-based taxation is the primary system of taxation around the world, used by 130 different countries. This includes virtually all other OECD countries (and developed countries in general) besides the US, including most of the EU, Australia, Canada, Japan, Korea, New Zealand, and more.

Under residence-based taxation, governments tax residents of their countries on their worldwide income.³ Many different countries vary slightly in how they classify tax residents, but a few common factors that are taken into consideration include:

• Where you spend your time
  • Many governments classify anyone who is physically present in their country for 183 days or more in a year as a tax resident
• Where you maintain a primary or permanent residence or abode
• Where your primary economic interests are located 
• Where your dependents live

Territory-based taxation

Another, albeit less common, system of taxation is the territorial tax system. Under this system, countries only tax income earned within their geographic boundaries. A few countries that have implemented territory-based taxation include Costa Rica, Hong Kong, Panama, and Singapore.⁴ As a result, it’s possible to live in one of these countries and not owe any income taxes to their federal government as long as all of your income is sourced from outside of the country.

Income tax-free countries

A handful of countries don’t charge federal income taxes at all. Notable examples include the Bahamas, Bermuda, the Cayman Islands, Qatar, and the United Arab Emirates.⁵ These countries raise tax revenue through alternate tax laws, such as sales taxes, excise taxes, property taxes, and more.

Avoiding double taxation

Many American expats are at risk of double taxation, or being taxed by multiple different governments on the same income: once by the US, and again by any country that counts them as a tax resident. Understandably, this makes many expats nervous. Fortunately, though, there are ways to reduce your tax burden.

Tax treaties

The US has tax treaties with a number of different countries, including most of the EU, Australia, Canada, China, India, Japan, Korea, Mexico, New Zealand, Thailand, the United Kingdom, and more. In principle, these agreements are designed to help permanent US residents and citizens living abroad from double taxation. To claim one, you’ll typically use IRS forms W-8 BEN, W-8 BEN-E, or Form 8233.  

The tricky part is that most of these include a savings clause, which states that the US reserves the right to tax citizens and permanent residents as if the treaty didn’t exist in the first place (confusing, we know). Often, this limits the degree to which you can benefit from these treaties — meaning you might be better off leveraging another strategy below.

Totalization agreements

Totalization agreements are separate agreements that specifically prevent Americans abroad from having to pay social security taxes to two different governments. Which government you pay taxes to generally depends on how long you plan on staying there:

• 0 to 5 years: Pay social security taxes to the US
• 5+ years: Pay social security taxes to your country of residence 

Many countries that have a tax treaty with the US also have a totalization agreement, but not all, so make sure to double-check. Totalization agreements can be claimed by bringing a Certification of Coverage to a Social Security office or the foreign equivalent.⁶

Expats can claim most of the same tax breaks as the average taxpayer living in the US, plus a few additional ones, including the following:

Foreign Earned Income Exclusion (FEIE)

If you pass either the Physical Presence Test or Bona Fide Residence Test, you qualify for the FEIE, which allows you to a) exclude a certain amount of your foreign earned income from taxation ($112,000 for tax year 2022 $120,000 for tax year 2023) and b) write off qualifying housing expenses through the Foreign Housing Exclusion/Deduction.

You can claim the FEIE through IRS form 2555. 

Foreign Tax Credit (FTC)

The FTC, on the other hand, gives Americans who have paid income taxes to a foreign government credits toward their US income taxes, as long as they meet a few basic criteria. This usually drastically reduces or eliminates US income tax obligations entirely.

FATCA, FBAR, & other considerations

While being an American expat gives you some additional tax breaks, it also can bring with it some additional reporting obligations. 

The Foreign Account Tax Compliance Act (FATCA)

If you live abroad and have $200,000 USD or more in foreign financial assets by the end of the year — or more than $300,000 USD in foreign assets at any point during the year — FATCA requires you to report them on Form 8938.

Foreign Bank Account Report (FBAR)

On a similar note, those with $10,000 USD or more in a foreign financial account at any point in the year must report it on an FBAR, also known as FinCEN Report 114.

How to approach catching up on taxes

While not filing a US tax return or paying a US tax bill can lead to steep fines, the IRS offers an amnesty program called the Streamlined Filing Compliance Procedures for Americans living abroad. This program is available to eligible expats who misunderstood or weren’t aware of their overseas tax obligations. Under this program, you can catch up on outstanding tax obligations without additional penalties.

To qualify, you must a) take advantage of the program before the IRS notifies you of prior noncompliance b) be in good standing with the IRS (i.e. not currently under investigation) and c) certify that your earlier noncompliance was not intentional.

References 

1. Who needs to file a tax return
2. Publication 501 (2022), Dependents, Standard Deduction, and Filing Information
3. The Different Income Tax Systems Worldwide
4. Tax-Free Countries 2023: No Income Tax Regions for Businesses 
5. International Programs – U.S. International Social Security Agreements
6. Claiming SS Certificate of Coverage