Worldwide Income – Why the US taxes citizens on worldwide income regardless of where they live?
Taxation of Worldwide Income
The U.S. is the only country that has taxation of worldwide income for all of its citizens, no matter where they live and regardless of how long they have been overseas. Well, actually the U.S. is almost the only country. Eritrea has what is known as a “diaspora tax” on its citizens.
If you are a U.S. citizen or resident alien, the rules for filing income, estate, and gift tax returns and paying estimated tax are generally the same whether you are in the United States or abroad. With taxation of worldwide income, your U.S. and foreign income is subject to U.S. income tax, regardless of where you reside. It is a citizenship-based income tax.
Elsewhere in the world, the basic rule is that taxes are based on residency and not on taxation of worldwide income based on citizenship.
The origin of taxation of worldwide income is with the first federal U.S. income tax, enacted in 1861 in the early months of the American Civil War as part of the Revenue Act of 1861. It levied a 3% tax on incomes over $800, but a 5% tax on income earned in the U.S. by “any citizen of the United States residing abroad.”
The aim was to prevent wealthy people ducking their military and civic obligations by fleeing the U.S. in its time of crisis. In 1864, the tax was expanded to include income from all sources, no matter where generated. Scholars say this happened as the proud sense of being a citizen of the U.S. – with all its opportunities and obligations – first flowered out of the battlefields.
The defense of citizenship-based taxation and taxation of worldwide income rests on the belief that U.S. citizenship confers benefits independently of residence. It is not necessary that the amount of benefit received be reflected precisely in the amount of tax charged. Income tax liability is measured by the ability to pay, not by the amount of services used during the tax year. But benefit is an important consideration in the scope of an income tax. Many overseas taxpayers feel that taxing the income of nonresident citizens is justifiable only if they derive significant benefit from their U.S. citizenship.
Nevertheless, this model of citizenship-based taxation of worldwide income has remained in the U.S. law ever since, even as the rest of the world has gravitated to a different model, one that simply considers where the taxpayer is living at the moment. Over the years, there has been no serious attempt by lawmakers to end the taxation of citizens who do not reside in the U.S. Instead, the focus of the debate has generally been on the extent to which the earnings of Americans working overseas should be taxed – by both the country of work/residency and the United States.
Tax Residency Taxation Model
The question of whether the U.S. should now switch to the residency model has been generating more debate in recent years, particularly as the U.S. has stepped up tax enforcement on its non-resident citizens. Americans abroad are renouncing their citizenship in greater numbers over the last couple of years, in part because of the increased red tape.
Many say it’s time to fall in line with other countries, especially in an age of increased globalization. But others argue that increased mobility makes a case for maintaining the U.S. model of taxation of worldwide income, not getting rid of it.
For more information and resources on taxes for taxpayers that reside overseas and the taxation of worldwide income, including preparation of your expatriate tax return, please visit Tax Samaritan for additional information or assistance.
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Hi Dean, I agree it is unfair that the U.S. taxes on worldwide income regardless of residency. It is an extra burden with tax compliance, but hopefully with a knowledgable and experienced tax professional the process can be as painless as possible with the least burden (optimally no tax liability to the U.S.).
Often, the tax code doesn’t follow common sense or logic. Heck, I do taxes everyday and sometimes I shake my head wondering “what was Congress thinking”. Nevertheless, it is the law and U.S. citizens and residents are required to comply and make the best of it. Foreign Donors (foreign citizens) aren’t held to the U.S. tax code as a U.S. taxpayer unless they are citizens or residents, however it does apply to a recipient that is.
I think that, taxing U.S. Citizens on their worldwide income, when they are not resident in the U.S., is ridiculous and unfair! When the rest of the world, taxes, based on residency & not citizenship
We are not living back in the 1860’s! No wonder, U.S. Citizens residing overseas, are renouncing their citizenship, by the thousands!
Who wants to be filing/preparing 2 separate tax forms, to 2 different countries, never mind having to pay double taxation or having to complete 2 tax forms for their spouse as well??
Do they think that. we have nothing more important to deal with in our every day life, given the economic
crisis or health problems, other than worrying about damn taxes for the U.S.??
Not to mention, that we are overtaxed, as it is, on every service or good we buy, in these E.U. member states!
It may also be done, by U.S. politicians, out of spike & ignorance! They somehow, misconceive, that all Americans living/residing overseas, are wealthy or trying to cheat the tax man & that is the reason they live overseas!
Our politicians, need to wake up! Who is looking out after our best interest? Who is representing us, on this
issue, I ask?? No one!!
These same politicians, are quick to ask for our vote & monetary support, come election time, whether we
live in the U.S. or abroad! In fact, we the ones overseas, get pestered with emails, by our politicians, much
more, than the voters residing in the U.S.!
On the Foreign Gift Tax, why does the Foreign Gift Donee, have to disclose, any gifts over the amount of
USD 100k? Does the Domestic Gift Donee, have to do the same??? And what of the Lifetime Gift Allowance
of USD 1 Million & Estate allowance of USD 2 Million, then, which applies, to domestic Gifts & Estate?
Shouldn’t that also apply to the Foreign Donor too, then??
Hi Dean, thank you for your comments. I agree that the treatment and additional rules for americans overseas is unfair and often burdensome and overly complex.