On February 28, 2019 TaxConnections kindly posted my first post comparing the way that 19th Century Britain and 21st Century America Treated Its Citizens/Subjects. The post received a great deal of interest resulting in more than 120 comments (largely reflecting the frustration of Americans abroad and accidental Americans).
The purpose of that post focused largely on citizenship and the fact that the United States imposes worldwide taxation on U.S. citizens who are tax residents of other countries and do NOT live in the United States. What that post did NOT do was to focus on HOW the Internal Revenue Code applies to U.S. citizens who do NOT live in the United States.
The Bottom Line Is:
The United States is in effect imposing a separate and more punitive tax system on its citizens abroad. Strange but true. The purpose of this post is to explain how that works and to provide specific examples.
This is an important post that we encourage you forward on to any person you know who is an American working and living abroad; or any accidental Americans who are caught up in this tax legislation. Please watch this video where John Richardson interviews Jim Gosart, Olivier Wagner and Solomon Yue about their work on behalf of all Americans Abroad. Although many other significant contributors have helped along the way, these gentlemen have been greatly instrumental in getting tax legislation H.R. 7358 to Congress.
If you have followed any of the initiatives to get this bill in front of Congress, you must know what they have accomplished is astonishing. The goal has always been to make the tax treatment of Americans Abroad fair. The new bill presented in Congress is appropriately called “Tax Fairness For Americans Abroad Act of 2018″ and you should follow it closely.
U.S. Treasury sought comments about the Sec. 965 transition tax. The deadline for comment was October 9, 2018. You can read the comments here. A particularly noteworthy comment was posted by James Gosart:
To: United States Department of the Treasury
Subject: Proposed Regulations under Section 965 [REG 104226-18]
The transition tax is a killer for small American owned overseas businesses. I am a small business owner of a consulting company in Hong Kong. Around the world, I’m sure there are thousands of small American business owners like me.
I formed the company in 2011 after spending more than 25 years based in China and Asia as an expat employee of a major US corporation. During the 7 years the company has been in operation, I have helped US companies and investors with their China and Asia strategies, ultimately growing their businesses in Asia and contributing to US based employment. My company paid corporate taxes annually in Hong Kong. I have now relocated to the US and I’m in the process of shutting the business down.
The new transition tax is so burdensome and complex that there is no way I would start such a business today.
An example of the perspective of the “tax compliance” community -Look at what the statute says and not what was intended.
“Probably Congress and the Administration did not contemplate the fallout to these USC taxpayers. They were focusing on a different group of taxpayer. Nevertheless, Section 965 imposes immediate U.S. individual taxation on the “phantom income” (i.e. when no dividends are distributed to the USC shareholder) of the USC shareholder.”
Does the “intent” matter? If the application of the U.S. transition tax to Americans Abroad was an accident and not intentional, then why should it apply to them? Read the “965 Hammer” for USCs residing overseas.
Origin Of Internal Revenue Service
The roots of IRS go back to the Civil War when President Lincoln and Congress, in 1862, created the position of commissioner of Internal Revenue and enacted an income tax to pay war expenses. The income tax was repealed 10 years later. Congress revived the income tax in 1894, but the Supreme Court ruled it unconstitutional the following year.
In 1913, Wyoming ratified the 16th Amendment, providing the three-quarter majority of states necessary to amend the Constitution. The 16th Amendment gave Congress the authority to enact an income tax. That same year, the first Form 1040 appeared after Congress levied a 1 percent tax on net personal incomes above $3,000 with a 6 percent surtax on incomes of more than $500,000.
In 1918, during World War I, the top rate of the income tax rose to 77 percent to help finance the war effort. It dropped sharply in the post-war years, down to 24 percent in 1929, and rose again during the Depression. During World War II, Congress introduced payroll withholding and quarterly tax payments.
Senate Committee on Finance
Attn. Editorial and Document Section
Dirksen Senate Office Bldg.
Washington, DC 20510-6200
Dear Chairman Hatch, Ranking Member Wyden, and all Members of the Committee:
Part A – Introduction
I am based in Toronto, Canada and work with U.S. citizens living outside the United States who are required to comply with the tax laws of both the United States AND their country of residence. U.S. citizens living in Canada (the majority of who are dual Canada U.S. citizens) are required to comply with the tax laws of both Canada and the United States. Dual citizens in general and “U.S./Canada dual citizens in particular, live in a world where compliance with U.S. tax laws is somewhere “between difficult and impossible”. The difficulty is first because of the potential for double taxation and second because the U.S. Internal Revenue Code imposes far more punitive taxation on U.S. citizens living outside the United States than it does on U.S. citizens living inside the United States.
U.S. tax laws impact the application of State tax laws. The “Tax Cuts and Jobs Act” has impacted State tax revenues in various ways. Therefore, the Section 965 “Transition Tax” will impact individual state tax revenues.
My previous posts have discussed the “transition/repatriation” tax from the perspective of individuals who (1) have small business corporations outside the United States, who are (2) tax residents of other countries. I have previously noted that the “transition tax” impacts individuals who are “tax residents” of ONLY the United States (actually giving them a “sweet deal”) very differently from how it impacts individuals who are “tax residents” of other countries (basically confiscating their retirement assets. If you are a U.S. citizen why are living outside the USA anyway?). See in particular Part 4 above.
Why The Transition Tax Creates A Fictional Tax Event That Allows The U.S. To Collect Tax Where It Never Could Have Before
This is the seventh in my series of posts about the Sec. 965 Transition Tax and whether/how it applies to the small business corporations owned by taxpaying residents of other countries(who may also have U.S. citizenship). These small business corporations are in no way “foreign”. They are certainly “local” to the resident of another country who just happens to have the misfortune of being a U.S. citizen. Read More