Dual Citizenship Taxes Overview (Intro Expat Guide)
Contents
An IRS Dual Citizenship Taxes Overview
When it comes to taxation for dual US Citizens, in general, the tax rules are the same for dual citizens as it is for US Citizens who do not have dual status. In other words, once a person becomes a citizen of the United States — even if they have dual citizenship with a foreign country — it does little to reduce or eliminate their US tax liability. The United States follows a Citizenship-Based Taxation model, which means the IRS taxes individuals on their worldwide income. For taxpayers who live abroad and generate earned income, they may be able to qualify for the Foreign Earned Income Exclusion. In addition, if they have paid foreign taxes overseas, they may qualify for a foreign tax credit. Here are a few important facts about dual US citizenship and US taxes.
Worldwide Income
The United States is one of the only countries that utilize a worldwide income/citizenship-based taxation model. That means the United States taxes US citizens and other US persons on their worldwide income. Therefore, even if a US citizen resides overseas and earns all of their money overseas, the United States still has an opportunity to tax the income generated by the US citizen outside of its borders, in accordance with the worldwide income citizenship-based taxation rules.
Foreign Income Taxable
One common misconception is that if income is earned overseas and that income is tax-free or exempt from tax in the foreign country, that is also tax-free in the United States. For example, some countries do not tax passive income such as interest income. Therefore, a US citizen that generates foreign interest income in a country that does not tax that source of income may presume that the income is not taxable in the United States either — but that would be incorrect. Unfortunately, foreign income is usually taxable in the US. Likewise, just because there is a tax treaty in place between the two countries does not typically exempt the income under US tax law.
Treaty Elections are Difficult
The US has entered into nearly 60 bilateral income tax treaties. Oftentimes, these tax treaties may reduce or eliminate certain taxation of income such as pensions, dividends, etc. But, tax treaties in general are geared toward non-permanent residents and not US citizens. Oftentimes, the saving clause –– which is contained in each tax treaty – – serves as a killjoy for US Citizens attempting to reduce or eliminate US taxes on foreign income.
Expatriation
In order to avoid US tax on worldwide income, US citizens will generally have to formally expatriate from the US and give up their US citizenship status. Depending on whether or not the person is a dual citizen a birth may impact whether they can avoid certain formalities and tax implications. If the taxpayer turns out to be a covered expatriate, there could be significant tax implications that they should consider before performing the formal expatriating act such as going to a foreign embassy to renounce.
Foreign Tax Credits
If a US citizen earns foreign income and has paid foreign taxes on that income, they may qualify for foreign tax credits. By using the foreign tax credits, the US citizen may be able to reduce or eliminate US tax liability on that same foreign income. It is not always a dollar-for-dollar credit — the equation/calculation is designed to ensure that those foreign tax credits are not used to offset other US-sourced income, so in some situations even if the taxpayer has significant foreign tax credits, it may not completely eliminate their tax liability in the US.
Foreign Earned Income Exclusion
If a US Citizen lives and works overseas, they may be able to apply for the Foreign Earned Income Exclusion to exclude upwards of $110,000 of their earned income. In addition, they may also be able to increase that amount based on expenses paid for foreign housing. Moreover, married couples who each qualify can both claim the exclusion. The exclusion is not used for passive income such as interest or dividends and does not apply to pensions either. Also, it is not based on dual citizenship per se – but can benefit dual citizens as well as US citizens and other US persons.
Current Year vs Prior Year Non-Compliance
Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.
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