Tax Implications of Dual Citizenship: What You Need to Know
Tax PlanningAre you a citizen of both the U.S. and another country?
Or perhaps you are considering becoming a dual citizen of the U.S. and another country.
Dual citizenship has become more common in an increasingly interconnected world. It comes with a number of advantages, such as expanded travel opportunities and access to social benefits like health care and education.
And unfortunately, it also comes with very real responsibilities, particularly in the realm of taxation.
If you fail to comply with your tax obligations, you could find yourself knee-deep in trouble, both legally and financially.
In this article, you learn the ins and outs of dual citizenship and the tax implications that come with it.
What Is Dual Citizenship?
When you hold legal citizenship in two separate countries at the same time, you have dual citizenship.
What Are the Benefits?
The benefits of dual citizenship can vary depending on your circumstances and the specific countries involved.
Here are some potential benefits.
Travel and mobility. You can use the passport of either country to travel.
Residency and work. You may be granted the right to live and work in both countries without the need for extensive visa applications or work permits.
Access to social services. In some cases, dual citizens may have access to social services, health care, and education in both countries.
Property ownership. It may be easier to own property in both countries, potentially reducing property taxes.
Cultural and family ties. Dual citizenship can allow you to maintain strong ties with family members in both countries.
Political rights. You may have the right to participate in the political processes of both countries.
Safety and security. You may have access to consular services and protection from both countries in case of emergencies or conflicts.
Education opportunities. Dual citizenship can open up educational opportunities in both countries, including access to universities and scholarships available exclusively to citizens.
How Do You Become a Dual Citizen?
There are two ways to become a dual citizen.
1. Dual Citizenship by Birth
In general, if you are born in the U.S. to parents who are not American citizens, you will acquire both U.S. citizenship as well as the citizenship of your parents’ home country or countries.
Likewise, in general, if you were born in another country to parents who are U.S. citizens, you are a citizen of both the U.S. and the country you were born in.
2. Dual Citizenship by Legal Process
Another way you can obtain dual citizenship in the U.S. and another country is to become a naturalized U.S. citizen while keeping your status as a citizen in the other country.
To become a naturalized U.S. citizen, a non-citizen must
- reside in the U.S. for five consecutive years (three years for spouses of citizens),
- be physically present in the U.S. for at least 50 percent of the time,
- be at least 18 years old,
- read and write basic English,
- demonstrate knowledge of U.S. civics,
- show good moral character, and
- pledge an oath of allegiance to the U.S.
Exceptions
Not all countries allow dual citizenship. In some countries, a baby born to foreign parents will be a citizen of the country they are born in until they choose to become naturalized into the citizenship of their parents’ country or countries.
Children of foreign diplomats. Children of foreign diplomats are not American citizens even if they are born in the U.S. This is because foreign diplomats are under the jurisdiction of their home country, making them exempt from U.S. laws.
The accidental American. As you would expect, accidents are bad. If you were born to American parents but lived your entire life outside of the U.S., you will, without realizing it, be designated a U.S. citizen. The term for this is “accidental American,” and it opens you up to fines for failure to file or pay your U.S. taxes just like any other U.S. citizen.
Tax Residency
Citizenship is a legal status. Taxes are a different matter.
The challenge when you become a U.S. citizen is complying with the U.S. tax system.
Tax obligations often depend on your “tax residency,” which may or may not align with your citizenship. This means it’s possible for a dual citizen to be a tax resident in one country and not the other. This can lead to complexities in tax filing and liability.
Tax residency for the U.S. tax system categorizes a person as either a resident alien or a non-resident alien.
You are a resident alien in the U.S. if
- you are a lawful permanent resident, aka a green card holder;
- you pass the substantial presence test; or
- you make the first-year election to be taxed as a resident.
Substantial presence in the U.S. is all about time. Once you spend a sufficient number of days in the U.S., you are taxed as a resident alien.
You can make a first-year election to be taxed as a resident alien. If your income is already subject to U.S. taxation, you may benefit from the more favorable tax treatment afforded to residents over non-residents.
For example, resident aliens can claim a standard deduction and do not have to itemize their deductions on their tax returns.
As a U.S. resident, you are taxed on income from all sources (worldwide income).
Double Taxation
If you are a U.S. citizen and have dual citizenship in another country, you must file taxes in the U.S. The U.S. will impose taxes on you regardless of where you live and where you earn your income.
Dual citizens who are living abroad may owe taxes to both the U.S. and the country in which they earn their income.
Double taxation results when both countries assert their right to tax the same income.
How to Avoid Double Taxation
A dual citizen who is a U.S. citizen can take advantage of three possible income tax breaks:
- The foreign earned income exclusion allows you to exclude up to $120,000 of your foreign income from federal income taxes.
- The housing exclusion (or deduction) allows you to exclude or deduct up to a ceiling amount of certain foreign housing costs, including rent, utilities (except telephone), and real and personal property insurance.
- The foreign tax credit allows you to reduce your taxes by the taxes you paid in the non-U.S. country. The foreign tax credit’s purpose is to eliminate the double taxation of foreign earned income. You can’t use the foreign tax credit on income you excluded using exclusions 1 and 2 above.
Tax treaties. Some countries have tax treaties that eliminate a citizen’s tax liability, meaning that the citizen will only have to pay taxes in one country.
To resolve the problem of dual citizens facing double taxation, many countries have established double taxation avoidance agreements (DTAAs) or double taxation treaties (DTTs).
These international agreements outline how certain types of income are to be taxed, ensuring that you are not subject to taxation on the same income by both countries.
DTTs play a crucial role in preventing double taxation and promoting international economic cooperation.
Social Security and Medicare. International agreements (known as “totalization agreements”) eliminate dual taxation on Social Security and Medicare taxes.
This is a beneficial tax break if your earnings are subject to taxes or contributions for similar purposes under the social security system of a foreign country. A similar exemption exists if you are self-employed.
Alert. You cannot use the social security taxes paid to a foreign country as taxes paid for the foreign tax credit due to a totalization agreement, because such an agreement already eliminates the double-taxation threat.
Foreign Account Reporting
Dual citizens often maintain financial accounts in both countries of citizenship.
Many countries require individuals to report foreign financial accounts and assets, aiming to curb tax evasion and ensure transparency.
Failing to comply with these reporting requirements can lead to severe penalties. The Foreign Account Tax Compliance Act (FATCA) in the U.S. is a prime example of such regulations, imposing obligations on U.S. citizens and dual citizens to report foreign financial assets.
Failing to file the correct tax forms, when required, can result in hefty fines and penalties. You need to understand the requirements and comply with them.
Wealth Transfers
Aside from income tax obligations, dual citizens need to be aware of potential tax implications when transferring wealth between countries, such as inheritances or gifts, as these transactions may trigger tax liabilities.
Consulting with a tax professional who specializes in international taxation is highly recommended to navigate these complexities effectively.
Takeaways
As a dual citizen, you have to consider the tax implications.
There are two ways to become a dual citizen: either by birth or by naturalization.
Tax obligations often depend on your “tax residency,” which may or may not align with your citizenship.
Tax residency for the U.S. tax system categorizes a person as a resident alien (taxed on worldwide income) or nonresident alien (taxed on U.S.-sourced income only).
Double taxation results when both countries assert their right to tax the same income.
If you are a dual citizen who is a U.S. citizen, you can take advantage of three possible income tax breaks:
- The foreign earned income exclusion, to exclude up to $120,000 of your foreign earned income from U.S. taxes
- The housing exclusion (or deduction), to exclude or deduct certain foreign housing costs
- The foreign tax credit, to reduce your U.S. tax liability by the amount of foreign taxes you paid to the other country of which you are also a citizen
Some countries have tax treaties that eliminate a citizen’s tax liability, meaning that you will only have to pay taxes in one country.
