Q. How does the inability of the state of Rhode Island to pay its employee pensions help us understand the “net worth” of a U.S. citizen wanting to renounce U.S. citizenship?
A. The answer (like most wisdom in the modern world) is explained in the following tweet.
Rhode Island Averts Pension Disaster Without Raising Taxes – luckily pension “statutory”, not contractual “right”
The article referenced in the above tweet helps us understand the difference between an “entitlement” created by statute and a “right” created by contract.
In most states, lawmakers or the courts have taken steps to make public pension systems creatures of contract law, as opposed to mere creatures of statute. This may sound obscure, but the difference is critical. Statutes are relatively easy to change — lawmakers just amend the law. But states that want to tear up pension contracts face an uphill fight, because of a clause in the United States Constitution that bars them from enacting any law that retroactively impairs contract rights.
Conclusion: Rhode Island’s Governor was able to change the Rhode Island pension benefits. The reason was that: the pension benefits were created by statute (the government can create the statute and the government can change the statute) and not by an enforceable contract (nobody can take the pension away) creating an enforceable right.
The article is fascinating. Other states have not been as fortunate and cannot legislate their pension obligations away. But, what does this have to do with anything?
Renouncing U.S. citizenship – leaving the U.S. tax system
“U.S. citizens” considering relinquishing U.S. citizenship or “long term residents” abandoning their Green Cards “may” be subject to the draconian S. 877A Exit Tax rules. I say “may”. Only “covered expatriates” are subject to the “Exit Tax.”
Unless you meet one of two exceptions,* “U.S. citizens” and “long term residents” will be “covered expatriates” if they meet ANY one of the following three tests.
1. Income test (well, based on “tax liability on taxable income”) – You have an average tax liability of approximately $160,000 for the five years prior to the year of relinquishment or abandonment
2. Net worth test – Assets totaling up to of $2,000,000 USD or more
3. Compliance test – Fail to certify compliance with the Internal Revenue Code for the five years prior to the date of relinquishment or abandonment
* See Internal Revenue Code S. 877A(g)(1) which describe the “dual citizen at birth” and the “relinquishment before age 181/2” exceptions.
Net worth is based on the value of all your property. Foreign pensions are included in property. Is non-U.S. “Social Security” included? “Social Security” is a creation of statute. “Social Security can be taken away by changing or repealing the statute.
Because “pensions” are based on a “contractual” right to receive the pension they are included as “property”. If your employer doesn’t pay the pension you are owed you have the right to sue.
Because “social security” is created by statute and can be taken away by statute it is NOT “property”.
Specified Foreign Financial ASSETS – “Non-U.S.” Social Security and Form 8938
When it comes to “non-U.S.” Social Security (think Canada Pension Plan) created by statute, the IRS says:
Foreign (non-U.S.) equivalent of social security – not specified foreign financial asset – not Form 8938 reportable
(This makes sense because “Social Security” which is created by statute is NOT property!)
But, when it comes to “foreign pensions” which were created by contract, the IRS says:
An interest in a foreign “non-U.S.” pension or deferred compensation plan, is reportable on Form 8938
(This makes sense because the “pension” is a contractual right and is therefore property.)
Is the Australian Superannuation a Foreign “Social Security Type” plan? – Are Australian “Poorer Than They Think?”
Is Super equivalent to Social Security? – Important for determining “covered expatriate status” for renunciation
Well, the “compliance industry” actually creates the law.** Perhaps the “compliance industry” in Australia should simply take the position that Australian Superannuation is the equivalent of “U.S. Social Security”. The U.S. Australian tax treaty would then exempt it from U.S. taxation.
Article 18(2) of the U.S. Australia Tax Treaty reads:
(2) Social Security payments and other public pensions paid by one of the Contracting States to an individual who is a resident of the other Contracting State or a citizen of the United States shall be taxable only in the first-mentioned State.
Important question indeed! Whether Australians are subject to asset confiscation the S. 877A “Exit Tax”, may depend on the answer to this characterization/question.
Food for thought!