New bill proposes US residence-based taxation (RBT) for Americans abroad

On Jan. 17, 2025, the House Budget Committee proposed exempting U.S. citizens living abroad from U.S. federal income tax on their worldwide income. A bill introduced on Dec. 18, 2024, by U.S. Representative Darin LaHood (R-IL), which would allow U.S. citizens residing abroad to elect to be treated as non-residents for U.S. tax purposes, may provide clarity on the House Budget Committee proposal. Representative LaHood’s bill would ensure that a U.S. citizen making the election would be subject to U.S. tax only on U.S. source income and gains, similar to the current tax treatment of foreign nationals residing overseas with U.S. source income.

Current legislation for American abroad

The current U.S. tax filing requirements for U.S. citizens residing outside the U.S. are complex.

If you are a U.S. citizen living outside the U.S., you are generally required to file income tax returns, and your worldwide income is subject to U.S. income tax. Foreign earned income exclusions and foreign tax credits are available to be claimed on your Federal tax return to reduce your US tax liability and minimize instances of double taxation.

Additionally, the U.S. requires US citizens to file a Foreign Bank Account Report (FBAR) to disclose foreign financial accounts with a balance of $10,000 or more at any time during the year. US citizens are also subject to FATCA legislation which includes the reporting of foreign assets through the filing of Form 8938, depending on the value of the account.

The U.S. has tax treaties in place with a number of countries to reduce the US taxes of individuals residing in foreign countries with certain exceptions. Most tax treaties have a saving clause which may prevent a US national from claiming a tax treaty benefit. However, many treaties also have exemptions to the saving clause and may still permit a US national to claim certain treaty benefits.

Challenges faced by American abroad under current legislation

The Foreign Account Tax Compliance Act (FATCA), enacted in 2010, requires foreign financial institutions to report their U.S. clients to the U.S. Department of the Treasury. These disclosure rules are complex, increase compliance costs, and expose foreign financial institutions to potentially significant penalties. As a result, foreign banks are often reluctant to accept U.S. citizens as clients.

Under U.S. tax legislation, mutual funds or Exchange-traded Funds (ETFs) held through foreign financial institutions are generally considered Passive Foreign Investment Companies (PFICs). This could subject them to the highest federal income tax rate, a significant interest charge, and complex U.S. reporting rules. U.S. citizens with foreign businesses may also be subject to significant reporting obligations. U.S. persons participating in foreign pension plans may not receive the same preferential tax treatment as U.S. pension plans, and additional reporting and adverse tax consequences may result depending on the location of the foreign pension and the terms of an applicable tax treaty.

The RBT election would eliminate FBAR and FATCA reporting provisions, easing the reporting burden for foreign financial institutions and U.S. nationals who were issued a certificate of non-residency.  However, a taxpayer making the election could be subject to taxation on a portion of their assets on departure, as described more fully below

Who would benefit from the RBT election?

• This legislation would benefit U.S. nationals born overseas who have never lived in the U.S. (accidental Americans).
• This election should be considered by U.S. citizens who intend to reside overseas permanently or for a significant period of time.
• International organizations with US nationals on long term assignments or those who have been living overseas for several years may be able to reduce the cost of their expatriate programs under this new bill, if passed.

Who would not benefit from the RBT election?

• Green Card Holders: This election is not available for green card holders residing overseas.
• Temporary Assignments: U.S. citizens on temporary assignments overseas with an expected return date of 2-3 years should not make this election. The bill includes a clawback provision for U.S. nationals returning to live in the U.S. within four years of their transfer overseas.
• Digital Nomads: U.S. citizens who have not established tax residency overseas would generally not be able to make this election.
• Taxpayers who spend considerable time in the U.S., have substantial US source income, or benefit from a favorable treaty position on their U.S. source income (e.g., U.S. retirement income with certain countries) would likely not consider this election.

Understanding the RBT election

The proposed RBT election would allow a U.S. citizen residing outside the U.S. to be taxed as a U.S. nonresident without renouncing their U.S. citizenship. Additionally, a U.S. national no longer considered a U.S. tax resident would still be entitled to U.S. Social Security benefits and allowed to vote in U.S. elections.

U.S. Taxation Under the Election

If an election is made, a U.S. citizen residing outside the U.S. would no longer be subject to U.S. taxes on their worldwide income. Instead, they would be taxed in the U.S. on U.S. source income and gains, such as:

• U.S. source compensation
• Income from ownership in a U.S. business
• Distributions from U.S. pension plans and deferred compensation payouts
• Income from U.S.-based assets (e.g., U.S. rental income)
• Other U.S. source income or gains

U.S. Income Tax Filing

A U.S. national making the election would file a U.S. nonresident return (Form 1040-NR) and be taxed on their U.S. source income. Under this election, the standard deduction or child tax credit would not be available.

U.S. Reporting Under the Election

The U.S. citizen would be exempt from reporting requirements on their foreign assets, including the FBAR.

Most income tax treaties with the U.S. contain a saving clause that preserves the right of the U.S. to tax its own residents as if no treaty existed. If an election is made, the saving clause would no longer apply.

RBT Election limitations

• The election is only applicable to federal income tax and will not impact current estate tax legislation.
• Some states may not follow the federal income tax treatment and may continue to consider U.S. nationals as state tax residents, even if they file a federal nonresident tax return.

When the RBT Election triggers departure tax

The taxpayer making the election would not be subject to a departure tax if the following conditions are met:

• The U.S. taxpayer’s net worth is below the estate tax exclusion amount ($12.99 million for 2025; $7 million currently projected in 2026 unless current provisions are extended), or
• The U.S. national has been a foreign tax resident for three of the past five years (proof of foreign tax residency would be required) and certifies under penalty of perjury that they have been compliant with U.S. tax obligations for the three years prior to the bill passing into law, or
• Grandfather Rules: The U.S. national has not resided in the U.S. since turning 25 years old or since the enactment of FATCA on March 28, 2010, whichever date is later. Addressing prior year non-U.S. tax compliance would not be required for these individuals.

Should the departure tax apply, the U.S. national would be subject to U.S. taxes on unrealized gains as if the assets were sold at fair market value upon making the election and deferred income. Some assets, including foreign pension plans, foreign principal residences, and U.S. real estate, would not be subject to the departure tax.

If the bill is passed into law, it is expected that children born outside the U.S. in the future would be issued a Certificate of Non-Residence at birth.

Are you eligible for the RBT Election?

The election applies to you if the following statements are true:

• You can certify that you have complied with all U.S. federal tax obligations for the five years preceding the election date.
• You have lived abroad and established foreign tax residency for at least three years prior to making the election.
• You can obtain a Certificate of Non-Residency (CNR) to present to foreign financial institutions.

Can the RBT Election expire?

The election would be effective for future years until the U.S. citizen either withdraws the election or resumes U.S. tax residency.

U.S. citizens returning to live in the U.S. would be subject to U.S. taxes on their worldwide income.

If you return to live in the U.S. after a period of less than three years, the election to be treated as a U.S. nonresident would be void, and you would be required to file amended returns for the prior years to reflect the change in U.S. taxation from nonresident to resident.

U.S. citizens with an RBT election need to monitor their U.S. presence. They would be subject to the same substantial presence test currently in place for foreign nationals with US physical presence.

US Substantial Presence Test - Under the substantial presence test, you are considered a U.S. tax resident if you are physically present in the U.S. for at least:

1. 31 days in the current calendar year, and
2. 183 days during the 3-year period that includes the current year and the two years immediately before that, counting:
   • All the days in the current year,
   • 1/3 of the days in the first year before the current year, and
   • 1/6 of the days in the second year before the current year.

Could the bill be passed?

It is difficult to predict the chances of this bill being passed into law, especially considering that a previous similar bill, the Tax Fairness for Americans Abroad Act of 2018, failed to pass due to concerns about its revenue impact.

The 2024 bill might have a better chance if it is included as part of a larger piece of legislation. Given that key provisions from the Tax Cuts and Jobs Act (TCJA) of 2017 will expire on Dec. 31, 2025, the elective residency-based tax bill could potentially be included in a larger tax bill, which might improve its chances of advancing.