NEWS / US Congress mulls shift to residence-based taxation system

The United States is considering a bill practically end the current system of citizenship-based taxation replacing it with a system based on residence. If implemented, United States citizens living abroad will no longer be subject to United States federal income tax along with the associated onerous IRS reporting requirements.

The bill was introduced by Representative Darin LaHood, a Republican from Illinois, on December 18, 2024. It appears to have been spurred by President-elect Donald Trump’s campaign promise to end the “double taxation” of US citizens.

The bill’s language would allow United States citizens living abroad to elect to be treated as a non-resident of the United States for taxation purposes. To qualify for this election, individuals would need to certify that they have been compliant with their US tax obligations for the last 5 years.

Certain individuals with high annual income (resulting in an average net tax liability in excess of $201,000 in the previous 5 years) or high net worth ($2 million or more) would be required to pay expatriation tax. All their assets would be treated as sold, and they would be taxed on their net unrealized capital gain.

Once an individual makes the election to be treated as a non-resident of the United States, they will remain a tax non-resident until that individual revokes this election or re-establishes residency under the substantial presence test currently used to determine if a non-United States citizen or permanent resident is a United States tax resident. The test involves calculating the total number of days an individual is present in the United States over the past 3 years, with only a third of the days counted in the year before the tax year in question, and only a sixth of the days counted 2 years prior. An individual is them deemed to be a US citizen if the total number counted days is 183 or more.

Individuals making the election would be required to live abroad for at least 3 years. If they fail to do so, they would be retroactively reclassified as United States tax residents and would be required to pay back taxes, KPMG reports. United States individuals born abroad would be treated as having made the non-resident election by default.

The bill also exempts electing individuals from filing foreign reporting forms including FinCEN Form 114, Report of Foreign Bank and Financial Accounts (known as the FBAR), IRS From 8938, Statement of Specified Foreign Financial Assets, and IRS Form 5471, Information Return of United States Person with Respect to Certain Foreign Corporations.

The IRS would start issuing a Certificate of Non-Residency to confirm that a given individual is not a “specified United States person” for the purposes of the Foreign Account Tax Compliance Act (FATCA). This certificate could then be presented to foreign banks and financial institutions often hesitant to do business with United States citizens.