To understand the financial impact expatriation can have, we first have to look at the massive differences in taxation faced by US citizens and non-US citizens.
All US citizens face the same federal tax obligations whether they live in the US or abroad. They all have the same personal income tax on their global earnings, the same inheritance tax on their global assets, and the same reporting requirements.
In contrast to every other country in the world, a US citizen does not leave the US tax system by permanently moving outside the country. For his entire life, a US citizen is legally obligated to pay US taxes on his global income every year regardless of his residence. And at death, his estate is subject to US inheritance tax (the estate tax), regardless of where he lives in his final years.
The situation is significantly different for non-US citizens living outside the US
Non-US citizens who do not reside in the US face an entirely different US tax system. They pay significantly lower – and often, zero – taxes on investment and interest income derived from the US Earnings and investment income from outside the US are not taxed at all by the US government. They face no US inheritance taxes.
As an example, consider a US citizen and a non-US citizen who live and work in the same non-US country. They both have the same earnings from their job and both have the same investment portfolio, consisting of both US and non-US government bonds and bank deposits.
Both of them will pay taxes to their country of residence. In addition, the US citizen will be fully taxed by the US on all his global earnings and investment income. On the other hand, the non-US citizen will not only pay no taxes to the US on his earnings and foreign investment income, he will also pay nothing to the US on even his U.S-source investment income, thanks to US laws designed to encourage foreign investment.
The chart below summarizes in a very simplified form the basic taxes which apply to 3 groups: a citizen of the US who resides in the US, a citizen of the US who legally resides outside the US, and a non-US citizen who resides outside the US.
|US Tax on Income, by Citizenship and Residency|
|US Citizen residing in the US||US citizen residing outside the US||Non-US citizen residing outside the US|
|Earnings from the US||Fully taxed.||Fully taxed.||Fully taxed.|
|Earnings from outside the US||Fully taxed.||
Allowed foreign earned income exclusion of $107,600 in 2020. Above that amount, income taxed at rates which would have applied had the exclusion not been applied. Also allowed very limited deduction/credit for certain foreign housing costs.
|Not subject to US taxes.|
|Investment income from outside the US||Fully taxed.||Fully taxed. No credits or exclusions due to residency outside the US||Not subject to US taxes.|
|Interest income from the US||Fully taxed as income at individual’s top marginal rate.||Fully taxed as income at individual’s top marginal rate. No credits or exclusions due to residency outside the US||Not taxed if income is from US bank deposits, government bonds, or portfolio interest from domestic US corporations.|
|Short-term and long-term capital gains from US stocks||Fully taxed.||Fully taxed. No credits or exclusions due to residency outside the US.||Not taxed. (Long-term capital gains from mutual funds also not taxed).|
|Dividends from US stocks||Taxed at 15%-20% if stock held long enough to qualify. Otherwise, taxed at individual’s marginal rate.||Taxed at 15%-20% if stock held long enough to qualify. Otherwise, taxed at individual’s marginal rate.||Flat tax of 30%. Bilateral tax treaties with individual’s country of residence often reduce the rate; 15% is a standard rate under these treaties.|
|Estate tax (tax on all assets upon death)||Fully taxed. (In 2020, the rate is 40% of any amount above $11.6 million for an individual / nearly $23 million for a couple).||Fully taxed. (In 2020, the rate is 40% of any amount above $11.6 million for an individual / nearly $23 million for a couple). [Note that while transfers to a US-citizen surviving spouse are tax-free, transfers to a non-US citizen spouse are subject to estate tax].||Not subject to US taxes.|
An individual who renounces citizenship will immediately move from the “citizen” column to the “non-citizen” column. But in renouncing, he could possibly face the expatriate exit tax created in 2008. Please click on the link below to explore this tax in detail.