The United States has a Citizenship-Based Taxation system. This means that they deem individuals as “US Persons for Tax Purposes” using a variety of factors. These include physical presence, resident alien status and citizenship. Moreover, US taxpayers are subject to US income, capital gains, gift and estate tax on a worldwide basis.
However, most Americans are unaware that the US is the only major country that uses Citizenship-based Taxation.
Every other G20 country looks at physical presence and/or business and personal ties to determine if an individual is a taxpayer in its jurisdiction.
Therefore, the acquisition of another citizenship (with the noticeable exception of Eritrea) does NOT automatically make a person a taxpayer of that country. Only if the individual uses their citizenship to spend significant time or establish significant ties in the new country do they have to consider the possibility that they will become a taxpayer.
Citizenship-Based Taxation: So Why do US Citizens Living Abroad Still Pay US Taxes?
The United States takes a pretty unique approach to taxing individual income. Some countries – such as Monaco and Qatar – don’t tax income at all; for those that do – there are generally two taxation systems: territorial based and residence based.
What is territorial based taxation?
Examples include: Singapore, Hong Kong, Lebanon, Panama
In a territorial-based taxation system, you are only taxed on income earned inside the country’s borders. This means that if a person earns money in other countries, this income would be tax exempt.
What is residence based taxation?
Examples include: France, Germany, Portugal, Italy, Chile, Brazil
Residence-based taxation is by far the most popular system worldwide. The majority of countries do in fact use this system. Local residents are taxed on all income earned from both local and foreign sources. So you can be a non residing citizen and not have any tax to pay!
Citizenship based taxation
The USA is one of only two counties worldwide that use the citizenship based taxation system. This means that if you are a US citizen residing abroad, you must still file a US federal tax return and pay US taxes. This is true no matter where you live at that time.
It’s a common misconception that other countries follow the same tax model as the US, when in reality the US is the exception not the rule! This means that you may prepare for a backup plan by obtaining a second citizenship without making yourself liable for taxation abroad.
If you would like to find out more about how and where to apply for second citizenships do get in touch for a confidential, no-obligation chat.