With tax reform a hot topic in Washington, key Republican lawmakers in Congress are considering a major change to the U.S. tax system: eliminating citizenship-based taxation and moving to a residence-based system, according to a report in today’s Financial Times (subscription required) and also reported by Bloomberg. Under current law, U.S. citizens are taxed on their worldwide income, no matter the source and no matter where they live, and must file a U.S. income tax return (and pay applicable U.S. taxes) each year. The proposal under consideration would shift the U.S. tax system to a residence-based regime, which would tax only income earned in the United States.
The United States is one of the few countries in the world with a worldwide system that taxes its citizens regardless of where they live and work. To be sure, U.S. citizens living and working abroad are afforded some tax breaks under the current regime, including the ability to exclude nearly $100,000 of their foreign earnings from U.S. tax and the opportunity to claim credit on their U.S. return for certain foreign taxes paid in order to avoid, or at least minimize, the risk of double taxation.
In the article published in today’s Financial Times entitled “US expats hope for lower tax bills as shake-up seeks to end levies at home,” Demetri Sevastopulo and Barney Johnson write that “[m]illions of US citizens working overseas could see their tax bills lowered by an overhaul of the tax system as Republicans eye the elimination of a requirement for American expatriates to pay taxes both overseas and in the US.” According to the article, Republican Kevin Brady, who chairs the powerful House Ways and Means Committee, said that lawmakers were “seriously” considering moving to a residence-based tax regime. “It is under consideration. They have made the case,” Congressman Brady told the Financial Times.
According to the Association of Americans Resident Overseas, 8.7 million Americans reside in more than 160 countries around the world. That number is likely understated, as it does not appear to include individuals who are foreign nationals who also have U.S. citizenship.
In addition to being subject to tax on their foreign earnings, U.S. citizens residing abroad face additional U.S. tax compliance burdens, particularly those requiring all U.S. taxpayers to disclose information regarding their non-U.S. bank accounts and other non-U.S. financial assets under the “FBAR” and “FATCA” reporting regimes. The Taxpayer Advocate has expressed significant concerns about what she calls “FATCA-Related Hardships” imposed upon U.S. expatriates, including banking “lock-out” by foreign banks that have elected to eliminate their U.S. clientele. These burdens on U.S. citizens abroad have no doubt contributed to growing number of individuals who choose to renounce their U.S. citizenship or long-term residency status. Moving to a residence-based tax system in the U.S. would be welcome relief for the large community of U.S. expatriates and dual citizens residing around the world.