1. Understanding the U.S. Tax System
The United States has a complex tax system that is based on various elements such as income, property, and consumption, among others. It is a mixture of progressive, regressive, and proportional taxes. The primary purpose of the tax system is to fund government services and redistribute wealth. For an in-depth understanding of the U.S. tax system, you can refer to this comprehensive guide provided by the Tax Foundation.
“The U.S. tax system is a mix of income taxes, payroll taxes, corporate taxes, and taxes on investment income and profits.” - Tax Foundation
Citizenship and Tax Obligations
One’s tax obligations in the United States are greatly influenced by their citizenship status. U.S. citizens, including those residing abroad, have certain tax filing requirements and must report their worldwide income to the Internal Revenue Service (IRS).
“U.S. citizens, regardless of whether they live in the United States or abroad, are required to report their income from all sources, both U.S. and foreign.” - Internal Revenue Service
Citizenship determines not only federal tax obligations but also potential state and local tax liabilities.
2. Overview of U.S. Citizenship
Birthright citizenship, also known as jus soli, grants individuals U.S. citizenship by birth if they are born in the United States or its territories, regardless of their parents’ immigration status. This concept is based on the 14th Amendment of the U.S. Constitution.
“All persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States and the state wherein they reside.” - 14th Amendment, U.S. Constitution
Foreign nationals may become U.S. citizens through the naturalization process, which requires them to meet certain criteria, such as having a green card for a certain number of years, pass a test on U.S. history and government, and prove their ability to speak, read, and write English. For detailed information about the naturalization process, you can visit the U.S. Citizenship and Immigration Services (USCIS) website.
“Naturalization is the process by which U.S. citizenship is granted to a lawful permanent resident after meeting the requirements established by Congress in the Immigration and Nationality Act (INA).” - U.S. Citizenship and Immigration Services
Dual citizenship (or multiple citizenship) is a status in which a person is a citizen of two or more countries simultaneously. This can happen due to being born in one country to parents of another nationality, through marriage, or through naturalization. Each country may have its laws and regulations regarding dual citizenship, and the United States allows it in certain cases. It is crucial to understand the tax implications of dual citizenship and how it affects tax obligations in both countries. For more information, consult this guide provided by the U.S. Department of State 5.
“U.S. law does not mention dual nationality or require a person to choose one nationality or another. A U.S. citizen may naturalize in a foreign state without any risk to his or her U.S. citizenship.” - U.S. Department of State
3. U.S. Citizens and Tax Filing Requirements
U.S. citizens are required to file a tax return based on their filing status, which determines the tax rate and standard deduction applicable to their income. The Internal Revenue Service (IRS) recognizes five filing statuses:
- Married Filing Jointly
- Married Filing Separately
- Head of Household
- Qualifying Widow(er) with Dependent Child
“Your filing status is used to determine your filing requirements, standard deduction, eligibility for certain credits, and your correct tax.” - Internal Revenue Service
U.S. citizens must file their federal tax returns by the annual deadline, which is usually April 15, unless it falls on a weekend or holiday. In that case, the deadline is moved to the next business day. Taxpayers who cannot complete their return by the deadline can request an automatic six-month extension. However, any taxes owed must still be paid by the original deadline to avoid interest and penalties. For more information on filing deadlines and extensions, refer to the IRS website.
“The due date for filing your federal income tax return is generally April 15 of each year.” - Internal Revenue Service
Tax Forms and Documents
U.S. citizens need to use various tax forms and documents to report their income, deductions, and credits when filing their tax returns. The most common is Form 1040, U.S. Individual Income Tax Return. Additional forms and schedules may be necessary depending on the individual’s financial situation.
“Form 1040 is used by U.S. taxpayers to file an annual income tax return.” - Internal Revenue Service
4. Income Tax Rates
Progressive Tax Tables
The United States uses a progressive income tax system, meaning that as a taxpayer’s income increases, so does their tax rate. This system is designed to ensure that those with a higher income bear a larger share of the tax burden.
“The U.S. income tax system is progressive, so people with higher taxable incomes pay higher federal income tax rates.” - Tax Foundation 4
The IRS establishes tax brackets to divide income levels into ranges, with each range subject to a different tax rate. For 2021, there are seven tax brackets for each filing status, with rates ranging from 10% to 37%. Tax brackets are adjusted annually for inflation.
“There are seven federal tax brackets for the 2021 tax year: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.” - Tax Foundation
Standard Deduction vs. Itemized Deductions
When calculating their taxable income, U.S. citizens have the option to choose between taking the standard deduction or itemizing deductions. The standard deduction is a fixed dollar amount that varies based on the taxpayer’s filing status, and it reduces the amount of income subject to tax 6. Itemized deductions, on the other hand, are specific expenses that the taxpayer can subtract from their adjusted gross income (AGI).
“The standard deduction reduces the amount of income that’s subject to tax. The amount of the standard deduction varies by filing status and is adjusted for inflation each year.” - Internal Revenue Service
A taxpayer should choose the method that results in the largest reduction of their taxable income. Typically, itemizing deductions is more beneficial for those with significant deductible expenses, such as mortgage interest or charitable contributions.
5. Overseas U.S. Citizens and Taxes
Foreign Earned Income Exclusion (FEIE)
U.S. citizens living and working abroad may be eligible for the Foreign Earned Income Exclusion (FEIE). The FEIE allows eligible taxpayers to exclude a certain amount of their foreign earned income from U.S. federal income tax. For the tax year 2021, the maximum exclusion amount is $108,700.
“If you are a U.S. citizen or a resident alien of the United States and you live abroad, you are taxed on your worldwide income. However, you may qualify to exclude your foreign earnings from income up to an amount that is adjusted annually for inflation.” - Internal Revenue Service
Foreign Tax Credit (FTC)
In addition to the FEIE, U.S. citizens living abroad can claim the Foreign Tax Credit (FTC) to avoid double taxation on income taxed by both the United States and the foreign country where they reside. The FTC is a nonrefundable credit that reduces the taxpayer’s U.S. tax liability on a dollar-for-dollar basis for the amount of foreign income taxes paid or accrued during the tax year.
“The United States allows a credit against income tax for foreign taxes imposed by another country. This foreign tax credit is designed to reduce the double tax burden that would otherwise arise when foreign income is taxed by both the United States and the foreign country from which the income is derived.” - Internal Revenue Service
Foreign Bank Accounts and Financial Assets Reporting (FBAR and FATCA)
U.S. citizens with financial accounts held outside the United States may be required to report their foreign assets under the Foreign Bank Account Reporting (FBAR) and Foreign Account Tax Compliance Act (FATCA) regulations. The FBAR requires U.S. citizens with an aggregate value of more than $10,000 in foreign bank accounts at any time during the year to report these accounts to the Financial Crimes Enforcement Network (FinCEN).
FATCA, on the other hand, requires U.S. taxpayers holding foreign financial assets with an aggregate value exceeding specific thresholds ($50,000 for single filers and $100,000 for married filing jointly, for example) to report these assets on Form 8938, Statement of Specified Foreign Financial Assets, and file it with their annual tax return.
“U.S. citizens, resident aliens, and certain nonresident aliens who have a financial interest in or signature authority over at least one financial account located outside the United States must report foreign financial assets to the Department of the Treasury.” - Internal Revenue Service
6. Tax Benefits for U.S. Citizens
U.S. citizens are eligible for various tax credits that can reduce their tax liability or, in some cases, provide a refund, even if they owe no tax. Popular tax credits include the Child Tax Credit, Earned Income Tax Credit (EITC), American Opportunity Tax Credit (AOTC), Lifetime Learning Credit, and various energy credits.
“A tax credit is a dollar-for-dollar reduction of taxes owed. Some credits are refundable – taxes could be reduced to the point that a taxpayer would receive a refund rather than owing any taxes.” - Internal Revenue Service
Deductions lower the amount of income subject to tax, which consequently reduces the overall tax liability. Some common tax deductions for U.S. citizens are home mortgage interest, state and local taxes, charitable contributions, medical expenses, and educator expenses.
“Deductions are expenses that reduce the amount of income subject to tax. There are two types of deductions: standard and itemized deductions.” - Internal Revenue Service
Personal exemptions were an amount that taxpayers could claim for themselves, their spouse, and dependents to reduce taxable income. However, the Tax Cuts and Jobs Act (TCJA) eliminated personal exemptions for tax years 2018 through 2025. Even though personal exemptions are currently suspended, other exemptions and adjustments to taxable income still apply.
“Exemptions are amounts on which no federal income tax is due. However, the Tax Cuts and Jobs Act temporarily eliminated personal exemptions, but increased the standard deduction and the child tax credit for tax years 2018 through 2025.” - Internal Revenue Service
7. Tax Implications of Renouncing U.S. Citizenship
When renouncing U.S. citizenship, certain individuals, known as “covered expatriates,” may be subject to a one-time expatriation tax, also referred to as the “exit tax”. This tax is calculated based on the individual’s net worth or the theoretical capital gains of their worldwide assets on the day before their expatriation date.
“Covered expatriates are subject to a one-time expatriation tax on the net unrealized gain in their property as if the property had been sold for its fair market value on the day before the expatriation date.” - Internal Revenue Service
To be considered a covered expatriate, the individual must meet one or more of the following criteria:
- Have a net worth of $2 million or more on the expatriation date.
- Have an average annual net income tax liability of the five tax years preceding expatriation exceeding a specified amount, adjusted annually for inflation.
- Fail to certify on Form 8854, Initial and Annual Expatriation Information Statement, that they have complied with all U.S. federal tax obligations for the five tax years preceding expatriation.
Foreign and Domestic Assets
Upon renouncing U.S. citizenship, individuals no longer have the obligation to report their worldwide income to the IRS. However, U.S. taxes may still be applicable to certain types of income derived from U.S. sources, such as rental income from U.S. property or dividend income from U.S. corporations. Furthermore, U.S. estate and gift taxes may still apply to former citizens’ U.S. situs assets.
“Former U.S. residents who relinquish their citizenship will continue to have U.S. tax consequences if they receive U.S. source income, dispose of U.S. property, or make gifts or bequests of U.S. property.” - Deloitte
Future Inheritance and Gifts from the Former Citizen
When a former U.S. citizen provides a gift or bequest to a U.S. citizen or resident recipient, the recipient may be subject to the U.S. inheritance tax. This tax is levied upon the recipient, rather than the estate of the former citizen, and may vary based on the individual’s relationship with the recipient.
“U.S. citizens or residents who receive gifts or bequests from a covered expatriate after June 16, 2008, may be subject to tax at the highest gift tax rate in effect at the time the gift or bequest is received.” - Internal Revenue Service
8. State and Local Taxes for U.S. Citizens
State Income Tax Rates
State income tax rates vary across the U.S.; some states have progressive tax systems, whereas others have a flat rate, and a few have no income tax at all. For information on individual state income tax rates, visit the Tax Foundation’s page on state income tax rates.
“Individual income taxes are a major source of state government revenue, accounting for 37 percent of state tax collections.” - Tax Foundation
Sales tax rates differ among states and local jurisdictions, and some states impose no sales tax. Sales tax is levied on the purchase of goods and services, with certain items (such as groceries or medicine) possibly being exempt or taxed at a reduced rate.
“Forty-five states and the District of Columbia collect statewide sales taxes. Local sales taxes are collected in 38 states.” - Tax Foundation
Property tax is a primary source of revenue for local governments, and it is levied on real property such as land, buildings, and other improvements. Property tax rates fluctuate between states and local jurisdictions, and they are typically determined by the assessed value of the property and the tax levies imposed by various governing entities.
“Property taxes are the largest source of revenue for local governments, accounting for 72 percent of local tax collections in fiscal year 2018.” - Tax Foundation
9. Staying in Compliance
Proper tax planning is crucial for U.S. citizens to minimize their tax liabilities and ensure compliance with federal, state, and local tax regulations. Tax planning involves understanding and evaluating one’s financial situation, making strategic decisions regarding income, investments, and deductions, and keeping up with changes in tax laws.
“Tax planning is the analysis of a financial situation or plan from a tax perspective. The purpose of tax planning is to ensure tax efficiency.” - Investopedia
Voluntary Disclosure Programs
The IRS offers voluntary disclosure programs to assist taxpayers who have failed to report income or file tax returns, enabling them to resolve their tax liabilities and avoid potential criminal prosecution. U.S. citizens should consider participating in these programs, such as the Offshore Voluntary Disclosure Program (OVDP) or the Streamlined Filing Compliance Procedures (SFCP), if they have undisclosed foreign assets, income, or tax liabilities.
“The IRS encourages taxpayers to voluntarily disclose previously undisclosed foreign assets.” - Internal Revenue Service
Seeking Professional Advice
Given the complexities surrounding U.S. tax laws and regulations, it is advisable for U.S. citizens to consult with tax professionals who specialize in international taxation. These professionals can provide guidance on how to navigate the tax system, identify potential tax savings or liability reduction strategies, and ensure compliance with all tax filing requirements.
“Hiring a tax professional who specializes in international tax law can save taxpayers considerable amounts of time and help them avoid costly penalties.” - Forbes
10. Understanding Your Tax Obligations
U.S. citizenship has a significant impact on one’s tax obligations. As a U.S. citizen, it’s essential to understand the tax implications related to federal, state, and local taxes, and how to comply with the various filing requirements to avoid penalties or interest. Staying informed about the tax system will help you make informed decisions and minimize your tax liabilities.
Importance of Compliance
Complying with all tax regulations is crucial for U.S. citizens to prevent potential legal consequences, such as fines or criminal prosecution. By engaging in proper tax planning, disclosing unreported income and assets through voluntary disclosure programs, and seeking professional advice, U.S. citizens can ensure that they fulfill their tax obligations and contribute to funding vital government services.