How to Renounce Citizenship: History

By Expat News

American citizens are taxed on their worldwide income. This well-known fact is probably the main reason that more American expats renounce citizenship. Before we discuss the procedure to renounce citizenship, let’s review the history of tax system and double taxation in the USA.

All other countries except for Eritrea use a residency-based taxation. This model of citizenship-based taxation has remained in the U.S. for the past 150 years.

The history goes back to 1861 when the first income tax was enacted to fund the American Civil War efforts. Back then the US government taxed its citizens on US income and residency-based taxation was introduced. Congress levied a 3% tax on incomes over $800. American expatriates living abroad paid only a 5% tax on income earned in the U.S. The tax on foreign income did not exist as overseas income was excluded.

However, in 1864 Congress decided to move to citizenship-based taxation and passed a new law that taxed non-resident citizens on their overseas income as well. The tax on foreign income that was applicable to both residents and non-residents, was only in effect until 1872. The idea to renounce citizenship did not exist before 1900s.

When did American expatriates start to renounce citizenship?

The big change came in 1878 when the 16th Amendment to the Constitution was passed. This is the year that the modern federal income tax system was introduced. The new income tax regime, the foundation of the modern system of U.S. taxation, was created in 1913 and revised in 1916. This new tax system applied to every citizen of the United States, whether residing at home or abroad.

Per the new law, American expatriates living abroad have to pay tax on their global income. Starting in 1914 American expatriates living in London had begun to renounce citizenship in order to escape double taxation. Multiple American Abroad groups challenged the legality of the new provision. The issue of double taxation was brought to the Supreme Court. The significant ruling happened in 1924 when the Supreme Court ruled in a case brought by a U.S. citizen living in Mexico that taxing American expatriates living abroad on their global income was indeed constitutional.

Since the year of 1924 lawmakers have not challenged citizenship-based taxation system. The main point of any debate had generally been the idea of double taxation. The fact that American expatriates living abroad are taxed both by the country of residence and the United States has been controversial.

Starting in 1918 the US government has introduced several tax provisions to minimize the effects of double taxation. Congress created a foreign tax credit in 1918 and foreign earned income exclusion in 1926.

The number of people who decided to renounce citizenship has been on the rise. Globally, 1,781 Americans renounced their citizenship in 2011, compared with 742 in 2009 and 278 in 2006, according to Treasury data.

If you decide to renounce citizenship or you have questions about renouncing citizenship, please contact an expert that provides international tax services.