5 ways citizenship-based taxation harms Americans abroad

by Eric Vence

Dear Congress,

Living abroad can be an exciting and enriching experience. It offers individuals the opportunity to explore new cultures, build international connections, and expand their horizons. For American citizens residing overseas, however, complying with U.S. tax laws often presents daunting challenges and complexities.

Unlike most countries, the United States enforces a citizenship-based taxation (CBT) system, which means that regardless of where they live, Americans are required to report and potentially pay taxes to the U.S. government in addition to their countries of residence. This article aims to shed light on how CBT affects Americans living abroad, particularly those who already pay taxes in their country of residence.

I am French-American. Both of my parents are French. I was born in Boston. I left the United States when I was 1 year old. I now live in Paris with my wife and two kids. I have an engineering degree and, after working for 10 years in the private sector, I now run my own software publishing company.

Understanding CBT

Citizenship-based taxation is a unique concept employed by only two countries worldwide, the United States and Eritrea. Under the U.S. system, U.S. citizens are obligated to report their worldwide income to the U.S. Internal Revenue Service regardless of its source or where they live. This approach stands in stark contrast to residence-based taxation, which most countries use and which requires individuals to pay taxes based on their country of residence.

Some Americans abroad pay double taxes

The biggest fear for Americans living abroad is the potential for double taxation. Double taxation occurs when an individual is taxed on the same income by both their country of residence and the United States. For instance, if an American citizen is already paying taxes to their host country, CBT would require them to report the same income to the U.S. government, potentially resulting in additional tax liability. Some bilateral treaties address this issue, but not all countries have them.

Foreign tax credits and exclusions

To mitigate the issue of double taxation, the United States offers certain provisions such as foreign tax credits and exclusions. The foreign tax credit allows individuals to offset any U.S. taxes owed by claiming a credit for taxes already paid to their host country. This provision aims to prevent Americans from being taxed twice on the same income. Additionally, the Foreign Earned Income Exclusion (FEIE) permits eligible individuals to exclude a certain amount of their foreign earned income from U.S. taxation.

Complex reporting requirements

One of the significant challenges for Americans living abroad is the complex reporting requirements associated with citizenship-based taxation. U.S. citizens abroad are obliged to file various forms, such as the Report of Foreign Bank and Financial Accounts (FBAR) and the Foreign Account Tax Compliance Act (FATCA), which Americans living in the United States are not. Failure to comply with these reporting obligations, even inadvertently, can result in severe penalties, making it crucial for American expatriates to keep up-to-date with evolving tax laws and regulations.

Financial burdens and compliance costs

For many Americans living abroad, the intricacies of citizenship-based taxation translate into additional financial burdens and increased compliance costs. The complexity of the U.S. tax code, coupled with the need for professional assistance to navigate the intricacies, often leads to higher accounting and legal fees amounting to thousands of dollars per year. Furthermore, the process of preparing and filing taxes becomes more time-consuming and demanding, requiring expatriates to allocate significant resources to ensure compliance.

Impact on savings and professional opportunities

The citizenship-based taxation system may also impact personal and professional opportunities for Americans living abroad. Some individuals face limitations on employment or investment opportunities due to the reporting requirements and potential tax implications. Additionally, many foreign financial institutions are hesitant to provide services to U.S. citizens because of the regulatory burdens the U.S. government places on foreign financial institutions with U.S. clients.

Advocacy for tax reform

Over the years, many organizations and advocates have called for reforms in the U.S. tax system for citizens living abroad. They argue that CBT places an undue burden on Americans residing overseas, hindering their ability to live normal lives abroad and fully embrace their international experiences. Proposed reforms often suggest a shift towards residence-based taxation or the implementation of a "territorial" tax system, similar to what is followed by most other countries. Unfortunately, those calls so far have fallen on deaf ears in the U.S. Congress. That’s one reason we have launched this campaign — to help make Americans abroad harder to ignore.

American citizenship-based taxation harms U.S. citizens living abroad, particularly those who already pay taxes and want to build projects abroad.