TaxConnections

 

Access Leading Tax Experts And Technology
In Our Global Digital Marketplace

Please enter your input in search


The United States Imposes A Separate And Much More Punitive Tax On U.S. Citizens Who Are Residents Of Other Countries



John Richardson April 10

Reposted Due To Upcoming Debate On Citizenship Taxation

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.

Prologue

Do you recognise yourself?

You are unable to properly plan for your retirement. Many of you with retirement assets are having them confiscated (at this very moment) courtesy of the Sec. 965 transition tax. You are subjected to reporting requirements that presume you are a criminal. Yet your only crime was having been born in America (something you didn’t even choose) and attempting to live as a U.S. tax compliant American outside the United States. Your comments to my recent TaxConnections Post reflect and register your conviction that you should not be subjected to the extra-territorial application of the Internal Revenue Code – when you don’t live in the United States.

The Internal Revenue Code: You Can’t Leave Home Without It!

The problem of Americans abroad is beginning to attract attention. The first legislative initiative – The Fair Taxation Of Americans Abroad Act – was introduced by Congressman George Holding in December 2018. (Congressman Holding plans to reintroduce the bill in the new Congress. Along with Republicans Overseas President Solomon Yue, Congressman Holding will be hosting a “town hall” meeting on April 24, 2019 in London, UK._ ACA “American Citizens Abroad” has been relentless in its advocacy for change. I am writing this post the day after the Democrats Abroad released the results of its 2019 Survey of Americans Abroad. I highly recommend their report (although the survey sample may be skewed in favour of those who file U.S. taxes). The report describes much of the pain suffered by – the “every day people” who compose the group of Americans abroad. It describes some of the many injustices inflicted on Americans abroad – making it an important read.

The truth is far worse than the various advocacy groups describe

The truth is far worse than the Democrats Abroad report implies. When one reads the report one is left with the impression that the injustice is limited to the fact that the United States imposes worldwide taxation on Americans abroad. But, this in only part of the problem (and I would argue the less significant part). Yes, the United States is imposing worldwide taxation on Americans who are residents of other countries. But, it’s imposing a separate and more punitive tax system on those Americans who are residents of those other countries. Some of these Americans are “accidental Americans” – meaning they do not have (other than an accident of birth) and have never had any connection to the United States.

(Furthermore the group of Americans abroad are not even treated equally. Their U.S. tax treatment depends largely on what country they reside in. The reason is that the United States has different tax treaties with different countries. But there is no doubt that Americans abroad, as a group, are living under a different tax system than those individuals who are residents of the United States.)

Americans Abroad Are Subjected To At Least Three Forms Of Discrimination

First Form Of Discrimination: The same laws do not apply to ALL Americans abroad who live outside the United States. Different groups are treated differently depending on their country of residence. This is because different countries have different kinds of tax treaties with the United States. For example, Americans in Canada have the benefit of a Social Security totalization agreement. Americans in Israel do not. Americans living in Canada benefit from a tax treaty that exempts their Canadian pensions from U.S. taxation until they are paid out. Americans in Australia have to deal with the uncertainty of how their Australian Superannuations are treated (if at all) under the U.S. Australia tax treaty.

Second form of discrimination: Americans living outside the United States are taxed far more punitively on their foreign income than Homeland Americans are taxed on their income earned in the United States. This is because the Internal Revenue Code is designed (1) to treat foreign investment income far more punitively than U.S. investment income and (2) All foreign assets (which are local to Americans abroad) are subject to particularly penalty laden reporting requirements. Remember also that Americans abroad are generally also subject to taxation in the countries where they live.

Third form of discrimination: To be a U.S. citizen includes being a member of the world’s premier “Tax, Form and Penalty Club”. But, membership is administratively costly. On the one hand the compliance costs are unreasonably (and in some cases prohibitively) high. On the other hand, the penalties for noncompliance are extremely punitive. To put it simply: the returns can be so complicated and expensive to file that some people simply cannot afford to comply. Think of it: (as this comment suggests) people are forced to renounce U.S. citizenship because they can’t afford the compliance!

In the 2017 Meadows FATCA hearing, Republicans Overseas lawyer Jim Bopp put it simply. He said:

“Americans abroad have a right to be taxed in a way that meets constitutional standards”.

If people can’t understand what is expected of them, can’t afford the costs of compliance and are (in some cases) renouncing U.S. citizenship for these reasons, one might ask:

Is the U.S. tax treatment of Americans abroad constitutional?

But, just hold on: Is this real equality or is this real discrimination?

Some people (for example Judge Rose in the FATCA Legal Action lawsuit) would say:

All U.S. citizens are subject to exactly the same rules and therefore there cannot be discrimination.

Others (for example the late Justice Brian Dickson of the Supreme Court of Canada) might say:

The true interests of equality may require differentiation in treatment.”

The point is that Americans abroad live outside the United States and are subject to the tax system where they reside. They are also subject to the U.S. tax system. But, they are subject to a U.S. tax system that treats their income and assets to be foreign (look out) when that same income and assets are local to the individual.

As a general principle, Americans abroad are potentially subject to:

1. Double taxation not relieved by tax treaties (For example the Obama 3.8% Net Investment Income Tax)

2. Taxation on income by the United States that is not subject to taxation in their country of residence (For example, the U.S. taxation of capital gains generated by the sale of a principal residence)

3. Taxation on phantom gains that are caused by nothing but exchanges in the U.S. dollar exchange rate (discharge of a mortgage denominated in non-U.S.currency).

4. Taxation based on “fake income” caused by legislated fictitious tax events which operates to impose U.S. taxation prior to a taxable event in the country of residence (Section 965 Transition tax, GILTI, Sec. 877A Exit Tax.

The IRS seems to recognize the difference between Americans abroad and Homeland Americans

The IRS (to its credit) recognises this principle in having two kinds of Streamlined Compliance Programs – Domestic (for Homeland Americans) and Offshore (for Americans abroad).

Congress (at least so far) does NOT recognize the difference between Americans abroad and Homeland Americans

Congress would deny that Americans abroad have one set of rules applied to them and Homelanders have another set of rules applied to them. In fact, Congress might say: ALL AMERICANS are subject to EXACTLY the same rules. Perhaps, but it’s also true (as we said in 17th Century France) that:

“The law in its majestic equality prohibits both the rich and the poor from sleeping on the park bench”.

Americans abroad are subject to higher taxation than Homeland Americans: If you were to ask your friends the following question:

Q. Do you think that the United States would impose more punitive taxation and compliance requirements on: (1) U.S. citizens living in the United States or (2) dual U.S./Canada citizens living in Canada?

A. The probable answer would be: Don’t be absurd. Of course the United States imposes more punitive taxation on U.S.citizens living in the United States than on dual U.S./Canada citizens living in Canada.

Wrong! Wrong! Wrong!

To put it simply: The Internal Revenue Code of the United States imposes taxes, sanctions and penalties on certain Canadian residents that are not imposed on Homeland Americans at all. The point is that U.S. citizen “non-residents” are subjected to a harsher set of U.S. tax rules than are U.S. residents.

One answer to the question includes …

I know the answer to this question. I filed one year using TurboTax (and a host of paper filings since TurboTax falls way short of being sophisticated enough for a foreign return) and it had a helpful function at the end where you could compare your US tax liability against others in a similar income band. My US tax liability was 2.5x the average bill in the same income band. That’s not 2.5% but 2.5x. My “fair share” was more than twice as much for the same level of income as the homelander “fair share”.

Thankfully, the out of pocket cost was limited by the taxes I had already paid in the UK. But, it shows the cost of not living a life optimised for the rules of the US tax system can be enormous. If you live in the US, there are tax no brainers. If you live in the UK, there are tax no brainers. But if you’re subject to both systems at the same time, you can’t benefit from the tax no brainers since, by and large, the other country takes what the other giveth.

As I’ve said before, the US tax system includes on the basis of citizenship but excludes on the basis of physical location since participation in the tax no brainers is limited by things like US source earned income which you can, generally, only get when you live in the US.

In “people talk” this means that there are many instances where a U.S. citizen living abroad who earns his salary abroad, owns his assets abroad, has his pension abroad and is married to a non-U.S. spouse will pay higher U.S. taxes on income that is local to him than a comparable Homeland American would pay on income that is local to him.

Bottom line: The United States is imposing a more punitive tax system on U.S. citizens who live outside the United States than it imposes on U.S. citizens who live in the United States.

#YouCantMakeThisUp!

Equality Of Discrimination? – Twelve Examples – The Dirty Dozen

Although there are many examples, I have decided to describe only 12 examples. I refer to the 12 examples as “The Dirty Dozen” (named after an old movie I like).

As you read these examples, please understand that the United States (where the person does not live) is imposing more punitive taxation on income earned by a person in a country where he does live. For example: A dual U.S./Canada citizen living in Canada might say:

If I lived in the U.S. and earned my income in the U.S. I would be taxed less heavily on the income I am earning in Canada while living in Canada.

Here we go:

12 examples (in addition to the “transition tax”) which U.S. residents can “laugh about” and U.S./Canada dual citizens resident in Canada can/should “rage about”:

1. Templeton Mutual Fund bought in the U.S. by a U.S. resident is NOT subject to PFIC confiscation. The same mutual fund (with exactly the same securities) bought in Canada by a Canadian resident is subject to PFIC confiscation. Furthermore, the Canadian resident is required to report his ownership in his Canadian mutual fund on Form 8621.

2. A U.S. resident who invests in a ROTH IRA has automatic “tax deferral” and is not subject to U.S. taxation. A Canadian resident who invests in an equivalent Canadian TFSA (in Canada) does not have “tax deferral” and is subject to U.S taxation on the income on TFSA in the United States even though he is not subject to taxation on the income in Canada.

3. A U.S. resident who invests in an ABLE plan (Achieving a Better Life Experience Act) has automatic tax deferral. A Canadian resident who invests in an RDSP (equivalent “special needs plan”) is subject to U.S. taxation on that income. Furthermore, the Canadian resident is required to report his ownership of his RDSP on Form 3520.

4. A U.S. resident who invests in a S. 529 “education plan” has automatic tax deferral. A Canadian resident who invests in an RESP (equivalent “education plan”) does not have “tax deferral” and is subject to U.S. taxation on that income. Furthermore, the Canadian resident is required to report his ownership in his RESP on Form 3520. (See also this discussion from Virginia La Torre Jeker who describes the difficulties Americans abroad may experience should they try to make use of a Section 529 plan.)

5. A U.S. resident who receives distributions from a 401K plan is not subject to the 3.8% Obamacare surtax. A Canadian resident who takes a distribution from an (equivalent) Canadian RRSP is subject to the 3.8% Obamacare surtax. Furthermore, the Canadian resident is required to report his Obamacare surtax  on Form 8960.

6. A U.S. resident is not required to report his local U.S. bank accounts to U.S. Financial Crimes. A Canadian resident is required to report his Canadian bank accounts to U.S. Financial Crimes. This is a very special category of “form crime” -see information about Mr. FBAR.

7. A U.S. resident is not required to report his U.S. financial assets annually to the IRS on Form 8938. A Canadian resident may be required to report his Canadian financial assets annually to the IRS on Form 8938. Form 8938 is an extremely intrusive, time consuming form.

8. A U.S. resident is NOT required to treat his business activities in the USA as foreign and subject to penalties and reporting. Certain Canadian residents are required to treat their business activities in Canada as foreign and subject to penalties and reporting. Check out Form 5471 and Form 8865.

9. A U.S. resident married to a U.S. citizen spouse is allowed to make unlimited gifts to his spouse. A Canadian resident married to  a Canadian citizen spouse is NOT allowed to make unlimited gifts to his spouse. Furthermore, the Canadian resident is required to report certain gifts to his spouse on Form 709. Furthermore, the Canadian resident is required to report certain gifts from his spouse on Form 3520. The U.S. imposes numerous forms of punitive taxation on U.S. citizens who marry non-citizens.

10.  A U.S. resident who renounces U.S. citizenship will not have his U.S. pension plan subject to confiscation because of the Section 877A Exit Tax. A Canadian resident who renounces U.S. citizenship would have his Canadian pension plan subject to confiscation because of the S. 877A Exit Tax. It’s because it the pension is NOT a “U.S. pension”, but is a “Canadian pension”.

11. The TCJA includes a provision that allows U.S. residents to deduct property taxes on their U.S. principal residences, but specifically does NOT allow a Canadian living in Canadian to deduct property taxes on his Canadian principal residence.

12. As explained by Virginia La Torre Jeker, The TCJA provided allows a deduction of up to 20% of pass through income for specified service business owners with income under $157,500 (twice that for married filing jointly) for certain income effectively connected with the conduct of the trade or business within the US. A U.S. resident operating a U.S. business is entitled to the deduction. A Canadian resident carrying on a small unincorporated business in Canada is NOT entitled to the 20% reduction.

Conclusion

The United States and Eritrea are the only two countries that impose worldwide taxation on their citizens who live abroad. But, there is a huge difference between HOW the two countries impose worldwide taxation on their citizens abroad. Eritrea imposes only an excise tax that is based on the percentage of tax paid to the other country. The United States is imposing (in effect) a different set of tax rules for how taxable income earned in the other country is calculated. Taxable earned in that other country is “foreign” to the United States. The “foreign” source of the income (particularly in the area of investment and pension income) sets the stage for punitive U.S. taxation. Americans abroad are subjected to U.S. taxation that is far more punitive than domestic income earned by Homeland Americans. This punitive taxation often means that Americans abroad will first pay tax to their country of residence and second pay more tax to the United States. In fact, Americans abroad are subject to the highest level of taxation in their country of residence. Put it another way: Americans abroad will be the highest taxed people in the country with the highest tax rates in the world.

To put it in people talk: Americans abroad are the most highly taxed people in the world. It’s the simple FATCA of the matter!

Written by John Richardson.

TaxConnections asks you to leave commentary and share your stories and experiences in these matters.

Join Us For A Debate On Citizenship Taxation

 

 

 

Avatar

The Reality of U.S. Citizenship Abroad

My name is John Richardson. I am a dual citizen. I am a lawyer – member of the Bar of Ontario. This means that, any counselling session you have with me will be governed by the rules of “lawyer client” privilege. This means that:

“What’s said in my office, stays in my office.”

I am also a member of the American Citizens Abroad Professional Tax Advisory Council (PTAC). This is an advisory panel focused on assisting American Citizens Abroad in an FBAR and FATCA world.

The U.S. imposes complex rules and life restrictions on its citizens wherever they live. These restrictions are becoming more and more difficult for those U.S. citizens who choose to live outside the United States.

FATCA is the mechanism to enforce those “complex rules and life restrictions” on Americans abroad. As a result, many U.S. citizens abroad are renouncing their U.S. citizenship. Although this is very sad. It is also the reality.

6 thoughts on “The United States Imposes A Separate And Much More Punitive Tax On U.S. Citizens Who Are Residents Of Other Countries

  1. Avatar Sun Tzu says:

    Also needing further discussion is the loss of opportunities under citizenship based taxation. This is something statesiders need not concern themselves with, but it is a major concern for overseas expats. Countless times I am stymied in pursuing economic activity because of the horrendous reporting requirements. This goes largely unreported.

    What I also find striking is many 3rd parties such as journalists, academics, etc., are derelict on US international tax policy. They simply take the government position and regurgitate their data as gospel and don’t bother investigating how FATCA and citizenship based taxation is being applied on the ground.

    As Mr Anderson asserts, there is a large gap in public perception to the impact on American lives. I attribute this to challenged journalists and to academics who are beholden to what is codified into law. They fail to see FATCA acting as a Trojan horse to onerous laws and see it as a good worth keeping even when evidence suggests the law requires serious reforming.

    US has a long history of implementing apparent just laws with supposed good intentions. Hopefully, people in positions of authority can push back against this blind trust and report on what is happening.

  2. Avatar Suzanne says:

    “The true interests of equality may require differentiation in treatment”. Very eloquently said. It puts the needs of the individual over law, without which laws would never change to accommodate the needs of the individual. If this is not true, how can the IRS justify creating a different set of rules for non-residents? The ability to retain citizenship should not be less important than the laws that govern it. CBT cheapens citizenship to the point where one feels compelled to rid themselves of it just to live by the same standards residents in the US take for granted…

    • It is clear that the USA is forcing certain Americans abroad to renounce US citizenship because of unreasonable demands. Citizenship Taxation may not be per se unconstitutional – but when it reaches point where people can’t comply it is unconstitutional.The US Supreme Court in Afroyim v. Rusk has ruled that Congress cannot pass laws that result in the forcible destruction of citizenship. See the majority opinion of Justice Black here: https://www.law.cornell.edu/supremecourt/text/387/253

    • “The Internal Revenue Code in its majestic equality imposes regulation on both Homelanders and Americans abroad who dare to have a bank account outside the United States.”

      This disproportionately punishes Americans abroad. As you point out, one must consider the effects of laws in order to determine their reasonableness. This is a hard thing for American culture which confuses the concept of “rule of law” (law in context) and “rule by law” (law regardless of context).

  3. Avatar Suzanne says:

    …I think it’s well documented that the imposition of tax on non-residents has the effect of being disrespectful to Citizenship! CBT was not handed down by God. If laws are to evolve to accommodate the needs of the individual, their adverse affects need to be considered above any precedent in maintaining them.

Comments are closed.