The Uniqueness of the U.S. Tax System
There are two main types of taxing systems in the world.
In a “worldwide system,” tax is imposed on residents of a country for all income- including at home and overseas. Foreign tax credits may be used to mitigate the effect of double taxation.
Most countries use a “source-based taxation,” or “territorial,” system. In this format, the country in which the income is earned is the jurisdiction to tax you, regardless of where you live. In other words, if the income is earned within the jurisdiction’s territory, they will tax you there. Participation exemptions or dividends-received deductions are a hallmark of the territorial system.
The U.S., uniquely, prior to passage of the Tax Cuts and Jobs act in 2017, had or “worldwide,” tax system. In this method, the U.S. taxed the global earnings of corporations, but deferred the tax until the earnings were repatriated. This encouraged corporations to keep their earnings offshore. Additionally, inversion formats were often adopted in order to avoid US tax. US based companies would merge with a foreign-based company in order to attain residency in the foreign country and therefore reduce or avoid US taxation.
To add to more complexity, there are citizenship-based (CBT) or residence-based (RBT) basis of taxation. In a CBT tax system, citizens are taxed on their worldwide income regardless of their physical presence in another jurisdiction. The United States uniquely imposes this taxation structure. CBT is unfavorable for U.S. expats living abroad because they must continue to file and pay taxes on their worldwide income. Tax may be somewhat alleviated with a foreign tax credit, however, the filing requirement is not.
In a RBT tax system, a resident of a country is subject to tax based on where they live versus where they are a citizen. This alleviates filing requirements for citizens who are residents abroad.
To learn more, please visit our international tax page: https://abfinwright.com/international-tax-services/
