RBT / CBT: What’s Going On?

Legislation for residence-based taxation (RBT) for Americans living abroad has finally been introduced.

Introduction

The United States is unique in that it taxes its citizens based on their worldwide income, regardless of where they live and regardless of where their income is sourced or earned (“citizenship-based taxation,” or “CBT”).

Most countries impose tax based on two methods: residency (taxing the income of residents of the country) and source (taxing the income sourced in the country). Three countries do tax the foreign income of their nonresident citizens, but they do so in manners that are different and considerably more limited as compared to the United States. The United States not only imposes tax on persons living in the U.S. and on income sourced in the U.S. but it also taxes the non-U.S.-source income of Americans and green card holders living outside the United States. Therefore, the entire income of an overseas American citizen and green card holder, including income with zero economic connection to the United States, is subject to taxation by the U.S. as well as (in most cases) by that person’s country of residence.

The original rationale for CBT comes from the 19th century; overseas Americans had to pay taxes to show their civic duty during the Civil War. In 1924, the U.S. Supreme Court upheld the constitutionality of the principle that the United States may tax people and property located outside the U.S. (Cook v. Tait) on the basis that the U.S. “government, by its very nature, benefits the citizen and his property wherever found.” There has been little appetite by Congress to eliminate CBT because it affects people without a strong political voice – whose vote is dispersed among the 50 States and who have historically voted in low numbers.

American citizens abroad are unfairly burdened by CBT. It has negatively affected the lives of overseas Americans by creating double/punitive taxation, FATCA and FBAR reporting complications, investment account issues and the inability to effectively save for retirement. This complex system also imposes significant costs on tax preparation and reporting, often where no tax is due, and leads to employment discrimination and/or competitive business disadvantage. Spouses of overseas Americans are also unfairly affected.

AARO and other groups have for years advocated for change to bring U.S. tax policy for overseas citizens more in line with the rest of the world, i.e., ending CBT and aligning the United States with the universal practice of residency-based taxation.

The Bill

Representative Darin LaHood (R. IL) introduced the Residence-Based Taxation for Americans Abroad Act (H.R. 10468) (the “Bill”) in December 2024, that would permit Americans living abroad to elect to become part of a new system, in which the United States would no longer tax their income earned outside the United States. Electors would remain taxed on a residency basis and on their non-U.S. source income by their resident country while the United States would continue to tax them on their U.S. source income. The Bill in effect creates a “source-based” tax system for the non-residents who elect. If one does not elect into this system, one remains taxed under CBT.

AARO’s Summary of the Bill

The Bill includes other features in addition to this “election” aspect, such as:

• Electing individuals would thereafter be treated by the Tax Code as “non-resident aliens”; and
• Electing individuals whose net worth, after excluding certain assets, is above a certain threshold would be required to pay a “Departure Tax.”

The Departure Tax on high net-worth individuals is intended to prevent abuse and to offset revenue loss.

There are also “grandfathering” provisions:

• Americans who have lived overseas 3 of the last 5 years would not pay the Departure Tax; and
• Americans born abroad or born in the U.S. but have lived overseas for a long time or since a young age (so-called “accidental Americans”) would be exempt from the Departure Tax, as well as from past tax non-compliance.

AARO has prepared a summary of the Bill.

The Bill expired at the end of the 118th Congress, but AARO expects that a similar bill will be re-introduced in the 119th session. It is probable that some aspects of the Bill will change. In this case, AARO will update the summary to reflect any such changes.

AARO’s Summary of the Taxation for Those who Elect

Because a person who elects RBT will be treated thereafter as a non-resident alien for tax purposes, AARO has prepared a chart comparing taxation under the current CBT system with taxation of a person who elects RBT.
Please see the chart here.

Please note that the chart is provided for informational purposes only and is not intended nor should be construed as legal or tax advice.

A Complicated Choice

As with any tax issue, making a decision is complicated and depends on many factors including:

• Foreign country of residence: Whether that country has a tax treaty with the United States, as well as the content of that treaty and local tax laws.
• Overseas residency: How long one has lived overseas.
• Employment status: Whether one is working overseas, working remotely, not working or retired.
• Income type: How much of one’s income is based on wages, pensions, Social Security, interest, capital gains, dividends, royalties, rents, etc.
• Source of income: Whether and how much of one’s income is sourced from the United States or elsewhere.
• Marital status: Whether one is single, married to another American or married to a non-U.S. citizen.
• Net worth: The amount of one’s deferred income/unrealized gains.

As you can see, making a decision is not easy, and will require careful analysis for each individual case. Before electing RBT, one should consult with a tax professional.

Scoring the Bill

As part of the legislative process, a bill such as this generally must be “scored” in order to estimate how much its implementation would cost the U.S. government. Scoring the cost of such a change in law requires a comparison of (i) the size of key budget items as they would be if no change is made with (ii) the magnitudes of the same items as they would be in a hypothetical scenario in which the change is implemented.

Scoring the Bill is complicated because many assumptions must be made, including, among others, how many people will elect, the types of income the electors have, how the income of those electors would be taxed after election and how many electors would be required to pay the Departure Tax.

AARO’s Scoring of the Bill

With the assistance of David Pinto, an engineer with whom AARO has been consulting for many years, AARO has prepared a paper scoring the cost of the Bill.
Scoring of the Bill