Why the U.S. Taxes Worldwide Income?

Why the U.S. Taxes Worldwide Income?

Only two nations in the world tax their people’ worldwide income, regardless of where they reside or make their money, and the United States is one of them. The U.S. government demands a portion of an American’s income through federal taxes, regardless of whether they are working remotely from Costa Rica, operating a small business in Paris, or teaching English in Tokyo.

This distinctive taxation strategy has long been a subject of discussion and misunderstanding. Supporters assert that it guarantees justice and responsibility, while detractors contend that it penalizes Americans residing overseas and complicates international financial life.

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1. Understanding Worldwide Income Taxation

The term “worldwide income” refers to all income earned by a U.S. citizen or resident alien, regardless of where that income originates.

This includes:

• Wages, salaries, and bonuses earned abroad
• Profits from foreign businesses or investments
• Rental income from overseas property
• Interest and dividends from foreign banks
• Pensions and retirement income

In short, if you are a U.S. citizen or green card holder, the IRS expects you to report all income — both domestic and foreign — every year when you file your tax return.

2. The United States Is Nearly the Only Nation Doing This

Citizenship-based taxation (CBT) is only practiced in two nations worldwide:

• The United States

• Eritrea

The majority of other countries employ residency-based taxation (RBT), which means they only impose taxes on residents of those countries. For instance, only Brazil taxes income earned by a German citizen who relocates to Brazil.

However, things are drastically different for Americans. An American is still required to file an annual U.S. tax return even if they haven’t resided in the country for 20 years.

3. A Retrospective: Citizenship-Based Taxation’s Past

America’s global tax policy has over a century of history.

• The Federal Income Tax’s Origins and the Civil War

In order to finance the American Civil War, the government imposed the first federal income tax in 1861. But the notion of taxing foreign nationals was not yet in place.

• 1913: The Development of the Current Tax Code

Following the ratification of the 16th Amendment in 1913, which gave Congress the authority to levy income taxes, politicians started taking into account residents who had fled the nation in order to evade taxes.

• 1918: Global Taxation Is Enacted

Congress formally instituted citizenship-based taxation by 1918. The logic was straightforward:

“Being a citizen has advantages and obligations.”

4. The IRS’s Enforcement of the Legal Foundation

Gross income is defined as “all income from whatever source derived” in Section 61(a) of the Internal Revenue Code (IRC), which includes income received outside of the US.

Furthermore, by mandating foreign banks to report accounts held by U.S. persons, the Foreign Account Tax Compliance Act (FATCA), which was passed in 2010, increased the IRS’s jurisdiction.

Banks all around the world are required by FATCA to notify the US government if an American has an account worth more than $10,000. Because of this, it is practically impossible for Americans living overseas to conceal assets or income.

5. Double Taxation: What About It?

Opponents frequently claim that taxing global income results in double taxation, or paying taxes on the same amount of money twice.

There are measures in the American tax system to stop this:

• The Foreign Tax Credit (FTC) enables taxpayers to use taxes paid to foreign countries to offset their U.S. taxes.
• The Foreign Earned Income Exclusion (FEIE) allows eligible Americans to deduct up to $126,500 (for 2024) from their U.S. taxes.
• Tax Treaties: To specify which countries have the power to impose taxes, the United States has treaties with other nations.

6. The Stress on Americans Living Abroad

More than nine million Americans reside abroad. Many of them claim that the global tax system causes needless hardship.

Typical Grievances:

• Complicated filing requirements: Even if they owe nothing, foreigners are nonetheless required to file U.S. taxes.
• Exorbitant compliance costs: Many must employ specialized tax experts.
• Banking difficulties: Because of FATCA restrictions, several overseas banks reject American customers.
• FATCA data-sharing exposes personal financial information worldwide, raising privacy issues.

The result is growing frustration among expats, with some even renouncing U.S. citizenship to escape the system.

7. Total Citizenship Renunciations

A growing number of Americans have renounced their citizenship in recent years, mostly due to tax concerns.

Data from the U.S. Treasury shows that thousands of Americans renounce annually, citing the difficulty and weight of international taxes.

But giving up citizenship is not easy. It includes:

• A U.S. consulate exit interview
• One of the highest fees in the world, $2,350
• Perhaps a wealthy person’s “exit tax”

For many, it’s a difficult but essential step on the path to financial independence.

Conclusion: Why the U.S. Taxes Worldwide Income?

A deeply rooted concept in the obligations of citizenship is reflected in the U.S. international taxation system. The foundation of FATCA, from its early 20th-century beginnings to its current implementation, is the notion that Americans are always liable to their country.

However, this method is increasingly being criticized for being unfair and out of date in a world when people can reside anywhere in the world and work remotely.

For the time being, Americans living overseas have to negotiate a complicated web of tax regulations while juggling the advantages of citizenship with its practical drawbacks.

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