A New/ Old Concept For An American: Perspective On Residency Based Taxation
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Today's post is going into dig into details of a Bill proposed by Congressman Darin LaHood (R) in December 2024 and how it may affect you if you are a U.S. Citizen and long-term resident overseas.
This bill proposes "Residency Based Taxation" (RBT) for American Citizens who are not residents of the United States.
If you remember, United States Citizens and Permanent Residents (Green Card holders) are subject to Citizenship Based Taxation (CBT)- a system of taxation under which no matter where you live in the world, you are subject to U.S. taxation and need to file your Income Tax return.
Even with many tax exclusions and credits that can be availed of, there might be some circumstances under which a non-resident U.S. citizen may be subject to double taxation under CBT.
The CBT rule has caused complex compliance situations for many of the estimated 5.5 million Americans (statistics for 2024) who live outside the United States. Quite a number of the Americans living abroad can be classified as "Accidental Americans" and this compliance is not voluntary and can be quite burdensome for them if their plan does not include settling in the U.S. Organizations such as American Citizens Abroad, representing these individuals have lobbied for a change in this tax complexity for a long time.
The Bill (linked below in Bibliography) goes into detail about many of the Code Sections that will need to be updated when it passes.
Disclaimer, I definitely need to re-read this proposal many times to get into all the points and look through the entirety of the Act. Watch this space as I learn and share!
For the sake of simplicity, I thought of first going over the broad aspects of the Bill for you ( if passed); what and whom it may impact; the process of election; eligibility etc.
Let us break down the Residency-Based-Taxation Bill into these categories:
- Eligibility
- Election
- Taxation
- Transition Tax
- FATCA Reporting
- Termination of Election
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Eligibility:
- One needs to be a U.S. Citizen living abroad and maintain a Tax Residency in the another country to be eligible to make an election to be taxed under RBT.
- The Bill proposes that in order to make this election, you should NOT have been a resident of the U.S for at least 3 out of previous 5 taxable years ending before the introduction date.
- The above 2 points will need to be certified under penalties of perjury.
- If you were born outside the United States and have never lived in the United States, beginning on the date you turned 25 years old or March 18, 2010 (whichever is later), you may be treated as eligible for this election.
- If you are abroad for a short term (less than 5 years), you may not be allowed to make this election.
- If you are a federal employee, you are not allowed to make this election.
- Language for Permanent Residents (Green Card holders) has not been added to the Bill, hence we can deduce that a Permanent Resident will continue to be taxed under the CBT or can make use of "Closer Connection" elections under tax treaties for tax savings.
Election:
- A United States Citizen can make an Irrevocable Election to be taxed under the RBT system.
- The user fee is proposed to be $100 per application adjusted for inflation.
- We can deduce from the Bill that an "Electing Individual" under the RBT will be treated as if they were Non-Resident Aliens (NRAs) for purposes of taxation.
- In order to make this election, the U.S. Non-Resident Citizen will have to certify that they have been current with their U.S. tax filings for the previous FIVE years.
- Once the Election is made, the electing person will be issued a Certificate of Non-Residency and their name will be added to a public database. The database will be updated if the election is terminated.
Taxation:
- Unlike the CBT, under the RBT an Electing Individual will only be taxed on their U.S-source income.
- At this time, it looks like they will have to file a Form 1040-NR, U.S. Nonresident Alien Income Tax Tax Return for the purpose of declaring their U.S- source income. At this time, unless amended for this purpose, the Form 1040-NR does not provide for the same deductions and credits as one may get if they are filing a "Regular" Form 1040.
- The United States will no longer be able to apply the "Savings Clause" under their Tax Treaties with other countries.
Transition Tax
- Certain "specified" electing individuals ( meaning those with a net worth more than the lifetime estate/ gift tax exclusion or $13.99 million in 2025) will be considered having made a "Deemed Sale" of all their assets on the day before the election date. They will have to recognize gain and pay taxes on the gain. They are allowed to net losses against these gains. Certain assets are exempted from application of deemed sale rules.
FATCA & FBAR Reporting
- Electing Individuals will no longer be subject to reporting under the Foreign Accounts Tax Compliance Act (FATCA) or the Form 114a, Report of Foreign Bank and Financial Accounts (FBAR) under the Bank Secrecy Act.
- This means they will not have to file certain forms to report their foreign specified financial assets or their holdings over a certain threshold or their holdings in the stock or interests in foreign business entities. These are Forms 8938, 5471, 8858 etc.
Termination of Election
- Your election will be terminated if you become a resident of the United States.
- Your election may be terminated and you will be treated as NOT having made any election for your entire term abroad- if you had made an election and your stay abroad ended in less than 5 years.
What are the chances that this Bill will pass?
Related Blog Posts That Might Interest You
Bibliography: Congressman Darin LaHood; H.R. 10468 - 118th Congress (2023-2024) “Residence-Based Taxation for Americans Abroad Act” ; AARO.org: How Many Americans Live Abroad; A side-by-side analysis of the Act written by ACA.
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