US Residence-Based Taxation

Question: What do the United States of America and the small nation of Eritrea have in common?

Answer: They are the only two countries in the world that impose worldwide tax based on citizenship. Translation: unlike other countries, they tax their citizens regardless of where they live whether it be in the country or abroad.

As an American expat and cross-border wealth planner, nearly every day, I see the effect of this. From burdensome reporting requirements to punitive taxation of foreign investments to paying hundreds of thousands of dollars of extra tax each year, the implications are manifold.

However, back in December 2024, there appeared a potential light at the end of the tunnel…cue residence-based taxation.

What Happened?

On December 18, 2024, U.S. Representative Darin LaHood from Illinois introduced the Residence-Based Taxation for Americans Abroad Act. This bill details a plan to shift the US from citizenship-based taxation to residence-based, which is in-line with most countries (e.g., France, Spain, Australia, Mexico).  

For US persons abroad, this could simplify cross-border tax reporting, decrease punitive tax on foreign investments, and save significant amounts of money for those living in a low-tax jurisdiction (e.g., Singapore, Hong Kong, Dubai), along with costly tax preparation-filing fees, particularly for those with foreign businesses.

What Does the Proposal Entail?

First, this legislation would not automatically apply. Rather, you would have to opt-in to it. This would involve certifying under penalty of perjury that you have complied with all US tax requirements for the five previous years and, pay a departure tax, if applicable.

Upon making this election, you would only be subject to US tax on US sourced income (e.g., business income performed in the US, US rental property income, and distributions from US retirement accounts). However, income earned from non-US sources, like wage income abroad and foreign rental property income, would not be taxed by the US. This election would be valid until an individual terminates it or moves back to the US.

Moreover, this would enable you to avoid specific reporting requirements like Statement of Specified Foreign Financial Assets (Form 8938), Information Return of US Persons with Respect to Certain Foreign Corporations (Form 5471), and FBAR. For foreign business owners, this can be particularly impactful.

Lastly, by making this election, you would still retain US citizenship, your ability to vote in elections, and receive social security benefits.

What Is the Departure Tax? 

For those with significant assets, making the election could result in immediate tax. This would be a mark-to-market tax on assets, treating them as if they were sold on the day prior to the election. However, this would not apply to specific assets that are tied to the US, like real estate in the US, IRAs, 529 Plans, HSAs, and the like. Also, foreign property that you have lived in for the past two of five years would not be subject to this mark-to-market.

Moreover, there are exceptions for those who have:

1. A net worth less than the estate and gift tax exemption ($13.99MM in 2025).
2. Lived abroad for at least three of the past five years and certified that they have been in tax compliance for the three years prior.
3. Not lived in the US since attaining age 25 or post-March 28, 2010 (date FATCA was adopted).

What Else Is There to Consider?

This election is primarily for those who intend on living abroad for a long period of time.  In this regard, there is a clawback provision for those who make the election and then return to live in the US within the next three years.

For example, if I make this election in 2025, do not pay US tax in 2025 and 2026, but then in 2027 there is a family emergency and I move back to the US, then I can be retroactively taxed for 2025 and 2026. For those who aren’t sure of their timeline abroad, this is a consideration.

What Are the Implications of this Proposal?

If this bill comes to pass, a few thoughts come to mind:

1. Tax Savings—For those who live in a low-tax jurisdiction, this can save significant amounts of US tax annually.
2. No Tax Savings, But Simpler Reporting—For those in high-tax jurisdictions, this may not save in tax, but it could simplify your tax situation and annual reporting.
3. Foreign Business Ease—For those with foreign businesses, this can be a major advantage in terms of avoiding GILTI tax and burdensome/costly reporting requirements.
4. Clawback Danger—For those unsure of their timetable living abroad, it will be important to consider before making this election, as there can be tax ramifications if moving back to the US within three years.
5. FATCA—Since those who make the election won’t be subject to FATCA, foreign banks might be more intent on working with US persons abroad, enabling access to foreign investments. It will be important to be cautious though, since a lot of foreign investments have high, hidden fees and can be risky.
6. US Persons Abroad Grandfathered-In—It appears that in its current form, US persons who have lived abroad for the previous three of five years may not be subject to the departure tax, even if their net worth is above the $13.99MM threshold.

Conclusion

While this bill is highly appealing for US persons living abroad, there is no promise that it will pass. Per one source:

“The chances of a bill like this to be passed on its own is slim; therefore, the goal is to attach the bill to a bigger tax bill.  Currently, discussions are underway in Congress for a tax bill that must pass by December 31, 2025, due to certain tax provisions expiring. This is the best opportunity for the Elective Residency-Based Tax bill to get attached to a bigger tax bill that is moving. Legislation is more likely to pass when it garners strong bipartisan support. It’s important to ask all Members of Congress if they will co-sponsor the bill regardless of party affiliation. While there is no guarantee the bill will pass, having more co-sponsors and encouraging constituents to urge their Congressional representatives to co-sponsor the bill increases bipartisan support. This, in turn, raises the likelihood of the bill being attached to the larger 2025 tax legislation, improving its chances of becoming law.”

Currently, we are at a “wait and see” point to determine if this proposal will pass and in what final form it may take, as it is subject to change. We will continue to monitor the situation and advise clients as it progresses.

For more questions on residence-based taxation, please reach out to one of our wealth planners.

Sources:

https://iqconnect.house.gov/iqextranet/iqClickTrk.aspx&cid=IL18DL&crop=0000.0000.0000.0000&report_id=&redirect=https%3a%2f%2flahood.house.gov%2f_cache%2ffiles%2fc%2f2%2fc2b6cbcc-e804-4e07-9782-4572d2e96c08%2fECA47B5FAE86A2B5140AB4729D0E23F7.residence-based-taxation-for-americans-abroad-act.pdf&redir_log=342633302981060

https://kpmg.com/xx/en/our-insights/gms-flash-alert/flash-alert-2024-257.html

https://lahood.house.gov/2024/12/lahood-introduces-bill-to-modernize-tax-system-for-americans-living-overseas

https://www.americansabroad.org/breaking_news_residence_based_taxation_legislation_introduced_today_by_representative_lahood_in_the_118th_congress_241218

https://www.democratsabroad.org/elective_rbt_explainer

https://www.democratsabroad.org/rbt_bill_faq

This material is intended for educational and informational purposes only. It is not intended to provide specific advice or recommendations for any individual. Additionally, you should consult with your Financial Advisor, Tax Advisor, or Attorney on your specific situation. The views expressed in the material are that of the author and do not necessarily reflect those of any market, regulatory body, State or Federal Agency, or Association. All efforts have been made to report or share true and accurate information. However, the information may become materially outdated or otherwise rendered incorrect due to subsequent new research or other changes, without notice. The author nor the firm are able to always verify the content from third-party sources. For additional information about the firm, please visit the MAS Website at https://www.mas.gov.sg/  and the SEC Website at www.adviserinfo.sec.gov. For a copy of the firm's ADV Part 2 Brochure, please contact us at info@avriowealth.com.