In order to apply the proper tax-related rules, payment professionals, tax advisors and return preparers need to know which employees, payees, or clients are U.S. citizens, and which are not and may, therefore, be subject to a different set of tax rules and procedures.
Taxation of Worldwide Income. U.S. citizens are subject to U.S. income tax on their worldwide income while noncitizens are only taxed like citizens if they meet the Internal Revenue Code (IRC) definition of resident alien. Taxation on worldwide income is imposed based on citizenship status (called citizenship-based taxation) regardless of where in the world the citizens reside or where the income is sourced.
Taxation of Citizens Abroad. As a result of citizenship-based U.S. taxation, the 6 to 7 million U.S. citizens who reside outside the U.S. are subject to U.S. income tax and related rules. U.S. citizens abroad may not use an income tax treaty between their country of tax residence and the U.S. to reduce their U.S. income tax and withholding obligations. (They may not use the treaty to reduce their country of residence tax obligations either.) Citizens abroad may avoid double taxation on their worldwide income with special IRC rules – the section 911 foreign earned income exclusions and foreign tax credits.
Withholding and Reporting on Employee Compensation. Employee compensation of citizens is subject to U.S. Social Security and Medicare taxes as well as federal and any applicable state wage withholding. U.S. citizen employees provide information for wage withholding purposes on Form W-4 using the standard rules. (Noncitizens who are not resident aliens are subject to special Form W-4 rules.) Special rules and forms are available for citizens employed abroad by an American employer to avoid double wage withholding. Wages and withheld taxes are reported on a Form W-2 (whether or not the employee is a citizen).
Withholding and Reporting on Nonemployee Compensation. Nonemployee compensation of U.S. citizens is not subject to withholding if the individual provides a U.S. Social Security Number unless the IRS has notified the payer that the individual is subject to backup withholding. As a matter of company policy, a payer may solicit such information on a Form W-9, but a form is not required of individuals under the tax rules. (An individual taxpayer identification number indicates that the service provider is not a U.S. citizen and might be a nonresident alien and subject to different withholding and reporting rules.) Nonemployee compensation of citizens must be reported on a Form 1099-MISC if the compensation equals or exceeds $600 in the tax year. Form 1099-MISC reporting is also required if the income was subject to backup withholding.
U.S. Tax Return Obligations. U.S. citizens who meet the income threshold based on their tax return filing status must submit a Form 1040 individual tax return (or simpler 1040A or 1040EZ) by April 15 of the following year. Citizens who have foreign income or assets might have special disclosure form obligations as well. For example, Form TD 90.22-1 (called the FBAR) is required annually of all citizens with foreign financial accounts that equal or exceed $10,000 in the aggregate in the tax year. U.S. citizens with foreign financial assets may be obligated to submit annually the new Form 8938 introduced by FATCA if their foreign assets exceed a specified threshold (which varies based on their residence in the U.S. or abroad).
Tax Impact of Loss of Citizenship. Citizens who renounce their U.S. citizenship may be subject to a departure tax and/or special tax and reporting rules depending on the date that they lost their citizenship. (The tax law and related procedures related to loss of citizenship have changed several times since 1996.) Under current rules, former citizens must provide information about their compliance with their U.S. income tax obligations on Form 8854 immediately following their loss of citizenship status. The rules for claiming tax treaty exemptions from U.S. tax and for withholding on certain types of distributions vary depending on the set of rules in effect at the time their U.S. citizenship was lost. A U.S. citizen who renounces citizenship for tax-related reasons is barred from entry into the U.S.
Impact of Dual Citizenship. A U.S. citizen may also be a citizen of another country because of place of birth or foreign laws conferring citizenship on children born to citizens of the country. For U.S. tax purposes, a U.S. citizen is treated for all purposes as a U.S. citizen regardless of any other citizenship. Many dual citizens were born in the U.S. while their parents were in the U.S. to study, train, engage in research, or work temporarily, and returned with their parents to their home country when they were very young. These citizens (referred to as accidental citizens) may not understand the U.S. tax obligations that birth in the U.S. conferred upon them with their U.S. citizenship. A U.S. citizen must enter the U.S. on a U.S. passport, although it is not unusual for an accidental citizen to enter on a foreign passport unaware of their U.S. citizenship (but sometimes intentionally) and expect to be treated under the tax rules and procedures that apply to foreign nationals.