1.Summary
Gaudreau and Civil Engineer highlight the resemblance between citizenship-based and residence-based taxation when residence is implicitly (as in Gaudreau) or explicitly (as in Civil Engineer) defined as domicile, the taxpayer’s permanent home. Both domicile and citizenship are measures of long-term permanent allegiance rather than short-term physical presence. Consequently, the outcomes in tax cases will often be the same whether in personam jurisdiction to tax on a worldwide basis is asserted in terms of an individual’s citizenship or in terms of her domiciliary residence.
Determining domicile – the taxpayer’s permanent home – is often a factually daunting challenge, as is demonstrated by Gaines- Cooper. Consequently, in tax cases, citizenship is an administrable proxy for domicile. From this vantage, the U.S. system of citizenship-based taxation is closer than is generally recognized to other nations’ residence-based tax systems: When residence is defined for tax purposes as the taxpayer’s domicile, citizenship-based and residence-based taxation converge, but citizenship based taxation reaches these similar results more efficiently by eliminating the need for factually intensive inquiries about domicile.
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- Qualifications, Objections, and Concerns
In this final Part, I anticipate nine potential objections to and concerns about my analysis and acknowledge some necessary qualifications.
- Should Residence for Tax Purposes Be Defined as Domicile?
Consider initially the argument that residence for tax purposes should be defined short of domicile. According to this argument, the other three definitions of residence – an individual’s physical presence in any year, less physical presence augmented by other factors, and “ordinary” residence – more properly implement the benefits and ability-to-pay rationales for residence-based taxation than does domicile. If domicile is an ill-suited definition of residence for tax purposes, citizenship ceases to serve a valuable proxy function as an administrable marker for such domicile. 263
Consider, in this context, Civil Engineer. In that case, the taxpayer, a British citizen, lived in Hong Kong for roughly thirty years and was, during that period, physically present in the United Kingdom only intermittently. In this setting, the taxpayer’s non-U.K. gifts were subject to U.K. inheritance tax because the taxpayer was found to be domiciled in the United Kingdom.
If domicile – the taxpayer’s permanent home – is properly deemed to establish residence for tax purposes, then it is compelling to view this taxpayer’s British citizenship as an administrable proxy for his British domicile. However, the argument would go, the taxpayer’s domicile is not a sensible basis for taxing this individual in the United Kingdom. In terms of public benefits, it was Hong Kong, rather than the United Kingdom, which provided the taxpayer with his social and civil rights during the thirty years he worked in Hong Kong. In ability-to-pay terms, the taxpayer was for three decades physically present primarily in Hong Kong, where he undertook the bulk of his income-producing activity. Consequently, Hong Kong, not the United Kingdom, was best positioned to assess the taxpayer’s worldwide ability to pay and to enforce its tax laws against him.
In short, the argument goes, in a case like Civil Engineer, domicile is an overly broad definition of residence for tax purposes. For an extended period abroad, an individual’s connection with his nation of domicile may be too tenuous to justify taxation there under either a benefits or an ability-to-pay rationale. If domicile is an inappropriate basis for asserting residence-based tax jurisdiction, citizenship ceases to be a useful proxy for such domicile.
[*1343] Although there are countervailing facts in Civil Engineer, 264 the larger point has validity. When, as in Civil Engineer, an individual spends most of his working career abroad in a single nation, that nation has a stronger benefits justification for taxing him than does his more remote nation of domicile. In such cases of prolonged presence abroad, the nation in which an individual is physically present is also better placed than is his country of domicile to enforce taxation of the individual’s worldwide income. While this individual intends eventually to return to his nation of domicile, for the (extended) meanwhile, the country in which he currently resides can better enforce its tax laws upon him and provides the social and civil benefits he receives from the public sector.
However, in other cases, domicile is the best of the possible definitions of tax residence. Consider again the facts of Clark. Mr. Clark, a British citizen domiciled in the United Kingdom, spent a single year in the United States. The United States provided public services to Mr. Clark for that entire year and thus, in benefits terms, had a strong claim for residence-based taxation for that year. 265 On the other hand, in terms of tax administration, the United Kingdom was better positioned to enforce its tax laws against Mr. Clark than was the United States. In terms of tax administration, Mr. Clark’s twelve-month sojourn in the United States was figuratively a blink of the eye. He apparently had no significant assets in the United States, nor did he have any significant contact with the United States before or after his single year of residence in California.
Enforcing the tax law is often an arduous and protracted process. Given Mr. Clark’s lifestyle and connections to the United Kingdom, HMRC was better positioned to enforce tax obligations upon him than was the IRS. Hence, in Clark, the nation of domicile, the United Kingdom, was better able to enforce worldwide taxation than was the United States.
In sum, domicile is often a plausible and frequently a compelling definition of residence for tax purposes. Like many legal categories, domicile may be overly broad in particular tax settings (e.g., Civil Engineer) while being appropriate in others (e.g., Clark). Given its utility in many instances, nations will continue to use domicile as a definition of tax residence. As long as they do, citizenship is an administrable proxy for such domicile.
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- Should Nations Continue To Tax Their Citizens on Their Worldwide Incomes?
In the tax policy community, no question engenders greater controversy today than whether nations should continue to tax their residents on their worldwide incomes. In this debate, important voices contend that nations should tax only on a source basis, i.e., should tax only the income arising within their respective territories. 266 There are, this argument goes, both practical and theoretical reasons why nations should tax only income and assets located within their respective borders. For tax purposes, a nation need not determine who its residents are when it does not levy worldwide taxation against those residents.
This debate is largely conducted in terms of corporations. Nevertheless, the arguments for limiting taxation to each nation’s respective territory are often applicable to individuals as well as corporations. If worldwide taxation of individual residents is thrown overboard, citizenship-based taxation goes over the gunnels also, at least to the extent such citizenship-based taxation is justified along the lines argued here, as a proxy for domiciliary residence.
There are two rejoinders to this argument. First, the switch to solely source-based taxation hasn’t happened. As long as nations continue to tax their residents’ worldwide incomes and assets and as long as residence is defined for tax purposes in terms of the taxpayer’s domicile, citizenship serves as an administrable proxy for such domicile. Second, most who advocate that nations restrict the reach of their tax systems to their respective borders except from this territorial limit highly mobile, passive income such as bank account interest and patent royalties. 267 A nation that taxes its residents worldwide only on such passive income must still determine who, for tax purposes, its residents are. Citizenship could still serve as an administrable marker for domicile under a system which taxes only residents’ passive incomes on a worldwide basis.
- What if an Individual’s Domicile and Citizenship Are Different?
Consider cases in which an individual’s nation of domicile and her nation of citizenship are different. Citizenship is a compelling proxy for domicile in cases like Gaudreau, Civil Engineer, and Applegate because in those settings the taxpayers all intended to return ultimately to the nations of which they were citizens. However, the argument would run, in other settings, citizenship and domicile diverge, e.g., the retiree who remains a U.S. citizen even as she plans to spend the rest of her life on an island in the Caribbean. In such cases, the argument goes, citizenship fails as a proxy for domicile. In this vein, Professor Avi- Yonah, in a published critique of an [*1345] earlier draft of this paper, argues that “citizenship is a poor proxy for domicile.”
Whenever an objective marker (e.g., citizenship) replaces a more subjective, fact-sensitive legal category (e.g., domicile), there will, in particular cases, be instances of over-and underinclusiveness. It is typically a matter of judgment whether, in such settings, the benefits of administrability engendered by the objective category outweigh the category’s costs in the form of particular cases being decided differently than they would have been under the more subjective, individualized classification. I conclude that the benefits derived from the enforceability of a citizenship standard for worldwide taxability outweigh what I suspect are the relatively few cases in which that standard reaches the wrong result, that is to say, the comparative handful of cases in which a taxpayer’s domicile is a nation other than the country of her citizenship.
Consider again the retiree planning to live for the remainder of her life on a Caribbean island while retaining her U.S. citizenship. At first blush, this looks like a case in which citizenship and domicile diverge. On a second look, matters are more complicated and suggest that this individual may be domiciled in the United States. There is a reason this hypothetical retiree retains her U.S. citizenship rather than becoming a citizen of the nation in which she resides. Perhaps, the retiree remains a U.S. citizen merely to avoid the immediate taxation that her expatriation would trigger under § 877A.
However, more may be going on than this. By remaining a U.S. citizen, the retiree is making the classic Tieboutian choice that the tangible and psychological benefits of such citizenship justify the personal tax cost to her in the form of worldwide taxation. Among the benefits retained via her U.S. citizenship is the right to return to the United States if the retiree’s individual circumstances change or if the environment in which she is living becomes less attractive. Retaining that right of return buttresses the view that the United States remains her nation of domicile, despite her plans to reside in the Caribbean nation indefinitely. If so, the retiree’s U.S. citizenship turns out to be a good proxy for her domicile after all.
In sum, while there may be particular cases where citizenship fails as a proxy for domicile, I suspect that those cases are relatively uncommon and ultimately do not undermine the administrability gains derived from citizenship-based taxation.
- What About Cases in Which an Individual’s Citizenship Isn’t So Clear?
An important premise of my argument is that it is easier to determine an individual’s citizenship than his domicile. There are, of course, cases in which a particular individual’s citizenship is a matter of dispute. 269 However, [*1346] in the vast majority of cases, U.S. citizenship is an easily determined status while domicile is a fact-intensive category, more manipulable by the taxpayer and harder for the tax collector to ascertain and prove.
- Doesn’t the Code Forfeit the Administrability Benefits of Citizenship-Based Taxation in § 911?
Yes. Critical to the § 911 exclusion of foreign earned income are the fact-intensive concepts of an individual’s “tax home” 270 and an individual’s “bona fide” residence. 271 Under § 911, a U.S. citizen can exclude his foreign-source earned income if the citizen’s “tax home is in a foreign country” 272 and if the citizen “has been a bona fide resident of a foreign country or countries for an uninterrupted period which includes an entire taxable year.” 273 The Treasury regulations under § 911 specify that an individual’s tax home is “located at his regular or principal (if more than one regular) place of business or, if the individual has no regular or place of business because of the nature of the business, then at his regular place of abode in a real and substantial sense.” 274
Section 911 does not exclude unearned income, nor does it exclude foreign-source earned income in excess of the statutory ceiling. 275 Nevertheless, as to foreign-source earned income under the § 911 ceiling, that provision requires the subjective, fact-intensive determinations of residence (“regular place of abode”), which citizenship-based taxation otherwise makes unnecessary.
The administrability costs of § 911 buttress the opposition of those who would repeal that provision. Those enforcement costs are, for supporters of § 911, a reasonable price to pay for an otherwise desirable tax provision. For present purposes, it is unnecessary to decide which side in this debate is correct. Congress’s decision in § 911 to reintroduce under that provision subjective determinations of residence does not negate the administrability benefits of citizenship as an enforceable proxy for domicile outside the § 911 context.
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- In the Tiebout Context, Am I Demanding an Unattainable Level of Policy Coherence, Given the Realities of Political Compromise?
Consider the reality of compromise in an imperfect world. I have argued that the strong theoretical appeal of a Tiebout justification for citizenship-based taxation – the U.S. citizen determines for herself that the benefits of citizenship are worth thetax cost to her – is undermined in practice by the different tax prices the U.S. tax system assesses different citizens for the same benefits of citizenship. Depending upon the nature and amount of the taxes levied by the nation in which a nonresident citizen lives and earns her income, she may pay to the U.S. Treasury full U.S. taxes on her worldwide income, no U.S. taxes, or some amount of U.S. taxes in between.
At one level, this should surprise no one. The tax laws pursue sundry purposes because of, inter alia, political compromise and multiple, often conflicting, policy goals. It should thus astonish no one that the Code effectuates the Tiebout model imperfectly. he Code implements most policies imperfectly. We live in an imperfect world.
Fair enough. Nevertheless, at some point a policy becomes so attenuated in implementation that it ceases to be legitimately compromised and is instead ignored. That is the case with the Code’s implementation of citizenship-based taxation along Tiebout lines. If the Code exacted from different nonresident citizens somewhat divergent tax prices for their respective U.S. citizenships, that divergence could be rationalized as a reasonable accommodation of competing policies. However, the Code today straddles the entire gamut, charging some nonresident U.S. citizens nothing (because foreign tax credits, the § 911 exclusion, or both eliminate all federal income tax liability) while subjecting other nonresident citizens to full U.S. taxation (because these nonresidents live in and derive their incomes from nations that finance government through taxes which are neither creditable nor deductible). These different tax prices for U.S. citizenship bear no relation to the costs or benefits of the services the U.S. government provides its nonresident citizens.
Even if many, perhaps most, nonresident U.S. citizens fall in the middle of the spectrum in terms of their federal tax payments, it is unpersuasive to defend the United States’ taxation of nonresidents’ worldwide incomes in Tiebout terms and then, in random fashion, charge different citizens radically different prices for the same benefits of citizenship. Those differences may (or may not) make sense in terms of other policies, but they undermine any Tiebout justification for the Code’s approach to citizenship-based taxation.
- What About Dual Citizens?
In a world where citizenship-based taxation were to become widespread, what would happen to dual citizens? The same thing that happens today [*1348] when an individual is a resident of more than one nation: The dual resident is either (1) taxed by both nations in which he resides, or (2) the two nations must agree as to which has primary jurisdiction to tax the dual resident. For example, the U.S. model income tax treaty contains tie-breaking rules that determine which of the two signatory nations has primary jurisdiction to tax the income of an individual who resides in both nations. 276 These tie-breaking rules could easily be applied and adapted to a world of citizenship-based taxation to determine which nation has primary jurisdiction to tax a person who is a citizen of more than one country.
- Isn’t It Inconsistent for the United States To Tax Its Citizens Worldwide on the Basis of Their Citizenship, but To Tax Resident Aliens Worldwide on the Basis of Their U.S. Residence?
There is indeed some tension in taxing a U.S. citizen on her worldwide income and assets regardless of her residence abroad while taxing a resident alien on his global income and assets by virtue of her residence in the United States. In the former case, residence is treated as irrelevant while, in the latter case, residence is treated as controlling. However, upon examination, there is less tension here than first appears to be the case. An alien is subject to worldwide U.S. income tax either if she satisfies a physical presence test 277 or if she has attained the status of “permanent legal resident.” 278 That voluntarily acquired status is a statement of domicile, a declaration by the alien that the United States is her permanent home. The logic of U.S. taxation of an alien by virtue of her “green card” is the same as the logic of taxing a U.S. citizen on a worldwide basis by virtue of her citizenship: Like citizenship, permanent resident status is an administrable marker that the alien’s domicile – her permanent home – is the United States.
- Isn’t It Hard, or in Many Cases, Impossible, To Enforce Income Taxation Against U.S. Citizens Residing Abroad?
This is Professor Avi-Yonah’s principal objection to my argument: “The taxation of nonresident citizens is unadministrable.” 279 We all agree that administrability is an important value. Indeed, it is the value underlying my argument that citizenship based taxation is more efficiently enforceable than residence-based taxation when a taxpayer’s residence is defined as his domicile.
[*1349] Tax policy requires trading off competing values, concerns and objectives. The U.S. tax system taxes the interest earned in the foreign bank accounts of U.S. taxpayers, even though enforcing such taxation is difficult. 280 The U.S. tax system similarly demands that self-employed taxpayers report their incomes, though enforcing that demand is also often arduous. 281
If administrability were the sole criterion, we would tax in neither of these settings. Administrability, however important, is not the only consideration in the design of a tax system.
Taxing on the basis of U.S. citizenship makes the Code more administrable by eliminating factually intensive inquiries about residence in general and about domicile in particular. There indeed remain important hurdles to implement the taxation of nonresident citizens. On balance, however, such citizenship-based taxation is more rational and more consistent with international norms than is widely believed to be the case.
- Conclusion
The received wisdom about federal taxes and U.S. citizenship – the benefits of U.S. citizenship justify worldwide taxation of such citizen’s income and assets – is unpersuasive. The legal rights associated with U.S. citizenship are minimal. The psychological benefits of U.S. citizenship are significant for most of us, but, as a logical matter, do not justify the worldwide taxation of nonresident U.S. citizens. In theory, the Tiebout model justifies the worldwide taxation of U.S. citizens under a love-it-or-leave-it theory: Any U.S. citizen who finds the tax cost of U.S. citizenship inordinate can expatriate. In practice, however, U.S. citizens typically lack the mobility between nations necessary to make expatriation a practical alternative. Moreover, the Code taxes different U.S. citizens differently for the same benefits of U.S. citizenship.
While the traditional benefits rationale for the worldwide taxation of U.S. citizens is not compelling, such taxation can be justified in terms of administrability. An individual’s U.S. citizenship is an objective, enforceable proxy for his U.S. domicile.
Both the benefits and ability-to-pay justifications for taxation point to worldwide taxation by the nation in which an individual resides. The country in which an individual lives provides his basic social and civil rights. Moreover, the nation of residence is typically best positioned to aggregate [*1350] and assess an individual’s worldwide income and assets and to enforce its tax laws against him.
However, residence is typically a fact-intensive inquiry, often manipulable by the taxpayer, frequently difficult for the tax collector to enforce. When residence is defined as domicile, citizenship serves as an administrable marker for such domicile, since both citizenship and domicile focus upon permanent political allegiance rather than immediate physical presence. From this vantage, U.S. citizenship-based taxation resembles other nations’ residence-based taxation when those other nations define residence as domicile, and the U.S. system of citizenship-based worldwide taxation is not the outlier it is often thought to be. Moreover, such global citizenship-based taxation reaches similar results more efficiently by obviating the need for factually intensive inquiries into domiciliary residence.
For many reasons, a legal rule may persist after its initial rationale has ceased to be compelling. One good reason for the persistence of an old rule is that it serves a new, if as yet unrecognized, function. The United States’ traditional policy of taxing its citizens on their worldwide incomes and assets is such a rule. The traditional benefits rationale for citizenship-based taxation has ceased to be compelling. However, by serving as an administrable proxy for an individual’s domicile, citizenship-based taxation makes sense in the twenty-first century
(All footnotes will be provided: Edward Zelinsky)
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