While there are a few different tax systems around the world, most countries will fall under two of the most widely used tax systems, worldwide or territorial. Today, we are going to analyze these common tax systems and look at the details of when and how you may fall into that tax system.
The first tax system we’re going to look at is Citizenship-Based Taxation. This is the most difficult tax system to opt out of and only two countries in the world use this tax system. The first is the United States of America, and the second is Eritrea.
Under the citizenship-based taxation system, if you are a citizen of that country and hold a passport, you will be required to file and/or pay taxes in that country. This is a difficult tax system to opt out of because as long as you hold that country’s passport, you will be required to file and/or pay taxes. You will need to revoke your citizenship and give up your passport of the country if you want to opt out of the tax system.
In the United States, they do have a rule called FEIE, which is Foreign Earned Income Exclusion, which can be utilized for some to not pay any tax on their overseas income.
Within FEIE, if you are American and make around $110,000 per year or less, you will not have to pay taxes (keep in mind this amount increases slightly each year.) Therefore, if you live abroad and do make more than the annual FEIE amount that year, you will be required to pay taxes for that calendar year.
The next taxation system is Residence Based Taxation, also known as Worldwide Income Taxation. This is the most common type of taxation that most countries and almost all Western countries utilize (except the USA, of course).
If you are a resident of a worldwide taxation system, meaning you lived in that country for 183 days or more in a calendar year, you are a resident.
As a resident, you will be excepted to file and pay taxes within that country. However, it can get tricky to determine if you are a resident of that country or not if you have stayed less than 183 days in a calendar year. And yes, you can still be deemed a resident even if you did not meet the minimum stay requirement.
In this situation, it will vary depending on the country in question, but oftentimes there will be ‘tie breakers’ that the government will look for. Do you have bank accounts, a home, a family, a license, storage units, or memberships… the list goes on, but your potential residency will depend on how many ties you have to that specific country.
This tax system is also called the Worldwide Taxation System because, as a resident, you will be required to pay taxes on your worldwide income, even if that income is generated in another country.
The last significant taxation system I will mention is the Territorial Tax System. This is a great tax system if you are looking to optimize your taxes and live abroad.
The Territorial Tax System means that you are only taxed on your income that enters that specific country.
For example, if you are a resident of the country of Georgia, which is a territorial tax country, but the income you make does not enter the country of Georgia, your money will not be taxed in Georgia. However, any money that does enter Georgia will be subject to their tax rate, which is quite low.
Territorial tax countries are excellent ways to optimize your taxes and businesses, as long as your funds do not physically enter the country.
If you are looking to optimize your tax and live in another country, you absolutely have options. I would also recommend reading my blog post on the Five Flag Theory, as this goes hand in hand with the different types of tax systems and how you can use them to your advantage. I hope this article taught you more surrounding the different tax systems around the world and how they operate.
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