Disclaimer: The following is for informational purposes only. It is not intended to constitute legal advice, or to recommend a course of action, and does not create an attorney-client relationship between the reader and Renuka Somers, or Somers Tax Law, PLLC.

The Current Position

Currently, U.S. citizens are taxed on their worldwide income regardless of where they live and can claim a tax credit for tax paid in the foreign country of residence. Additionally, they have onerous foreign information reporting obligations with respect to foreign bank accounts, retirement accounts, investment accounts and managed funds, and trusts and companies that they own or control.  There is no statute of limitations with respect to certain foreign information returns and the penalties for noncompliance with reporting obligations can be severe.

What is proposed

The Residence-Based Taxation for Americans Abroad Act introduced in December 2024 by Illinois Republican Representative LaHood, and currently before the House Committee on Ways and Means, proposes an “elective residency-based income tax for nonresident citizens of the United States”.  If enacted, the rules apply to elections made in tax years ending after that date.

Under proposed section 899 of the Internal Revenue Code (IRC):

• A citizen can elect to be subject to income tax in the U.S. on U.S. source income and gains and be issued with a Certificate of Non-Residency.
• The election would apply for the tax year for which the election is made and all subsequent taxable years until terminated.
• The electing individual would be exempted from filing information returns with respect to certain foreign assets and transactions (including FBAR and IRS Form 8938).
• The election requires payment of any “exit tax” due on election (see below) and the electing individual certifying under penalty of perjury that they have complied with all U.S. tax and information return compliance obligations for the five preceding tax years and submitting evidence of compliance (some limited exceptions apply).
• U.S. citizens born abroad who have never lived in the U.S. are automatically considered to have made the election.

The Downside

• A new “exit tax” for “specified electing individuals” under proposed section 899A of the IRC:  A “specified electing individual” is an individual whose net worth exceeds the current estate tax exemption ($13.99 million for 2025, and approximately $7 million in 2026, unless the current exemption is extended or repealed). The net worth test excludes foreign retirement and tax deferred accounts, a foreign residence used as their principal residence for at least 2 of the 5 years prior to the election, and real estate located in the U.S.). The specified electing individual’s property is deemed to be sold at market value on the date of the election, with the gain (or loss) on the deemed sale being recognized for tax purposes for that tax year.
• An “entry tax” for short term non-residents: resuming U.S. residency prior to the beginning of the fourth taxable year to which the election would otherwise apply, would make the election void, and require the tax and information return filing by the electing individual as though they had been U.S. tax residents for the period of nonresidency.   Form an electing individual, residency can be triggered based on the number of days they spend in the U.S. under a modified version of the “Substantial Presence Test”. The Substantial Presence Test is satisfied where an individual is: physically present in the U.S. on at least 31 days during the current year, and 183 days during the 3-year period that includes the current year and the preceding 2 years, counting all of the days present in the current year, 1/3 of the days present in the year preceding the current year, and 1/6 of the days present in the second year preceding the current year.^[1]
• Only U.S. citizens are eligible to make the election. The tax and information reporting obligations for “Green Card” holders living abroad with current (and/or expired) Green Cards still apply.
• The election only covers federal income tax reporting obligations. U.S. citizens who are nonresidents would still be subject to federal estate tax (unless of course, the federal estate tax is repealed).

The questions – what is unclear

1. Would the new form of exit tax apply if federal estate taxes are repealed?  Presumably not.
2. Whether State income tax reporting obligations and State estate tax exposure remain unaffected.
3. How and would any inconsistency in tax treatment of foreign retirement accounts such as superannuation be addressed to achieve parity in tax outcomes?

The opportunities and benefits

If you are a U.S. citizen living abroad, or are considering relocating / returning abroad, assess your eligibility for the opportunities afforded under the proposed rules:

• Have you established foreign tax residency, or do you intended to do so?
• What is your net worth?
• Can you certify compliance with U.S. federal tax obligations for 5 preceding years? If not, you may want to consider remediation strategy now.
• Do you intend to remain overseas for at least the next 3-4 years?
• How frequently are you present in the U.S.?

For Australians

For Australian residents who are U.S. citizens, if enacted, the proposed changes could mean the end of having to report Australian source income and assets on U.S tax returns.  With Australia having the higher rate of taxation however, there is a benefit from the reduction in the compliance burden and continued exposure to IRS penalties from the nondisclosure, or incomplete disclosure, of foreign assets and income.  The real advantage here is the ability for Australian resident U.S. citizens to keep superannuation contributions and distributions outside of the U.S. income tax system.  In the absence of a Treaty resolution, the same does not hold true for Australian citizens living in the U.S. as U.S. citizens or residents, however.

Notes:

[1] IRC § 7701(b)(3); 26 CFR § 301.7701(b)-1

Renuka Somers.