Dual Citizenships mean access to two countries’ systems, healthcare, and development perks. But it also comes with a bane: double taxation. Essentially, if you hold two passports, you are liable to pay taxes in both those countries. This can be a huge financial burden, especially if you are settled in one country and hardly have links to the other. This article helps you avoid being taxed twice and outlines what you can do in the alternate scenario, so keep reading.
What is Double Taxation?
Dual citizens often face complex tax obligations, especially when earning income in multiple countries. The United States follows a citizenship-based taxation system, meaning U.S. citizens, including dual nationals, must report their worldwide income to the IRS. However, many foreign countries also tax income earned within their jurisdictions, which can result in double tax.
U.S. Tax Laws: Who is Eligible?
The US has a unique system of taxation called “citizenship-based taxation,” which stipulates that all Americans are subject to US taxes, even if they move abroad or hold a second passport. Any US citizen or permanent resident who meets the minimum income reporting threshold has to file a US tax return and potentially pay US taxes. If you’re unsure whether you need to file, the IRS has a handy tool to help you figure it out.
Explained: Avoiding Double Taxation as a Dual Citizen
In addition to US taxes, you may need to pay foreign taxes if you meet the tax residency definition in another country. Being a citizen of another country doesn’t automatically mean you owe taxes there, though. As per the latest norms, citizenship-based taxation systems only exist in the US and Eritrea.
Factors to Determine Your Status as a Dual Taxpayer
Each country has a different definition of tax residence, so it’s important to check the rules in the country or countries relevant to you. That said, you may be a tax resident in the country where you hold citizenship (or any other foreign country) if you:
- Maintain your permanent home/residence there.
- Spend over 180+ days per year there.
- Maintain significant social or economic ties there, including a job.
Tax Breaks You Can Claim: File US Expat Taxes
Expats can claim almost all of the same tax credits while living abroad as they would living in the US (e.g., the Child Tax Credit). What’s more, you can claim a few tax breaks like Citizenship-based taxation that are only available to Americans abroad, including the following:
-
Foreign Tax Credit (FTC)
- Foreign Earned Income Exclusion (FEIE)
- Physical Presence Test
- Bona Fide Residence Test
- Foreign Housing Exclusion (FHE)
- Tax treaties
- Totalization agreements
What Is the Foreign Tax Credit?
The Foreign Tax Credit is a U.S. tax benefit that offsets taxes paid to a foreign government against U.S. tax liability. It ensures that income is not taxed twice—once by the foreign country and again by the United States. This credit applies to both individual taxpayers and businesses that meet the eligibility requirements.
Who Is Eligible for the Foreign Tax Credit?
To claim the Foreign Tax Credit, you must meet the following criteria:
Tax Must be a Legal and Actual Foreign Tax Liability
You must have paid or accrued taxes to a recognized foreign country.
The Tax Must be an Income Tax
Only foreign income taxes qualify, not sales tax, property tax, or value-added tax (VAT).
The Tax Must be Imposed on You
If your employer pays the foreign tax, you cannot claim it.
You Must Have Foreign-Sourced Income
Only income earned in a foreign country qualifies.
The Tax Must Not be Refundable
If you receive a refund or tax benefit from a foreign country, you cannot claim a credit for that portion.
How Dual Citizens Can Use the Foreign Tax Credit
Let’s see how you can use this to your benefit.
Step 1: Determine Your Foreign Tax Liability
Dual citizens who ͏work, ow͏n prop͏erty͏, or receive passive income͏ (such ͏as dividends o͏r inter͏est) in a͏ foreign count͏ry sh͏ould determine how much tax they owe t͏o t͏ha͏t c͏ou͏ntry. ͏Kee͏p all ͏foreign tax doc͏uments, such as ta͏x returns͏ an͏d payment ͏receip͏t͏s, for ͏accura͏te reporting.
Step 2: Choose Between Foreign Tax Credit/ Foreign Earned Income Exclusion
The ͏Foreign Earned Income͏ Ex͏clusion (FE͏IE)͏ allows U.S. t͏axpayers to exclude a certain amo͏unt of fore͏ign-earned ͏inc͏ome fr͏om U.S. taxation͏. For͏ 2024, t͏he exclusi͏on limit ͏is $126,500 per quali͏fying͏ t͏axpayer. H͏owever, FEIE does n͏ot ͏reduce U.S. t͏ax liabili͏ty͏ on p͏assive ͏in͏come͏. Such͏ as capita͏l gains o͏r renta͏l income͏.
What Works?
Many dual citizens find that using the Foreign Tax Credit instead of FEIE is more beneficial, especially if their foreign tax rate is higher than their U.S. tax rate.
Step 3: Fill Out IRS Form 1116
To claim the Foreign Tax Credit, individuals must complete Form 1116, which includes:
- Country of the foreign income source.
- Type of income (wages, interest, dividends, etc.)
- Foreign taxes paid or accrued.
- Calculation of the credit limit. Businesses or corporations use Form 1118.
Step 4: Apply the Foreign Tax Credit Calculation
The Foreign Tax Credit is limited to the lesser of such values:
- The actual foreign taxes paid, or;
- The U.S. tax liability on that foreign income (calculated as a percentage of total taxable income)
If your foreign taxes exceed the limit, you can carry back the excess credit one year or carry forward for up to ten years; to use in future tax years.
Step 5: Maintain Proper Documentation
The IRS requires proof of foreign taxes paid. Keep always records of:
- Foreign tax returns.
- Payment receipts.
- Employer statements (if taxes were withheld at the source).
- Foreign bank statements reflecting tax payments.
Foreign Earned Income Exclusion (FEIE)
The Foreign Earned Income Exclusion (FEIE) is another provision that can offer tax relief for US expats. It allows you to exclude a portion of your foreign-earned income from taxation. For tax year 2023 (the taxes you file in 2024), the maximum exclusion is $120,000.
Bona Fide Residence Test
The Bona Fide Residence Test requires you to prove you’ve lived in a foreign country for at least one calendar year through official documentation. Some documents you can use to confirm your residency status include residence permits, foreign tax returns, and utilities bills.
Totalization Agreements
Totalization agreements can also help reduce the risks of double taxes. Similar to tax treaties, the US has totalization agreements with several other countries, including Canada, the UK. And most of the EU. These agreements prevent nationals of one country living in the other from having to pay social security taxes to both.
Tax 5 Years or Less?
Pay US social security taxes.
Taxes Over 5 Years?
Pay social security taxes in your country of residence.
Understanding Tax Treaties
Yet another option US expats have to minimize their tax liability is tax treaties. The US has signed tax treaties with dozens of other countries (including Canada, Mexico, and the UK) that prevent double taxation, at least in theory. In practice, a “saving clause” that gives the US government the right to tax Americans as if the treaty didn’t exist renders most of it useless to US citizen taxpayers.
Advantages of Expat Taxes
When it comes to US expat taxes, some of the advantages include:
- Excluding foreign-earned income from taxation with the FEIE.
- Getting dollar-for-dollar US tax credits on foreign income taxes.
- Increasing the amount of income you can exclude from taxation with the FHE.
- Claiming tax treaty benefits and totalization agreements.
Disadvantages
- Filing two tax returns.
- Potentially paying taxes to two different countries.
- Increased reporting requirements and more paperwork (e.g., FBAR, Form 8938)
Reporting Foreign Bank Accounts
This is a crucial step. Dual citizens with foreign bank accounts or assets must comply with additional IRS reporting requirements, including:
FBAR (Foreign Bank Account Report)
Required if total foreign account balances exceed $10,000 at any time during the year.
FATCA (Foreign Account Tax Compliance Act) Reporting
Applies to individuals with significant foreign financial assets. Failure to report foreign accounts can result in heavy penalties, so compliance is essential.
Conclusion
The double taxation with dual citizenship may scare individuals, depending on how they choose to tackle it. As we concluded, however, it can be thwarted with the FTC. By understanding eligibility requirements, tax treaties, and proper filing procedures, you can legally reduce your U.S. tax liability while complying with both countries’ tax laws. It is crucial to understand the clauses and stay up-to-date with the latest developments to avoid any trouble with international law.
FAQs
1. Do I have to pay taxes in both countries if I am a dual citizen?
Depends. While the U.S. taxes its citizens on worldwide income, no matter where they reside, not all countries do. If your second country of citizenship isn’t one with citizenship-based taxation, you might not owe taxes there unless you have specific residency or income requirements.
2. What is the purpose of the Foreign Tax Credit? How does it benefit me?
The Foreign Tax Credit (FTC) saves you from paying tax twice on the same income. If you’ve already paid income tax in your home country, the FTC allows you to credit that against your U.S. tax liability up to a threshold. It’s one of the most useful tools for dual citizens.
3. Is the Foreign Tax Credit superior to the Foreign Earned Income Exclusion (FEIE)?
It depends. If you’re paying more taxes overseas, the Foreign Tax Credit can potentially save you more. The FEIE allows you to exclude a block of foreign-earned income, but doesn’t assist with passive income such as dividends or rent income. Some expats actually utilize both in conjunction, when permitted.
4. I reside overseas and pay taxes overseas, so do I need to file a U.S. tax return?
Yes, if you’re a U.S. citizen or resident alien with a green card and have the minimum required income, you’re required to file a U.S. tax return, even if you’ve paid foreign taxes. Not filing could result in penalties. But filing allows you to claim credits and exclusions that limit or eliminate what you owe.
5. What documentation do I need to have in hand to substantiate my Foreign Tax Credit claim?
You’ll need good documentation to support your claim. That means foreign tax returns, receipts for payments, employer statements of tax withholding, and possibly even bank statements of payments.
6. What happens if I’ve paid more tax outside the U.S. than I owe stateside?
If your foreign tax is more than your U.S. tax liability for such income, you are not able to claim the full credit in the same year. However, a silver lining: you can carry over the unused part one year or carry it forward up to ten years.
7. Are all types of foreign taxes eligible for the Foreign Tax Credit?
No, only income taxes qualify. Property tax, VAT, sales tax, or taxes someone else paid for you (like your employer) don’t. And if the foreign country reimburses you for your taxes, you can’t claim that amount on your U.S. return.
Sources
Also Read:
Understanding Tax Credits vs. Tax Deductions: What’s the Difference and Why It Matters
