Territorial taxation is a tax system that taxes income earned within a country’s borders regardless of who earns it, rather than taxing a person’s worldwide income because of where they live or what passport they hold.
In plain terms
Most countries run some version of territorial or residence-based taxation: earn money inside the country’s borders, owe tax on it; earn money outside, generally don’t. The United States is the odd one out. It taxes its citizens and green-card holders on their worldwide income no matter where they live, a system called citizenship-based taxation — the only other country that does this with any real enforcement is Eritrea. Someone can move abroad, earn nothing in the US, and still owe the IRS a return every year, simply for holding an American passport.
How it works
A pure territorial system looks at the source of the income, not the identity of the earner: a French company’s profit earned in Singapore is Singapore’s to tax, not France’s, under many of France’s own treaty arrangements. A residence-based system, the global default, looks instead at where the taxpayer lives: move your tax residence and your home country generally stops taxing income earned elsewhere.
US citizenship-based taxation collapses both tests into one and keeps taxing regardless of either. The main relief valve is the foreign earned income exclusion under Internal Revenue Code Section 911, which lets a qualifying American living abroad exclude a capped amount of foreign wages — not investment income — from US tax, plus a smaller exclusion for foreign housing costs. It does nothing for capital gains, dividends, or a founder’s equity, which is why high earners abroad still frequently owe significant US tax on top of whatever they pay their country of residence.
The one genuine US territorial carve-out is Puerto Rico. Under 26 U.S.C. § 933, income a bona fide Puerto Rico resident earns from Puerto Rico sources is excluded from federal tax entirely — not deferred, not credited, excluded — which is the statutory foundation underneath the island’s Act 60 tax-decree program for new residents.
The numbers
- 2026 foreign earned income exclusion: $132,900 per qualifying person, up from $130,000 in 2025, adjusted annually for inflation under Section 911.
- 2026 foreign housing cost exclusion limit: $39,870.
- Countries taxing on citizenship rather than residence: the United States and Eritrea — essentially every other country uses some form of residence- or territory-based system.
- Puerto Rico-source income for a bona fide resident: excluded from US federal tax at 0%, under Section 933, regardless of amount.
What people get wrong
That moving abroad, or even renouncing a green card informally, ends the US tax relationship. It doesn’t. A US citizen living permanently in Singapore, a genuinely territorial jurisdiction, still files a US return every year and still owes US tax on investment income no local system touches — the foreign earned income exclusion only ever reaches wages. The only way to fully exit the US worldwide net is formal expatriation, which carries its own tax bill. The second misconception is that Puerto Rico’s Act 60 is a loophole; it’s a direct application of a decades-old statute, Section 933, that Congress wrote specifically because Puerto Rico is a US territory rather than a foreign country — which is exactly why it survives scrutiny that an offshore structure claiming the same benefit would not.
Related
Read more: Offshore: Tax Havens, Shell Companies, and the Panama Papers · Residency and Citizenship: Why the Wealthy Buy Options Across Borders
See also: Non-dom · Expatriation / exit tax · Domicile vs. residency