The question comes up in almost every initial consultation with Americans living abroad: “I moved to Portugal three years ago and haven’t filed U.S. taxes since leaving – I don’t live there anymore, so I assumed I didn’t owe anything. Was I wrong?” The answer is always yes, and it’s always expensive to fix. U.S. citizenship creates a worldwide taxation obligation that follows you regardless of where you live, where you work, or whether you ever set foot in the United States during the tax year. Moving to Lisbon, teaching in Seoul, retiring in Costa Rica, or working remotely from Bali doesn’t eliminate your U.S. tax obligations – it makes them more complex.
This fundamental misunderstanding stems from the fact that the United States is one of only two countries in the world that tax based on citizenship rather than residence. While virtually every other nation taxes you based on where you live, the U.S. requires citizens and green card holders to report and pay tax on worldwide income, no matter where they’re physically located. This creates confusion because the system is counterintuitive – if you’re not living in the country, not using its services, and not earning money within its borders, why would you owe taxes there? The answer is that U.S. tax law doesn’t care about your residence. Your passport determines your tax obligations, not your address.
Understanding worldwide taxation isn’t just about knowing you have to file. It’s about grasping the distinctions between tax residency and domicile, knowing when you can exclude foreign earned income from U.S. taxation, understanding how foreign tax credits work, and recognizing that compliance requirements extend far beyond simply filing Form 1040. The stakes are high – the IRS has unprecedented access to information about foreign accounts and income through FATCA reporting, and the penalties for non-compliance regularly exceed the taxes that would have been owed.
I’m going to walk you through exactly how U.S. worldwide taxation works, why your physical location doesn’t eliminate your U.S. tax obligations, the critical differences between residency and domicile, the mechanisms available to reduce double taxation, and what you must do annually to remain compliant – even if you never plan to return to the United States.
U.S. Citizenship-Based Taxation: A Global Anomaly
The United States and Eritrea are the only two countries in the world that tax their citizens on worldwide income regardless of where they live. Every other nation uses residence-based taxation, meaning you pay taxes in the country where you reside, not the country that issued your passport.
How Citizenship-Based Taxation Works
If you’re a U.S. citizen or green card holder, the Internal Revenue Code requires you to report and pay tax on your worldwide income. This includes:
- All earned income – Wages, salaries, bonuses, and self-employment income earned anywhere in the world
- All investment income – Interest, dividends, capital gains, rental income, and royalties from any country
- All business income – Income from businesses operated anywhere globally
- Retirement distributions – Distributions from both U.S. and foreign retirement accounts
- Other income – Prizes, awards, gambling winnings, canceled debt, and any other income regardless of source
Your tax obligation exists whether you live in the United States, lived there briefly and moved abroad decades ago, or were born abroad to U.S. citizen parents and never lived in the U.S. at all. The citizenship connection alone creates the tax obligation.
Why the U.S. Uses This System
The U.S. adopted citizenship-based taxation during the Civil War era and maintained it through the premise that citizenship provides valuable benefits – diplomatic protection abroad, the right to return and work in the U.S. without restriction, access to U.S. social programs – that justify taxation regardless of residence. Critics argue this system is outdated in a globalized world where millions of Americans live and work abroad, but Congress has shown no inclination to move to a residence-based system like other developed nations.
Who Worldwide Taxation Applies To
U.S. worldwide taxation obligations extend to:
- U.S. citizens – All citizens regardless of where born, where living, or dual citizenship status
- Green card holders – Lawful permanent residents even if living outside the U.S.
- Dual citizens – Holding another country’s citizenship doesn’t eliminate U.S. obligations
- Accidental Americans – Born in the U.S. but left as children and never lived there as adults
The Only True Exit: Renunciation
The only way to eliminate U.S. worldwide taxation is formally renouncing citizenship or abandoning your green card. Renunciation is irreversible and triggers exit tax for “covered expatriates” (net worth over $2 million or average annual tax over $190,000), eliminates the right to live or work in the U.S., and requires appearing before a consular officer abroad. For most expats, renunciation is too extreme – the goal is understanding compliance while living abroad and using FEIE or FTC to minimize double taxation.
Tax Residency vs. Domicile: Critical Distinctions That Create Confusion
Americans living abroad face a conceptual challenge: they must understand both U.S. federal tax rules (which follow citizenship) and state tax rules (which often follow domicile), while also navigating the residence rules of the country where they live. The confusion between tax residency and domicile creates compliance problems and unexpected tax bills.
Federal Tax Residency for Non-Citizens
While U.S. citizens are always tax residents, non-citizens become U.S. tax residents through:
- Green card test – Lawful permanent residents are tax residents
- Substantial presence test – Present in the U.S. for 31+ days in current year AND 183+ days using a weighted three-year calculation (all days in current year + 1/3 of days in prior year + 1/6 of days in year before that)
For expats, the substantial presence test matters when determining whether they’re still U.S. tax residents in addition to being U.S. citizens. However, citizenship alone is sufficient – you don’t need to meet the substantial presence test to have U.S. tax obligations as a citizen.
State Tax Domicile
Domicile is a legal concept meaning your permanent home – the place you intend to return to when absent. Domicile determines state tax obligations and is stickier than physical residency:
- Established by physical presence plus intent – You must be physically present in a state and intend to make it your permanent home
- Continues until abandoned – Domicile persists even when you leave, until you establish a new domicile elsewhere with intent to remain permanently
- Can only have one domicile – Unlike residency (you can be a resident of multiple jurisdictions), you can only have one domicile at a time
- Determines state tax obligations – Many states assert the right to tax worldwide income of domiciliaries even when living abroad
Abandoning State Tax Domicile
Moving abroad doesn’t automatically terminate your state tax domicile. States like California, New York, Virginia, and South Carolina are particularly aggressive about maintaining domicile claims. To abandon domicile, you typically need to:
- Sever residential ties – Sell or rent out your home, don’t maintain a permanent residence available for your use
- Eliminate economic connections – Move professional licenses, business registrations, and economic activity to your new location
- Change legal documents – Update driver’s license, voter registration, wills, trusts, and other legal documents to reflect new domicile
- Demonstrate intent – Your actions must show you intend your new location to be permanent, not temporary
- Establish new domicile – Most importantly, you must establish domicile in a new jurisdiction with intent to remain (or establish foreign domicile)
California’s Franchise Tax Board, for example, presumes California domicile continues for anyone who maintains close connections to the state – keeping a California driver’s license, maintaining professional licenses there, having family in California, or owning property there can all support the state’s position that you remain a California domiciliary subject to worldwide taxation.
Foreign Tax Residency and Dual Status
The country where you live has its own residency rules – typically physical presence for 183+ days, maintaining a permanent home, or where your personal and economic ties are closest. You can simultaneously be a U.S. tax resident (through citizenship) and a foreign tax resident. When both countries tax the same income, tax treaties provide tie-breaker rules based on permanent home, center of vital interests, habitual abode, or citizenship. Treaty benefits help avoid double taxation but don’t eliminate the obligation to file U.S. returns reporting worldwide income.
Foreign Earned Income Exclusion: Reducing U.S. Tax on Foreign Earnings
The Foreign Earned Income Exclusion (FEIE) allows qualifying Americans working abroad to exclude a portion of their foreign earned income from U.S. taxation. For 2026, the exclusion amount is $132,900. This is the primary mechanism most expats use to reduce their U.S. tax burden while living and working overseas.
Qualifying for the FEIE
To claim the FEIE, you must meet two requirements: you must have foreign earned income, and you must meet either the bona fide residence test or the physical presence test.
Physical Presence Test
The physical presence test is mechanical and easier to track:
- 330 full days abroad – Present in a foreign country or countries for at least 330 full days during any 12-month period
- Full days count – A full day means the entire 24-hour period; partial days don’t count
- Any 12-month period – Doesn’t need to be the calendar year; can be any consecutive 12 months
- U.S. and international waters don’t count – Days in the U.S. or over international waters break the count
Example: If you leave the U.S. on March 15, 2026, and return on January 10, 2027, spending only 20 total days in the U.S. during that period, you’d meet the physical presence test for the 12-month period from approximately mid-March 2026 through mid-March 2027.
Bona Fide Residence Test
The bona fide residence test is more flexible but subjective:
- Resident of foreign country – Established residency in a foreign country under that country’s laws
- For uninterrupted period – Includes an entire tax year (January 1 – December 31)
- Intent matters – Must intend to reside abroad indefinitely, not temporarily
- Can visit U.S. – Unlike physical presence test, brief trips to the U.S. don’t disqualify you
- Connections to foreign country – Employment, home, family, economic ties support bona fide residence
The bona fide residence test works better for expats with long-term overseas assignments who occasionally return to the U.S. for business or visits but have established genuine residence abroad.
What Income Qualifies as “Earned Income”
The FEIE only applies to earned income – compensation for personal services. This includes:
- Wages and salaries – Regular employment compensation
- Bonuses and commissions – Performance-based compensation
- Professional fees – Self-employment income from services provided
- Tips and gratuities – Service-related compensation
The following do NOT qualify for the FEIE:
- Investment income – Interest, dividends, capital gains
- Rental income – Income from rental properties (passive)
- Pension distributions – Retirement account distributions
- Social Security benefits – U.S. Social Security payments
- Alimony – Support payments received
Foreign Housing Exclusion
In addition to the $132,900 earned income exclusion, you may qualify for a foreign housing exclusion or deduction:
- Reasonable housing costs – Rent, utilities (not phone/internet), real and personal property insurance, residential parking, furniture rental
- Exceeds base amount – Can exclude costs above a base amount (16% of FEIE, or approximately $21,264 for 2026)
- Caps vary by location – IRS publishes location-specific caps; expensive cities like London, Hong Kong, Singapore have higher limits
- Exclusion for employees, deduction for self-employed – Employees exclude housing amounts, self-employed individuals take a deduction
Claiming the FEIE: Form 2555
You claim the FEIE by filing Form 2555 with your Form 1040. Key points:
- Must file to claim – The exclusion isn’t automatic; you must file Form 2555 even if your income is below the exclusion amount
- Once claimed, continues – After claiming FEIE, you must continue using it or formally revoke it
- Revocation has consequences – If you revoke FEIE, you can’t claim it again for 5 years without IRS permission
- Extensions available – Can request automatic 2-month extension or file for longer extensions if abroad
Foreign Tax Credit: Alternative to the FEIE
The Foreign Tax Credit (FTC) provides another mechanism to prevent double taxation. Instead of excluding income from U.S. taxation, the FTC gives you a dollar-for-dollar credit against U.S. taxes for foreign income taxes paid to other countries.
How the Foreign Tax Credit Works
Form 1116 calculates your foreign tax credit – a dollar-for-dollar credit against U.S. taxes for foreign income taxes paid. The credit applies to foreign taxes paid on foreign-source income and is limited to the U.S. tax that would be owed on that income, calculated separately by income category (passive, general).
FEIE vs. FTC: Strategic Considerations
Choosing between FEIE and FTC depends on your specific circumstances:
FEIE works better when:
- Low or no foreign taxes – Living in a low-tax jurisdiction, the exclusion provides benefit even without foreign tax payments
- Earned income only – Your income is primarily wages/salaries that qualify for exclusion
- Income below $132,900 – The exclusion eliminates your entire tax liability
- Simplicity preferred – FEIE is generally simpler than FTC calculations
FTC works better when:
- High foreign tax rates – Living in high-tax countries like UK, France, Germany, Japan where foreign taxes exceed U.S. rates
- Income over $132,900 – FEIE doesn’t help above the threshold; FTC can eliminate tax on any amount
- Passive income substantial – Investment income doesn’t qualify for FEIE but does generate foreign tax credits
- Foreign tax credit carryovers – Excess credits can be carried back 1 year or forward 10 years
You Cannot Double Dip
A critical limitation: you cannot use FEIE and FTC on the same income. If you exclude income using FEIE, you cannot also claim FTC on foreign taxes paid on that excluded income. You must choose one method or use FEIE for earned income and FTC for passive income not eligible for FEIE.
Ongoing Compliance Requirements for American Expats
Beyond filing Form 1040 and choosing between FEIE and FTC, American expats face multiple annual compliance requirements. Missing these filings creates penalty exposure that often exceeds the taxes owed.
Annual Form 1040 Filing
Every U.S. citizen must file Form 1040 annually if their income exceeds the standard deduction threshold (approximately $16,100 for single filers in 2026). This requirement exists even if:
- You owe no tax – Zero tax liability doesn’t eliminate the filing requirement
- All income excluded – Even if FEIE excludes all income, you must file to claim the exclusion
- You never visit the U.S. – Physical presence in the U.S. is irrelevant to the filing requirement
- You renounced citizenship – Must file for the year of renunciation and any prior unfiled years
FBAR (FinCEN Form 114)
The Foreign Bank Account Report requires separate filing if you have financial interest in or signature authority over foreign financial accounts with aggregate value exceeding $10,000 at any point during the calendar year:
- Not filed with tax return – FBAR files separately through FinCEN’s online system
- Due April 15 – Automatic extension to October 15, but must request extension
- Covers all foreign accounts – Bank accounts, investment accounts, some insurance policies, mutual funds
- Aggregate threshold – Total of all foreign accounts, not per-account threshold
- Severe penalties – Non-willful violations: $10,000 per account per year; willful violations: greater of $100,000 or 50% of account balance
Form 8938: Statement of Specified Foreign Financial Assets
Form 8938 files with your tax return and reports specified foreign financial assets exceeding reporting thresholds:
- Higher thresholds than FBAR – For expats filing separately: $200,000 on last day of year or $300,000 at any time; married filing jointly: $400,000 or $600,000
- Broader asset coverage – Includes stock in foreign corporations, partnership interests, foreign hedge funds, some foreign pensions
- Files with Form 1040 – Unlike FBAR which files separately
- 40% penalty on unreported income – Special 40% penalty on any understatement of tax related to undisclosed foreign assets
Forms 5471, 8865, 8621
As covered in previous articles, ownership in foreign corporations, partnerships, or PFICs creates additional annual filing requirements with severe penalties for failures.
State Tax Filings
If you haven’t successfully abandoned your state domicile, you remain subject to that state’s income tax and filing requirements. Some states require annual filings even for domiciliaries living abroad.
Self-Employment Tax and Totalization Agreements
FEIE and FTC only reduce income tax. Self-employed individuals abroad may still owe Social Security and Medicare taxes unless covered by a totalization agreement allowing you to pay into only one country’s social system. You need a certificate of coverage from the appropriate authority.
Common Misconceptions That Create Compliance Problems
These false beliefs lead expats into non-compliance and penalty exposure:
“Living Abroad Means I Don’t Pay U.S. Taxes”
FALSE. Citizenship creates the tax obligation, not residence. You must file and report worldwide income regardless of where you live. The FEIE and FTC reduce or eliminate the tax owed, but the filing requirement and income reporting obligation remain absolute.
“Foreign Income Isn’t Taxable in the U.S.”
FALSE. All worldwide income is taxable to U.S. citizens. The source of income – foreign or domestic – is irrelevant to taxability. The only question is whether you qualify for mechanisms like FEIE or FTC that reduce the tax owed.
“The IRS Can’t Find My Foreign Income”
FALSE. FATCA (Foreign Account Tax Compliance Act) requires foreign financial institutions to report accounts held by U.S. persons directly to the IRS. Banks in virtually every country now report U.S. account holders’ information annually. The IRS has more information about foreign accounts than ever before, and compliance has become effectively mandatory.
“Moving Abroad Eliminates State Taxes Automatically”
FALSE. State tax obligations depend on domicile, which continues until you affirmatively abandon it and establish a new domicile. Simply moving abroad while maintaining connections to your former state often isn’t sufficient to terminate state tax obligations.
“I Can Just Not File – I Don’t Owe Anything Anyway”
FALSE AND DANGEROUS. The penalties for not filing required returns and information returns (FBAR, Form 8938, Forms 5471/8865/8621) often exceed any taxes you might owe. Failing to file Form 1040 creates penalties of 5% per month (up to 25%) of tax due. Failing to file FBAR creates penalties up to $10,000 per account per year for non-willful violations. The “I didn’t owe tax so I didn’t file” defense doesn’t work for information returns with separate penalty regimes.
“I’ll Deal With It When I Move Back”
FALSE. Waiting to address compliance creates larger problems. Statute of limitations doesn’t run while returns remain unfiled, interest compounds on unpaid taxes, and penalties multiply for each year of non-filing. The IRS has streamlined compliance procedures for expats with reasonable cause, but these programs require you to come forward before the IRS contacts you. Once the IRS initiates contact, your options narrow and costs increase.
Navigating Worldwide Taxation Requires Specialized Expertise
U.S. worldwide taxation creates complexity that exceeds what general-practice CPAs typically handle. The interaction between U.S. federal tax rules, state domicile rules, foreign country tax rules, and multiple information reporting requirements demands professionals who specialize in expat taxation.
If you’re an American living abroad, working overseas, or planning an international move, you need to understand your ongoing U.S. tax obligations before problems develop. The FEIE and FTC can substantially reduce or eliminate your U.S. tax liability, but only if you file the required forms correctly and timely. The information reporting requirements – FBAR, Form 8938, Forms 5471/8865/8621 – carry penalties that dwarf the income tax considerations.
Contact us for a comprehensive expat tax consultation. We’ll evaluate your specific situation, determine whether FEIE or FTC provides better tax results for your circumstances, assess your information reporting obligations across all required forms, address any state domicile issues, and develop a compliant strategy that minimizes your global tax burden while eliminating penalty exposure. If you’ve missed prior-year filings, we’ll evaluate streamlined compliance procedures and work to bring you into compliance with minimal penalty consequences.
Living abroad doesn’t eliminate your U.S. tax obligations – it makes them more complex. Get expert guidance before the IRS discovers non-compliance and your options narrow.