Representative Darin LaHood just introduced the “Residence-Based Taxation for Americans Abroad Act” on December 18, marking a potentially transformative moment for Americans living overseas. This bill aims to overhaul the United States’ unique system of citizenship-based taxation—a regime that taxes citizens on their worldwide income regardless of where they live—and replace it with a residency-based system. If enacted, this change could significantly alleviate the compliance burdens that expatriates have endured for decades.
The Current U.S. Tax System: A Global Outlier
For those unfamiliar with the intricacies of the U.S. tax regime, the current framework is an anomaly in the global landscape. Most nations tax individuals based on residency, meaning income earned abroad by non-residents generally falls outside their tax scope.
By contrast, U.S. citizens, even those who have never lived in America or have lived abroad for decades, must file U.S. tax returns and report foreign income. While special rules such as the foreign earned income and foreign housing exclusions as well as foreign tax credits exist to mitigate double taxation, they do little to ease the administrative and financial burdens imposed on expatriates. The Residence-Based Taxation Act is designed to address these issues by aligning the U.S. tax system with those of nearly every other country.
Key Provisions of the Residence-Based Tax Proposal
Under the proposal, Americans living abroad who elect to transition into this new framework would be taxed solely in their country of residence. For U.S. tax purposes, they would be treated as nonresident aliens, subject only to tax on U.S.-source income.
This transition is not automatic and involves stringent requirements. To opt into the new system, individuals must certify under penalty of perjury that they have complied with all U.S. tax obligations for the preceding five years. (This will often present a huge challenge for an “Accidental American”). They must also submit evidence to the IRS proving residency in a foreign country. The IRS will then issue a certificate of nonresidency. Once the election is made, it is irrevocable except under specific circumstances, and individuals must continue to meet nonresidency criteria to remain eligible.
Residence-Based Taxation: Reporting Exemptions and FATCA Relief
Significantly, those who elect into the new system would be exempt from a host of U.S. tax reporting obligations, including filing requirements under the Foreign Account Tax Compliance Act. Foreign financial institutions, often reluctant to deal with American clients due to FATCA’s stringent reporting mandates, would no longer need to report on these individuals once presented with the IRS-issued certificate of nonresidency. This might alleviate banking problems experienced by many Americans abroad who find they are not welcome at foreign financial institutions.
Americans Born Abroad, Wealthy Individuals and Green Card Holders
The legislation also makes provisions for Americans born abroad, who will automatically fall under the new system unless they establish U.S. residency.
Wealthy individuals—those with a net worth exceeding the estate tax exclusion amount, currently $13.61 million—would be subject to a “departure tax” upon opting into the system. It’s worth noting that the exclusion amount is slated to revert to approximately $7 million after 2025 unless Congress acts to extend current provisions. The departure tax would treat the individual as selling his worldwide assets at fair market value, requiring payment of U.S. tax on any pretend gains.
Interestingly, the bill appears to exclude green card holders from electing into the new system, further narrowing its scope. This would make sense since green card holders living and working abroad do not remain outside the U.S. for long periods. If they do, they often face U.S. immigration challenges as to whether they are maintaining the required U.S. residency requirements.
Future Prospects for Residence-Based Taxation
While the bill’s fiscal impact remains under evaluation, mechanisms like the departure tax and associated application fees could offset potential revenue losses. Representative LaHood is actively seeking bipartisan support to move the legislation forward. However, with the current Congress winding down, it seems unlikely the bill will gain traction before the new 119th Congress convenes on January 3, 2025.
Unsurprisingly, the proposal has been met with enthusiasm from expatriate advocacy groups, who see it as a long-overdue step toward fairer tax treatment. However, history may dampen this enthusiasm.
A very similar residence-based taxation proposal, the “Tax Fairness for Americans Abroad Act of 2018” (H.R. 7358), was introduced six years ago but failed to advance. Its failure highlights the significant political and logistical hurdles such legislation faces, despite widespread support from expatriate groups. Critics of the earlier bill raised concerns about revenue impacts and enforcement mechanisms, issues that will likely resurface as LaHood’s proposal is debated. Whether history repeats itself or this marks a breakthrough remains to be seen, but the introduction of the Residence-Based Taxation Act signals that the conversation about tax fairness for Americans abroad is far from over.
I help with tax matters around the globe.
Reach me at vljeker@us-taxes.org
Visit my US tax blog www.us-tax.org It is an invaluable guide in all areas of U.S. international tax. It will help you stay on top of legislative developments, keeping you ahead of US tax changes impacting your life, family or business.
Read the full article here
