- Implementing Citizenship-Based Taxation
As a final preliminary to evaluating the United States’ citizenship-based taxation of individuals, we must explore the Code’s implementation of such taxation. Recall, in this context, that the Code currently prescribes three different income tax treatments for the foreign taxes paid by U.S. citizens and residents. Foreign income taxes levied against foreign-source income are fully creditable against U.S. income taxes to the extent such foreign taxes are equal to or less than the U.S. taxes assessed against such foreign-source income. 124 All foreign taxes paid in connection with trade, business, and investment activity are deductible for U.S. income tax purposes, as are foreign real property taxes. 125 Other foreign taxes, such as general sales taxes levied by foreign nations, are neither creditable nor deductible. 126 As a result of this disparate treatment of different foreign taxes, otherwise similarly situated U.S. citizens who reside abroad pay different U.S. taxes depending upon the types and amounts of the taxes levied by the countries in which they live and earn their incomes.
To take another simplified example, consider in this context three U.S. citizens, A, B, and C, who reside respectively in countries X, Y, and Z. A, B, and C each has total income of $ 100, derived totally from sources within the country of her residence. A, B, and C are each in the 30% bracket for U.S. income tax purposes. X finances its government by an income tax assessed at a 30% bracket, while the government of Y levies a property tax and Z uses a general sales tax to pay for their public services. To keep the math simple, let us further suppose that B pays $ 30 of property tax to Y and that C pays $ 30 in sales tax to Z.
As a matter of law, A, B, and C, as U.S. citizens, are all subject to U.S. income taxation of their respective worldwide incomes. In practice, however, the Code treats A, B, and C quite differently. At one extreme, A pays no U.S. income tax since her $ 30 income tax payment to X is totally credited against, and thus eliminates, her federal income tax obligation. At the other end of the spectrum, C pays $ 30 to the federal fisc on her income of $ 100 since C receives neither a credit nor a deduction for her $ 30 sales tax payment to Z. In between is B, who, after deducting her $ 30 property tax payment to Y, pays $ 21 of income tax to the federal Treasury. 127
If A or B is subject to the AMT, 128 B loses the deduction for her property tax payments unless these are connected with business or with the [*1314] production of income, while A’s credit for foreign taxes is tied to her AMT liability.
Further complications ensue if a U.S. citizen’s income qualifies for the § 911 exclusion. 129 Suppose, for example, that D and E, both nonresident U.S. citizens, live in the same foreign nation, Q. Let us further assume that both D and E have income of $ 100 from Q sources, that both of them are in the 30% bracket for U.S. income tax purposes, and that Q finances its government services with a 30% sales tax. However, suppose that, while they are otherwise similarly situated, D’s $ 100 income stems from employment by a foreign corporation and qualifies for the § 911 exclusion, while E’s income is from investments and thus does not qualify for the § 911 exclusion. In that case, D pays no federal income taxes because of the exclusion, while E pays federal income tax of $ 30.
(All footnotes will be provided at the end of this multipart series by Edward Zelinsky)