Breaking! Residence-Based Taxation for Americans Abroad May Become Reality

Representative Darin LaHood just introduced on December 18 the Residence-Based Taxation for Americans Abroad Act, aiming to modernize the US tax system for Americans living overseas. This proposal seeks to shift from the current citizenship-based taxation—which taxes US citizens on their worldwide income regardless of residence—to a residency-based system. The existing US tax framework has been criticized for imposing significant compliance burdens on expatriates, despite provisions like the Foreign Earned Income Exclusion and foreign tax credits designed to mitigate double taxation.

There is a lot to unpack requiring a careful reading and analysis of the bill.   Meanwhile, I provide some salient points in a nutshell, subject to the caveat that this is from an initial overview of the bill and further reading and analysis could change things!

• Under the new system, Americans residing abroad who elect to be taxed under this proposed new system would pay income taxes solely in their country of residence, aligning the US with the tax practices of most other nations.  They would be taxed for US tax purposes as nonresident alien individuals (i.e., subject to tax only on US-source income).
• The election, once made, is irrevocable but can be terminated under special rules. Nonresidency requirements must continue.
• If an individual’s election to switch to the residency-based taxation system is canceled before it has been in effect for four tax years, it will be as though the election never happened. This means the individual would be taxed under the regular rules for all the years the election would have applied.
• Electing individuals must certify under penalty of perjury that they have met all tax requirements for the 5 preceding taxable years and submit all other required evidence to the IRS which will then issue a certificate of nonresidency.
• Electing individuals would be exempt from various US tax reporting rules and FATCA reporting by their foreign financial institutions would not apply if the individual presents a certificate of non-residency to the financial institution.
• Americans born abroad will automatically fall under the new system (until they become US residents).
• Taxpayers having a net worth above the estate tax exclusion amount (currently $13.61 million) would be required to pay a “departure tax” if they elect to be taxed under the new system.  This departure tax would treat all of their worldwide assets as if they were sold and they would be required to pay tax on the pretend gain.  (Note: The exclusion amount will revert to $5 million, or approximately $7 million when adjusted for inflation, if Congress does not extend the relevant Tax Cuts and Jobs Act provision.)
• The bill includes “grandfather rules” to exempt certain individuals from the departure tax.
  • One such exemption is aimed at individuals who have spent a significant portion of their adult lives outside the United States, ensuring they are not unfairly taxed on assets they accumulated abroad while having little or no recent connection to the US tax system. This exemption essentially acknowledges that people in these circumstances should not face penalties for formalizing their nonresident status.  This examption does not require the individual to certify compliance with US tax obligations during this period. Even if they weren’t fully compliant with US tax laws in the past, they can still qualify for the exemption. The exemption applies to individuals who haven’t been US residents under the so-called substantial presence test during the timeframe that starts on either the date they turned 25 years old, or March 18, 2010 (this is the date FATCA was enacted), whichever date comes later and ends on the date the bill is enacted into law.
  • Another exemption from the departure tax applies to individuals who meet specific criteria based on their residence and compliance with US taxes.  This exemption is designed for those who already live abroad and have limited recent ties to the United States.  The individual must meet the “ordinary residence” test (meaning the individual must have been living outside the United States as of the bill’s introduction date of December 18, 2024 and have their primary home abroad).  The individual must not have been a US resident for tax purposes for at least three out of the last five tax years before the bill’s introduction. A US resident, in this context, generally refers to someone who lived in the US long enough to meet the aforementioned substantial presence test.  Finally, the individual must certify under penalty of perjury that he has complied with all US tax obligations for the last three tax years. This certification includes submitting any evidence of compliance that the IRS may require.
• Green card holders are apparently not eligible for the election into the new system.

The proposal has garnered positive responses from expatriate communities and organizations who view it as a step toward fairer tax treatment.  While the bill’s impact on federal revenue is under evaluation, with considerations like the departure tax and application fees potentially offsetting losses, LaHood is actively seeking bipartisan support and feedback to refine the proposal. This initiative reflects a broader recognition of the challenges faced by Americans abroad under the current tax system and represents a concerted effort to address these longstanding issues.

I cannot see this bill passing under the current Congress.  The the 119th Congress will be sworn in on January 3, 2025.  Let’s see what happens in January.  As an aside, a very similar residence-based taxation proposal was made 6 years ago.   As we know the Tax Fairness for Americans Abroad Act of 2018 (H.R. 7358), went nowhere.

Posted  Dec. 19, 2024