Residence-based taxation: New Bill aims to simplify taxes for US citizens living abroad

The US has a unique taxation system where tax liabilities are determined based on citizenship rather than residency. Consequently, many US citizens living abroad face double taxation, as they are taxed both in their country of residence and by the Internal Revenue Service (IRS) in the US. This existing US tax framework has long been criticised for imposing significant compliance burdens on citizens living overseas despite provisions such as Foreign Earned Exclusions and Foreign Tax Credits designed to mitigate double taxation. Under the current system, some US citizens staying abroad are renouncing their citizenship due to the tax burden.

On 18 December 2024, US Representative Darin LaHood, a member of the House Committee on Ways and means, from the State of Illinois, introduced the Residence-Based Taxation for Americans Abroad Act in the House of Representatives. This landmark legislation aims to modernise the US tax system by shifting from citizenship-based taxation to residence-based taxation for American expatriates.

The new Bill, which proposes a shift from Citizenship-based taxation (CBT) to Residence-based taxation (RBT) for all US citizens living abroad, will significantly alter the current framework where all US citizens are subject to CBT regardless of their residence. It will provide relief for qualifying US citizens living abroad by both reducing their US tax liability and easing information filing requirements. The Bill aims to benefit legitimate long-term overseas residents rather than those parachuting in occasionally.

Key highlights of the Bill

The Bill establishes an elective process whereby a US citizen living abroad can be treated as a US non-resident for income tax purposes without renouncing their US citizenship. 

• Electing individuals must certify, under penalty of perjury, that they have met all tax requirements for the preceding five taxable years. They must also submit all other required evidence to the IRS, which will then issue a certificate of non-residency.
  
  
• An elective taxpayer will be subject to US tax only on US-sourced income and gains (such as income from ownership in a US business). They will also be subject to tax on deferred income distributions from US retirement and deferred compensation plans, income from assets physically located in the US (such as rent from real-estate investments), and other income or gains in the US.
  
  
• The election, once made, will be effective for the current and all future tax years unless terminated by the electing individual or if they become a US resident for tax purposes under the existing residency rules.
  
  
• The election will be reversed if an individual does not live abroad for at least three years after the election.
  
  
• This election is irrevocable except under specific circumstances, and individuals must continue to meet non-residency criteria to remain eligible.
  
  
• Electing individuals will be exempt from certain reporting requirements with respect to foreign assets and transactions. Foreign Account Tax Compliance Act (FATCA) reporting by foreign financial institutions will not apply if a certificate of non-residency is presented to the financial institution.
  
  
• Electing individuals will be entitled to claim the benefit of income tax treaties between the US and their country of residence, although they will remain US citizens.

Departure Tax for certain high net worth individuals 

• Specified electing individuals whose net worth exceeds the basic exclusion amount of USD 13.61 million as of the election date are required to pay a tax known as the "Departure Tax." This tax is applicable on a deemed sale of all their property as if it were sold for its fair market value on the day before the election.
  Deemed sale refers to all property of a specified electing individual which will be treated as sold on the day before the election date for its fair market value. It is applicable when a specified electing individual opts to be treated as a US non-resident.
  
  
• There are three exceptions to the Departure Tax for an individual. These are:
  1. If an individual has net worth of less than the applicable estate tax exemption amount (USD 13.61 million for 2024, USD 13.99 million for 2025); or
     
     
  2. Is a tax resident of a foreign country where the individual has lived for three of the past five years and certifies that he or she has followed US tax requirements for the three years prior to the Bill’s introduction; or
     
     
  3. If an individual has not been a US resident at any time since turning 25 years old or after 28 March 2010 (date that FATCA was adopted) through the date of enactment of the Bill

• Once departure tax is paid, the basis of each taxed asset is stepped up to its fair market value as of the election date. 
  
  
• The deemed sale rule does not apply to certain properties and income items, including deferred compensation, specified tax-deferred accounts (e.g., section 529 plans, health savings accounts), interests in non-grantor trusts, US real property, and foreign real property used as the individual's principal residence for at least two of the prior five years.

As the Bill undergoes federal evaluation, LaHood is actively seeking support and feedback to refine the proposal. This Bill aims to do more than eliminate double taxation. If passed, it will establish a new optional procedure for US citizens living abroad, enabling them to no longer be subject to US taxation on non-US sourced income.

Expert guidance to help you navigate legislative changes with ease

Our US Tax experts can help you stay informed about the latest developments on this proposed Bill and provide insights on how it could impact your tax obligations, helping you navigate the complexities of this proposed legislation with ease.