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  • Writer's picturePeter Blomfield

Intro to U.S. Tax for U.S. Citizens Living Abroad

Updated: May 17, 2023

Perhaps you were born in the U.S. and moved to Canada as a child, or maybe you were born to U.S. parents and haven’t even set foot in the United States. Either way, you’ve heard that you, as an American citizen, may have to file U.S. taxes. Now you’re trying to get a better understanding of how it all works and what your next steps should be. In this post, we’ll go through a general overview of how the U.S. taxes its citizens and what your options are going forward. If you’ve got any questions, we’re here to help.

Citizenship and Resident Worldwide Taxation

Usually, the country where you reside taxes you on your worldwide income – this means you have to report every dollar you earn from anywhere in the world on your tax return. This is called residency based taxation and is standard in many parts of the world. The United States is no exception. However, the U.S. takes this a step further. Unlike virtually all other countries in the world, the U.S. also imposes a tax based on citizenship, regardless of where the citizen resides. Even if you don’t set foot in the U.S. for decades, they can still tax you if you’re a citizen.

You also may be a U.S. citizen without realizing it. Contrary to popular belief, U.S. citizenship isn’t something you opt into if you meet the requirements of inherited citizenship at birth – you simply are one or you aren’t. If you’re not sure if you are one, it’s a good idea to find out.

U.S. permanent residents (“Green Card holders”) are generally also subject to the same rules, though there are some exceptions. You should also know that even if your Green Card has expired for immigration purposes, the IRS may not see it that way. Tax residency and immigration residency are not the same thing.

How Can the U.S. Actually Enforce This?

Great question. You’ve lived abroad for years, and nothing has happened. No IRS notices have come your way, and you’ve crossed the border dozens of times without a problem. Why would you even be on their radar? Even if the IRS knew who you were and that you were a citizen, how would they actually force you to file or pay taxes?

The Foreign Account Tax Compliance Act (“FATCA”) was passed in 2010 and was gradually implemented over the following years. This law obligates foreign financial institutions to report account information about its U.S. citizen and Green Card holder account holders directly to the IRS – that’s why you’re asked questions about your citizenship and U.S. tax residency whenever you open a bank account in Canada. If institutions don't report this info to the IRS, they face significant penalties on investments they have in the United States. As such, it’s generally in their interest to play ball. Many governments also have mutual enforcement agreements in place, so they could effectively come after you on behalf of the U.S. government.

In short, the IRS has the means to find you and has the teeth to come after you should they so choose. With some of the last FATCA provisions finally coming into force in recent years as well as massive recent increases in IRS funding, your days of flying under the radar may be numbered, and it’s better to get out ahead of it than to be caught unawares. Hiding under a rock is not a great idea.

Will I Get Taxed on the Same Income Twice?

This is another great question. The high-level answer to this question is generally no, you are not taxed on the same income twice. Income is generally sourced to a specific country, and that sourcing will impact how different countries are able to tax the income. These sourcing rules are fleshed out in domestic law and elaborated or altered through tax treaties.

Mechanically, it could work out like this: You’ve lived in Canada for years but you’re a U.S. citizen. You earn a salary in Canada, your investments are all in Canada, and you only visit the U.S. for the occasional Disneyland vacation or long weekend. Your income would likely be sourced to Canada, so Canada gets to take the first bite of it when you get taxed. The U.S. would also tax your worldwide income, which includes the income you earned in Canada, but it recognizes you already paid Canadian tax on that income. This means you get something called a foreign tax credit, which then decreases your U.S. taxes. If the Canadian tax you paid exceed the U.S. tax you’d otherwise have to pay, you’re good. If not, any excess gets paid to the U.S. Since Canadian tax rates tend to be higher than U.S. tax rates, it can mean the U.S. basically gets left with nothing.

The above is only true as a generality, however. There are many scenarios where a Canadian could get hit with U.S. tax even though they’re already paying tax in Canada. For example, Canada doesn’t tax you on the sale of a principal residence – the U.S. does in certain circumstances. Canada has concepts like capital dividends, which aren’t taxable to shareholders – the U.S. has no such concept. Further, there are some particularly nasty regimes in place to discourage U.S. taxpayers from parking their investments and business activity offshore, and this hits particularly hard if you’re actually living abroad. Owning a corporation, investing in mutual funds, and having an interest in a non-U.S. trust are common examples where these regimes kick in. Suffice to say, don’t get too comfortable with the idea that since Canada generally has higher tax rates, you’d never owe anything to the U.S.

One other major point to make – even if you don’t owe any U.S. taxes, you probably still have to file tax returns. There are several forms and disclosures that are applicable particularly for people living abroad, and some of these forms carry very hefty penalties – several with minimum penalties of $10,000 USD per form per year. It can get very ugly very quickly if not done right.

What Should I Do Now?

If you haven’t filed taxes already, the best time to start is now. As I said above, it’s better to get out in front of any issues than it is to be caught unawares. Further, the IRS has certain amnesty programs such as the Streamlined Filing Compliance Procedures that help you get compliant without walking into massive penalties. These amnesty programs don’t have a permanent shelf-life, however, so it’s best to take advantage while they’re still available.

Let us help you navigate this and get you on track. It might seem daunting, but we’re committed to simplifying the process as much as possible, and helping you sleep at night.

This post is for informational purposes only and should not be used as official tax advice.


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