A proposal to end citizenship-based taxation for US citizens living overseas

Editor: Mary Van Leuven, J.D., LL.M.

On Dec. 18, 2024, U.S. Rep. Darin LaHood, R-Ill., introduced the Residence–Based Taxation for Americans Abroad Act (H.R. 10468), which would change the current system under which all U.S. citizens are subject to U.S. income tax regardless of their country of residence. If enacted, the bill would provide significant relief for qualifying U.S. citizens living abroad in relation to both their U.S. tax liability and their information–filing requirements.

Background

Since its inception, the U.S. income tax has applied to the worldwide income of U.S. citizens without regard to where they live. However, in recent years there have been a number of legislative proposals to mitigate or amend this rule. In 2018, Rep. George Holding, R–N.C., introduced the Tax Fairness for Americans Abroad Act of 2018 (H.R. 7358). In 2021, Rep. Donald S. Beyer Jr., D–Va., introduced the Tax Simplification for Americans Abroad Act (H.R. 6057), and in 2023 he introduced a similar version of the same bill (H.R. 5432). Each of these bills would have modified the rules under Sec. 911 (which provides an exclusion for the foreign earned income of U.S. citizens and residents living abroad) so as to expand the exclusion to cover unearned income and to make other changes to the reporting requirements applicable to U.S. citizens living abroad.

None of these bills moved forward through the legislative process and thus have not been enacted into law. However, the issue of ending worldwide taxation for U.S. citizens living abroad achieved a new level of urgency during the 2024 presidential campaign when Donald Trump released a campaign video on Oct. 20, 2024, in which he pledged to end double taxation on overseas citizens.

The introduction of the Residence–Based Taxation for Americans Abroad Act by LaHood in December 2024 is the first step toward implementing Trump’s proposal. The bill represents a comprehensive overhaul of the tax regime applicable to U.S. citizens abroad that departs significantly from the previous bills outlined above. The bill’s proposals are analyzed in detail below.

The bill’s proposals

Election to be treated as a nonresident: Under current law, the rules for determining whether an individual is a resident or nonresident of the United States for income tax purposes apply only to “aliens” — individuals who are not U.S. citizens. The bill would amend the residency rules in Sec. 7701(b) to enable U.S. citizens to be treated as nonresidents.

The current residency rules treat any individual who is not a U.S. citizen or green–card holder as a U.S. resident only if they meet the substantial–presence test (or make a first–year election under Sec. 7701(b)(4)). Under the substantial–presence test, an individual is a U.S. resident with respect to any calendar year if: (1) the individual is present in the United States on at least 31 days during the current calendar year and (2) the sum of the number of days of U.S. presence during the current calendar year, plus one–third of the U.S. days during the first preceding calendar year, plus one–sixth of the U.S. days during the second preceding calendar year, equals or exceeds 183 days (Sec. 7701(b)(3)(A)). The bill would enable the substantial–presence test to be applied to U.S. citizens, with the result that U.S. citizens who live abroad and meet certain other specified conditions could elect to be treated as U.S. nonresidents for income tax purposes without having to renounce their U.S. citizenship.

To make the election, U.S. citizens would have to pay or validly defer the tax due (if any) under the special departure tax rules described below and must certify their compliance with all U.S. tax obligations for the five years prior to the year of making the election. The bill further provides that the benefits of the election are not available for any year in which the individual is not a tax resident of a foreign country, or if the individual is an employee of the federal government at any time during the tax year.

The timing and other procedures for making the election (such as the required forms to be filed) would be determined by the IRS.

After making the election, taxpayers would be subject to U.S. tax only on their U.S.-source income and gains, including income from the performance of services in the United States, income from ownership of a U.S. business, distributions from U.S. retirement and deferred compensation plans, and income from assets physically located in the United States (such as rent from real estate investments).

Once the election is made, it would be effective for the current and all future tax years until terminated by the electing individual or if the individual again becomes a U.S. resident for income tax purposes. To obtain the benefit of the election, electing individuals would be required to live abroad for at least three years (the year of making the election and at least two full tax years thereafter), failing which the election would be reversed with retroactive effect. In addition, any individual who had been subject to the departure tax (described below) would not be entitled to a refund of any tax paid under this rule.

A special rule would apply to U.S. citizens born (and still residing) outside the United States, whereby they would be treated as electing individuals until such time as they establish residency in the United States. In other words, such individuals would not be required to affirmatively make the election to claim the benefits available to electing individuals.

Benefits under income tax treaties: Electing individuals would be entitled to claim the benefit of income tax treaties between the United States and their country of residence, notwithstanding the fact that they would remain U.S. citizens. This would be accomplished by a provision in the bill that requires a waiver of the treaty saving clause in relation to electing individuals. Under a standard saving clause, the United States reserves the right to tax its citizens and residents as if the treaty were not in effect, with certain exceptions.

Exemption from certain reporting requirements: The bill would provide electing individuals with an exemption from certain information–filing requirements, including those of Form 8938, Statement of Specified Foreign Financial Assets; Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations; and FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR).

Certificate of nonresidency for foreign financial institutions: Electing individuals and any U.S. citizen born in a foreign country after the date of enactment of the bill would be permitted to apply to the IRS for a certificate of nonresidency. This provision would permit such individuals to establish that they are not “specified United States persons” for purposes of the Foreign Account Tax Compliance Act (FATCA), P.L. 111–147. Hence, foreign financial institutions would not need to undertake FATCA’s financial reporting requirements, which frequently discourage those institutions from offering banking services to U.S. citizens living and working abroad.

Departure tax for certain high–net–worth individuals: The bill provides that electing individuals would not be treated as renouncing their U.S. citizenship. Hence, making the election would not subject an electing individual to the existing expatriation tax under Sec. 877A. However, the bill would introduce a special mark–to–market departure tax applicable to certain high–net–worth individuals. Under this provision, electing individuals would be required to pay tax on a deemed sale of all their property as if it were sold for its fair market value (FMV) on the day before they make the election.

The departure tax would not apply to individuals who meet any of the following exceptions:

• Their net worth is less than the applicable estate and gift tax basic exclusion amount ($13.99 million for 2025);
• They are tax residents of a foreign country where they normally or customarily lived for three of the past five years, and they certify that they have been in compliance with their U.S. tax requirements for the three years prior to the bill’s introduction; or
• They have not been U.S. residents at any time since turning 25 years old, or after March 28, 2010 (the date that FATCA was enacted), through the date of enactment of the bill.

Certain property and income items would not be subject to the deemed–sale rule: deferred compensation items (including U.S. and foreign retirement plans); specified tax–deferred accounts (including Sec. 529 qualified tuition plans, Coverdell education savings accounts, health savings accounts, and medical savings accounts); interests in nongrantor trusts; real property located in the United States; and foreign real property that has been owned and used as the individual’s principal residence for periods aggregating at least two of the prior five years.

Affected individuals’ basis in each asset subject to the departure tax would be stepped up to its FMV at the date of the election.

Foreign financial institutions prohibited from discriminating against U.S. citizens: The bill would add a provision to Sec. 1471(b), which sets out the FATCA reporting requirements applicable to foreign financial institutions. The provision would require that any agreement in effect between a foreign financial institution and the IRS should require the foreign financial institution to agree not to have policies or practices that discriminate against opening or maintaining financial accounts for individuals who are U.S. citizens and residents of the country in which the financial account is to be opened or maintained.

This provision would apply to all U.S. citizens living abroad and would not be limited to those who elect to be taxed as nonresidents under the procedures discussed above.

What the bill does not address

While the bill would enable electing individuals to be treated as U.S. nonresidents for income tax purposes, it does not address their potential exposure to U.S. gift and estate taxes. Thus, U.S. citizens living abroad would continue to be subject to U.S. gift and estate tax on their worldwide assets.

The bill is also silent in relation to green–card holders living abroad. These individuals are, like citizens, required to report and pay U.S. income tax on their worldwide income and can be subject to the same obstacles as U.S. citizens when seeking to open financial accounts in foreign countries.

Outlook uncertain

Estimates vary as to the total number of U.S. citizens living overseas. The U.S. government’s Overseas Citizen Population Analysis estimated that in 2022 approximately 4.4 million U.S. citizens were living overseas (U.S. Department of Defense, Federal Voting Assistance Program, “Overseas Citizens“), while a nongovernmental entity estimates the number currently to be 5.5 million (Speer, “How Many Americans Live Abroad?” The Association of Americans Resident Overseas (updated October 2024)). Without a change in the law, these individuals will continue to be subject to the anomalous rule of citizenship–based worldwide taxation. Globally, very few countries impose tax on their citizens living outside their borders (e.g., Eritrea imposes a “diaspora tax” and Myanmar taxes its nonresident citizens).

There appears to be a degree of bipartisan support for such legislation, given that bills addressing the issue have been introduced by both Republicans and Democrats over the years (as outlined above). However, passage of LaHood’s bill is significantly uncertain, given the numerous other legislative proposals and priorities confronting the 119th Congress.

Editor Notes

Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C.

For additional information about these items, contact Van Leuven at mvanleuven@kpmg.com.

Contributors are members of or associated with KPMG LLP.

The information in these articles is not intended to be “written advice concerning one or more federal tax matters” subject to the requirements of Section 10.37(a)(2) of Treasury Department Circular 230. The information contained in these articles is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. The articles represent the views of the authors only and do not necessarily represent the views or professional advice of KPMG LLP.