What is Double Taxation and how can US expats avoid it?

Before the election, President-elect Trump announced his intention to reform the US tax system for Americans living abroad, promising to end double taxation for expats. In his statement, Trump emphasized, “I support ending the double taxation of overseas Americans,” a pledge that has sparked significant interest and cautious optimism among the estimated 9 million US expats worldwide. 

Expats face unique financial and compliance challenges under the current citizenship-based taxation system. While the idea of eliminating double taxation is appealing, the details, implications, and feasibility require a closer look.

Is there double taxation for expats under the current system?

Under the US citizenship-based taxation, all US citizens must file US taxes and report their worldwide income to the IRS every year, wherever in the world they live or work. However, because many Americans living abroad must also pay taxes in their country of residence, citizenship-based taxation creates the risk of double taxation, meaning the same income is taxed by both the US and the expat’s country of residence. 

For example, an expat earning a salary abroad could owe income tax in their country of residence and still be required to report and potentially pay taxes on that same income to the US.

However, though claiming IRS provisions when they file their US tax returns such as the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit, as well as in some cases tax treaty provisions, the vast majority of expats can, under the current system, avoid double taxation. There are exceptions though, such as self-employment tax double taxation for expats living in a country that the US hasn’t signed a Totalization Agreement (social security tax treaty) with. 

How citizenship-based taxation creates issues for Americans overseas

Rather than double taxation, which can normally be avoided, a bigger source of frustration for most Americans living abroad is having to report both non-US income as well as their foreign bank accounts and financial assets to Uncle Sam every year. 

Annual filing often requires professional assistance, especially reporting obligations under the Foreign Bank Account Report (FBAR) and Foreign Account Tax Compliance Act (FATCA), and for expats with non-US corporations and investments. 

These complexities not only affect expats but also individuals known as “accidental Americans”. These are US citizens who were born on US soil but have no significant ties to the country. Often, they are unaware of their obligation to file US taxes. This lack of awareness can lead to unexpected liabilities.

The US tax system’s impact extends beyond tax filings, leading some expats to struggle to access banking relationships, mortgages, and other financial services. Due to FATCA, foreign banks and other financial institutions are burdened with compliance requirements, making them hesitant to work with Americans. Many institutions avoid the hassle altogether, refusing to work with US expats due to the complexities of cross-border reporting.

For many, the burden of complying with FATCA and US tax filings has led to the drastic decision to renounce their US citizenship. Renunciations reached record highs in recent years, and in response, the US State Department raised the renunciation fee from $450 in 2010 to $2,350 in 2015. This is more than twenty times higher than the global average. Despite criticism and legal challenges, this fee remains unchanged.

Will Trump end citizenship-based taxation?

Trump’s proposal to end ‘double taxation’ for expats didn’t provide any detail as to how he might achieve this. 

The implication however was that the president elect might replace citizenship-based taxation with residency-based taxation, where the US would only tax US residents. This would align the US with most other nations. 

However, was it just a pre-election sound bite to appeal to overseas voters? Certainly, changing the taxation of overseas Americans wouldn’t be straightforward in practice.

Legislative and political hurdles to change taxation for Americans abroad

The reason citizenship-based taxation and subsequent laws introducing FBAR and FATCA exist is to prevent offshore tax evasion. Switching to residence-based taxation could open the door to a large outflow of money and risk the US losing the ability to police offshore money laundering and tax evasion, along with a potential loss of tax revenues.

While studies suggest the overall impact could be minimal, Congress would need to weigh this risk against the benefits of reform. Republican control of Congress could improve the odds of implementing residence-based taxation, but prioritizing such reforms in a challenging fiscal environment remains uncertain.

Despite these hurdles, organizations like American Citizens Abroad (ACA) have championed reform for over two decades, in the form of a switch to residence based taxation or perhaps a simplified reporting requirement for lower earning expats. Trump’s recent commitment to ending double taxation has reinvigorated discussions, earning praise from ACA and prompting them to seek similar support from other political leaders.

The outlook for double taxation for expats

While current provisions such as tax treaties, the Foreign Earned Income Exclusion and the Foreign Tax Credit serve to prevent double taxation for most expats, compliance remains an ongoing challenge. A switch from citizenship based taxation to Residence Based Taxation would certainly alleviate the reporting burden for expats. However, the potential loss of revenue and more importantly the current global financial reach that the US government enjoys enabling it to prevent and disincentivize tax evasion perhaps makes a switch to residence based taxation unlikely. 

The other option of simplified reporting for lower earning expats or those with simple financial circumstances is perhaps a more likely scenario. However, similarly to Trump’s previous promise to introduce a postcard-sized tax return (which then necessitated additional appendices), reforming reporting for Americans abroad isn’t as straightforward as Trump may hope.

In the meantime, to avoid double taxation expats should be proactive, gain a clear understanding of their obligations, and seek professional advice if required.