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I've been looking at iPhone 4S prices. I'm not an US citizen but I've been wondering why does it cost only $199 with a Sprint/Verizon/AT&T contract and why does it cost $649 without those contracts?

What are the limitations if I was a US citizen and I was going to use one of those service providers?

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In the US, carriers offer phones if you sign up for a 2-year contract at a heavily subsidized price. The $649 is the price of the phone without that subsidy (retail price). The subsidy also means these phones are carrier-locked, or bound to one carrier. You can sometimes get the carrier to unlock these or hack it, but don't count on this.

Citizenship isn't so much a qualifier as having a US credit history and billing address. Presumably the carrier is on the hook to subsidize your hardware so they try hard to ensure you will honor your contract to maintain a stream of payments to them (or they can be fairly certain to collect the early termination fee). Having a US credit card (or cash) as well as having a Social Security or equivalent tracking number so the carriers can run a credit check against their US database of buyers increases your likelihood for being approved for a subsidized phone. If the carriers can't get a good credit check, you may be forced to pay the unlocked prices or buy on the grey market or a used handset.

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It's a similar deal in Australia. You pay a small upfront cost and sign up for a 2-year contract. Add these together and you have a minimum contract cost invariable over $1,000. That's far more than the $699 for buying the phone outright. – Hand-E-Food Oct 16 '11 at 23:38
I would rephrase the "discount", as in essence you are paying the price difference with your subscription. Hence why you can not just cancel the subscription and keep the phone, without at least buying out/paying a compensation for the contract breach. – Gerry Oct 16 '11 at 23:41
@Gerry yes, most people factor in the cost difference of the phone and the subsidized price, but fail to factor in the loss of business. When you sign up for a 2-year contract, the carrier (rightfully so) calculates that they will earn x dollars over the 24 months. They make a lot of business decisions based on these figures and it would be a blow to their business model if people ditched and simply squared up the cost of the device. It's a complicated web actually. – cksum Oct 17 '11 at 1:03

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