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You must pay US income tax, even if you don't live in here


Of the nearly 200 countries in the world only two (2) countries use citizen based taxation (CBT): Eritrea (a small impoverished African country) and the US. There are a handful of other countries that use CBT in very limited situations; primarily if citizens no longer have ties to their homeland.

What is CBT? CBT is a taxation scheme that taxes worldwide income of all citizens of a country, regardless of whether they reside in their home country. For example, if you are an American citizen residing and working in France, the wages you earn in France are taxed by the US. By contrast, residency based taxation schemes tax only residents. Is CBT unfair and unreasonable? Here’s an example that might be more understandable. Let’s say you moved from Michigan to Georgia. You are no longer a resident of Michigan but are now a resident of Georgia. Would it be unfair and unreasonable for Michigan to continue taxing your earnings when you no longer reside in Michigan? This results in double taxation.

There are some caveats to the US’s CBT scheme. It allows taxpayers to exclude foreign earned income and certain housing allowances. In 2015, the foreign earned income exclusion was $100,800. This exclusion requires meeting one of two residence tests, either the Bona Fide Resident test or the Physical Presence test. If you pass one of the residency tests, you are permitted to exclude foreign earned income up to the limit. Any foreign earned income above the limit is taxed as ordinary income. However, you may be able to take a foreign tax credit on your US return, if you paid income tax in your country of residence. The foreign tax credit laws are complex and you should consult an experienced international tax attorney or CPA for guidance.

It is important to note, that all US citizens are subject to the US’s CBT scheme. That includes individuals born and raised abroad that are US citizens simply by way of birth (i.e. having an American mother or father). Even if the individual has never lived in the US, has no ties whatsoever to the US, and has never applied for or obtained a US passport. The individual is still subject to CBT, as the laws are currently written. Moreover, this individual is also required to comply with the laborious FBAR and FATCA reporting requirements. For more details on FBAR and FATCA, see my article here. Although renouncing one’s US citizenship will relieve you of the ongoing taxation and compliance requirements, it will subject you to an exit tax. The exit tax is a tax paid in order to emancipate oneself from the US tax system.

CBT schemes are unfair and draconian. However, since most Americans and our elected leaders are more focused on terrorism, CBT will remain just another acronym.

Shame. Americans and our elected leaders are more focused on terrorism, CBT will remain just another acronym. Shame.