A Citizenship-Based Income Tax

The United States (U.S.) system of federal income taxation is a citizenship-based income tax.  Elsewhere in the world, the basic rule is that taxes are based on residency and not on taxation of worldwide income based on citizenship.

The origin of the U.S. taxation of worldwide income is the first federal U.S. income tax. Enacted in 1861 in the early months of the American Civil War, it was part of the Revenue Act of 1861. It levied a 3% tax on incomes over $800, but a 5% tax on income earned in the U.S. by, “any citizen of the United States residing abroad”.

The purpose was to prevent the U.S. wealthy from evading their tax obligations (military and civic) as American citizens and retaining the privileges of citizenship by fleeing the U.S. in its time of crisis. In 1864, the tax was expanded to include income from all sources, no matter where generated (i.e., worldwide taxation).  Scholars have said this was born from the proud sense of being a citizen of the U.S. With all the opportunities and privileges come obligations.  The concept first flowered out of the battlefields of the U.S. civil war. Hence, the defense of citizenship-based taxation and taxation of worldwide income rests on the belief that U.S. citizenship confers benefits independently of where a citizen resides.

It is not necessary that the amount of benefit received be reflected precisely in the amount of tax charged because the system of U.S. taxation is based on taxes benefiting society at large.  Therefore, the income tax liability is measured by the ability to pay, not by the amount of services used during the tax year. But benefit is an important consideration in the scope of an income tax. Many overseas taxpayers feel that taxing the income of citizens living abroad is justifiable only if significant benefits and privileges are afforded U.S. citizens wherever they live.  The primary privilege is the ability to have a voice: “taxation with representation.” The early U.S. colonists did not have representation with the King of England. This issue was the primary cause of the U.S. revolutionary war.

The model of citizenship-based taxation of worldwide income has remained in the U.S. law ever since, even as the rest of the world has gravitated to a different model known as territorial taxation.  Territorial taxation simply considers where the taxpayer is residing.  Over the years, there have been no serious attempts by U.S. lawmakers to end the taxation of citizens who do not reside in the U.S. Instead, the focus of the debate has generally been on the extent to which the earnings of Americans working overseas should be taxed – by both the country of work/residency and the United States.

In addition, some U.S. economists have suggested that the current system of U.S. income taxation was visionary in the sense that the U.S. Federal Government at the time considered the implications of Imperialism.  It has been discussed that shortly after the enactment of the current system in 1913, (allowed by the passage of the 16th  Amendment to the U.S. Constitution which no longer required apportionment among the states under the 14th Amendment of the Constitution), Congress also enacted the foreign tax credit and other measures to make it easy for U.S. persons to know what their worldwide tax obligation would be and encourage overseas investment.  The intention being to spread the American way of capitalism.

So, the thought of the U.S. system of worldwide federal income taxation appears to be rooted in the privilege of citizenship regardless of residence and Imperialism.

See our page on Pre-Immigration and Expatriation Planning for more information on tax liabilities for U.S. citizens living abroad or foreign nationals choosing to reside in the U.S.A.