What US Expats Should Know About Citizenship-Based Taxation 

If you’re a US citizen, there’s one burden you must carry no matter where you live or work in the world – Citizenship-Based Taxation (CBT). And as a US expat, this is arguably the most frustrating part of holding a US passport.

Here at Nomad Capitalist, we believe in ‘going where you’re treated best’. This includes living in a country that respects your freedom and doesn’t tax you into oblivion. 

Ideally, a country that doesn’t tax you at all. 

While practically everyone else in the world can become an expat in a low- or no-tax jurisdiction and simply slot into their new country’s tax rules, US folks are in a different situation. Just because you’ve left US soil, it doesn’t mean you’re free from the long arms of the IRS.

Proper tax planning is essential for US expatriates. This guide covers the must-know information.

What Is US Citizenship-Based Taxation?

Citizenship-based taxation is an approach that allows the US government to tax its citizens whether they live in the US, generate income from foreign sources or live overseas.

US citizens are required to file an annual federal tax return on their worldwide income and pay taxes wherever they live. 

The United States has doggedly committed itself to CBT over the course of the last century. Knowing about CBT, its rules, implications and penalties is, or at least should be, required reading for US expats.

So where did it come from?

It might seem odd, but the roots of the US citizenship-based taxation system – that causes expats so many sleepless nights – go back to the aftermath of the nation’s bloody civil war.

Back in the 1860s, as the US struggled with the destruction of war, much resentment was directed at Americans living abroad. 

These expats were accused of failing their civic duties during their country’s darkest hour, and an impatient Congress set out to ensure they contributed to the national cause.

Congress decided these citizens could compensate for their truncated civic participation by paying more tax on their US-sourced income. The law underwent several reforms until arriving at the present situation in 1913.

Citizenship and Taxes: Is CBT Common?

The US isn’t strictly alone in terms of its focus on CBT. 

A number of other countries like Mexico, Romania, Bulgaria, Vietnam, the Philippines, and Myanmar have done the same. However, they all quietly abandoned the idea after trying it out. 

Though not exactly the same, in a similar vein, nations such as Mexico, Norway and Finland require tax residents to pay taxes for a period of up to five years after migrating. 

For example, when a citizen of Finland moves to another country, they are generally regarded as a Finnish tax resident during the year when they move away and during the three following years. 

In Mexico, it’s five years, but only if they move to a country considered a ‘tax haven’.  

These days, it’s hard to find another country that uses CBT. Eritrea has something similar: the recovery and reconstruction tax (RRT), commonly known as the ‘diaspora tax’.

It’s not exactly the same as CBT. The Eritrean government charges a simple ‘diaspora tax’, a flat 2%, on its citizens who live abroad. The United States, on the other hand, taxes its non-resident citizens at the same rate as if they were at home.

Another difference between the two countries’ tax treatment of non-resident citizens is a United Nations Security Council (UNSC) resolution.

It seems the UNSC doesn’t like how Eritrea collects its ‘diaspora tax’ and passed a 2011 resolution denouncing the ‘extortion, threats of violence, fraud and other illicit means to collect taxes’ employed by the African nation. 

But while the US has escaped UNSC censure, it hasn’t escaped the sting of its own citizens’ displeasure. Many expats strongly object to what is described as an ‘unfair’ and ‘heavy-handed’ system that is out of sync with the modern world.

Even the Inland Revenue Service (IRS) admits its CBT system has shortcomings and insists on imposing ‘disproportionately high penalties for non-compliance’.

It’s fair to say the process is more than a little vexing for many US expats.

How Does Taxation of American Citizens Work?

As a US expat, here’s what you need to know about paying taxes. 

The United States taxes its citizens on their worldwide income, regardless of where they live. 

This means that even if a US citizen resides permanently abroad and earns all their income outside the US, they are still required to file a federal tax return and potentially pay US taxes. 

However, tax credits and exclusions, such as the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC), can help reduce or eliminate double taxation. 

Compliance is mandatory, and failure to file required forms like FATCA and FBAR can lead to severe financial penalties.

And while you’ll be filing tax returns with the IRS, you’ll also need to comply with the tax laws in your country of residence. 

There are various tax treaties with the United States that can offer some relief, and you could choose to live in a low- or no-tax country. 

So, you won’t necessarily be hit with an enormous double tax bill if you manage your affairs properly. 

However, it’s essential that you fully understand the tax implications of your scenario and that you plan it carefully. Our team of offshore experts can help.

Overseas US Citizen Taxes: Can You Escape the IRS?

Since the system has been in place, the onerous form-filling obligations and demanding timelines for submitting the required paperwork have caused expats no end of stress –  not least because failure to comply brings severe reprimand.

In fact, CBT has convinced many US citizens that it’s impossible to escape these obligations without renouncing their US citizenship. 

Here at Nomad Capitalist, we’re all too familiar with the impact of citizenship-based taxation on the entrepreneurs and investors we work with as they move overseas. 

It’s a major issue for many of these high-net-worth people, as blunt and indiscriminate as it is perplexing. 

On one hand, the US is the world’s leading economy and superpower. On the other, its tax arrangements for citizens appear draconian compared to countries like the United Kingdom, Australia and Canada.

If you move overseas from one of these countries, or just about any other you care to mention, you can pack your bags and live elsewhere relatively painlessly. 

By following the proper steps and checking all the boxes, you could end up paying less tax, depending on where you go. There is also the option of moving to a country that does not have personal or corporate taxes. er US$13,850 as a single filer. However, if you live overseas, you can use FEIE to reduce or eliminate much of your US tax liability. 

Complying with US Citizenship-Based Taxation Obligations 

US citizens have to file endless forms, such as FATCA, FBAR and forms 5471, 5472 and 2555. 

In short, being a US citizen overseas carries a major compliance cost. 

Even if you’re living or running a business in a high-tax country where you pay your fair share, you’ll still have the burden of complying with US citizenship obligations.

The question remains: why? 

According to the authorities, the answer is that every US citizen has a duty to contribute to their country regardless of where they live. 

In return for paying citizenship-based taxes, the individual has the right to return and participate fully in the economic and social life of the country whenever they choose. 

Another aspect is the value of consular services provided to US expats abroad. 

At Nomad Capitalist, we think the idea that the country has some unique claim to tax its citizens abroad when no other country does is unfair. 

The excuse that having a US passport is the golden ticket to success and that the US embassy is right behind you no longer rings true. 

American Citizens Abroad: Taxes and Foreign Living

One of the most exciting developments of the post-COVID era is the ability for so many people to live and work remotely. This has led to an explosion in the number of people choosing to move abroad. 

For most countries, taxation is based on residency. As the name implies, this means that only residents of the country are subject to the country’s taxation laws. 

However, if you’re a US citizen or resident living outside the United States, you’re generally required to file and pay estimated taxes, just like individuals residing within the US. 

Leaving the US doesn’t mean leaving the IRS.

The following are just some of the duties expats are expected to carry out:

• Income tax returns
• Estate tax returns
• Gift tax returns.

If you have foreign bank accounts, even if they don’t generate any taxable income, you must report them. 

Many Americans living abroad qualify for special tax benefits, such as the Foreign Earned Income Exclusion and foreign tax credit. Still, it’s only possible to avail of these by filing a US tax return. 

If you were under 65 at the end of 2024, you must file a tax return if your gross income was at least:

• US$14,600 as a single person
• US$21,900 as the head of a household
• US$29,200 if married and filing jointly
• US$5 if married and filing separately
• US$400 if self-employed.

You’ll need to express the amounts you report in US dollars and convert any foreign currency income or expenses in your return. 

In addition, foreign financial assets, income from a foreign trust or gifts from a foreign person must also be reported.

IRS Publication 501 includes the tax rules that affect every person who may have to file a federal income tax return. It answers some basic questions, such as who must file, what filing status to use and the amount of standard deductions. 

There’s a chart that shows your filing status, your age and what your gross income would need to be to require you to file a federal tax return. 

You can see that returns are generally required if you earn over US$14,600 as a single filer. However, if you live overseas, you can use the FEIE to reduce or eliminate much of your US tax liability. 

How Does the Foreign Earned Income Exclusion Work?

All overseas US citizens must file Form 1040 (Individual Income Tax Return) to report their worldwide income. 

Any foreign income, foreign companies or foreign bank accounts you have must be reported. However, the IRS does allow you to earn some income tax-free by claiming the FEIE. 

For more information, see our Ultimate Guide to the FEIE. 

Qualifying US citizens living abroad can exclude the first US$130,000 for the tax year 2025. For taxation purposes, the IRS classifies your income as active or passive:

• Active Income: Income earned through work activities in a foreign country. It includes wages, bonuses or self-employment income (this can be earnings from a US-based business or client). Even as an employee of a US-based company, if you actively generate income by living and working overseas, you will qualify for FEIE. However, you will still have to pay for social insurance and Medicare.
  
• Passive Income: This includes stocks, forex and crypto trading, capital gains, real estate profits, pension income, rental income and social security benefits. This is always taxed by the IRS.

That said, there are perfectly legal ways to use foreign corporations and foreign partners to reduce your taxes dramatically within FEIE rules. 

However, even if you qualify for complete income tax exclusion through the FEIE, you still need to file a tax return and report your income to the IRS.

What Happens if You Don’t File Your Taxes as a US Expat? 

Most penalties, such as those for not filing or paying taxes, are based on you owing some tax. 

To exclude a certain portion of your income or use a tax credit to offset any taxes you would owe, you have to file the tax return to receive the exclusion or the tax credit. So, if you haven’t filed, you could technically owe tax. 

You may be required to file other forms while living overseas that you aren’t required to while living in the US. These include the FBAR or the FinCEN 114 form, where you report your foreign bank accounts. 

If you own a foreign business or trust, those must be reported separately to the IRS. These forms come with penalties for failing to file. 

Whether you owe tax or not, these are informational returns, and these penalties can be significant. We’re talking US$10,000 and upwards. 

Making a US Tax Return from Overseas

Citizenship-based taxation has had a significant impact on the US expat community.

Thousands of US Citizens have handed back their US passports and reduced their travel privileges because they didn’t want to deal with the requirement of making a tax return from overseas. 

Ultimately, those who renounce their US citizenship want to avoid the hassle of filing and reporting taxes. 

They want to avoid dealing with the Foreign Corrupt Practices Act (FCPA) and Office of Foreign Assets Control (OFAC) and the multitude of different rules and sanctions that can apply. 

They want to live their lives and do business the same way that just about all other nationalities do.

However, as a US citizen under citizenship-based taxation, you must not only pay tax but also file a tax return. 

Exemptions and credits can dramatically reduce the bill, but trying to do everything from abroad can be a frustrating battle that endlessly and needlessly complicates your life.

Banks and brokerages may not want your business because you’re too much of a hassle. 

You may be unable to open certain bank accounts, make certain investments, or participate in certain crypto exchanges. 

Those things relate to citizenship-based taxation and the United States’ regulations on its citizens. 

While Canada, Australia, Germany and other Western countries have residential taxation, as a US citizen, you’ll pay tax on everything you do worldwide. 

Whether you live overseas or live in the US, you cannot escape federal taxation unless you plan to leave permanently. 

The bottom line is, if you’re looking to live the Nomad Capitalist lifestyle, having a second passport is essential for a US citizen. 

At least then, you have an option, an escape plan and greater control of your taxes. You will undoubtedly have a lot less hassle filling out your tax return.

Taxation of American Citizens: FAQs

Is US Citizenship-Based Taxation Worth It?

Choosing to renounce US citizenship is a tried and tested means of lowering your taxes, which many of our clients have achieved with relative ease. 

It takes planning to get a second passport and ensuring you have the ideal mix of location, lifestyle, tax planning and asset protection strategies to work in combination to achieve your goals. 

You can still substantially lower your taxes without renouncing by choosing to live overseas or moving to Puerto Rico. 

But whatever you decide to do, it must be structured properly. 

Your strategy will need to incorporate the best solutions among all available options. 

It’s what we call ‘going where you are treated best‘, and it looks different for each of the 2,000+ high-net-worth clients we’ve helped. 

Rest assured, our global team of professionals and country-specific advisors leave no stone unturned when it comes to helping you win personal and financial freedom. 

So, if you’re a US citizen reviewing your options, take the first step towards your new life and discover the Nomad Capitalist difference.