Citizen & Residence-Based Taxation Systems

It is very important for you to know the difference between the taxation systems that are employed all over the world. The more commonly known used systems that we will talk about are Residence-Based and Citizen-Based taxation systems. Knowing what, who and how much that is taxed is important because it determines the implications on Americans who live in foreign countries that have differing tax systems.

If you are an American that is living abroad either for a short or long period of time, you might be possibly hearing these terms for the first time! It might be a little confusing at first but knowing the systems will help you understand what you need to know depending on where you live.

What is Citizen Based Taxation?

Citizen Based Taxation is the rarest of all the systems as the only two countries that employ this kind of system are the United States and Eritrea. This kind of system is simple for you to understand: Citizens that are from countries that employ this system that live in another country are required to file regardless of the source. 

For example, If you are an American citizen that is living in Canada, and even a citizen of Canada, you are still subject to taxes from the United States. This can be frustrating for those who solely live and make money elsewhere outside of the US but the only way out of this is to renounce your citizenship, however a decision like that should not be made so hastily or without a considerable amount of thought. 

Demonstrating the variety of people.

Perhaps you don’t make any income outside of the United States or Eritrea so you may think you don’t have to file but are still required to file an annual information return. There is the Foreign Earned Income Exclusion that allows expats to free from US tax liability but though exemption can still be attained a return is still required to file. The FBAR (Foreign Bank Account Reporting) is something you may want to look into if you have possessions that meet or exceed the thresholds. The thresholds are met if during at any point in the tax filing year you have more than $10,000 in all of your foreign bank accounts in total. Another

What is Residence-Based Taxation?

Residence-Based Taxation is far more common. This kind of system is employed by countries such as Mexico, Canada, United Kingdom, New Zealand, Australia, the majority of the EU. Countries in Africa, South America, and Asia use similar systems. How each country defines a tax resident differs so it is important to read into how the country you are residing is defining how a resident status is attained. This kind of system implies this: Residents of the country are subject to taxation on their local and worldwide income. Nonresidents are only subject to taxation on income that is from the country. 

It is important to note that if you are a US expat that lives in a country that employs a residence-based taxation system you could be facing double taxation. This complicates things but you can lighten the tax rate with the Foreign Tax Credit, which is a credit for your US taxes based on the taxes you paid in a foreign country.

We know that these systems can be overwhelming at first but our team is dedicated to help make this process so much easier for you to understand and to know that you are in good hands. Please don’t hesitate to reach out and get the answers you are looking for.

In our last post we discussed several key aspects of taxes that US citizens should know. If you are here on the website for the first time and are looking for an introduction on things you need to know as an American that is living abroad you can read more here! 

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