Due to all of the commentary from U.S. Citizens living abroad, I thought it was a good idea to include a portion of a post written by Tax Lawyer John Richardson:
“The Internal Revenue Code of the United States of America”
– Title 26
The beauty, genius and timeless wisdom found in the Internal Revenue Code include the principle that:
“The Internal Revenue Code in its majestic equality punishes both Homelanders and Americans abroad for having financial assets and accounts outside the United States.”
Part C – What does it mean to be a U.S. citizen abroad?
- All U.S. citizens abroad live outside the United States.Therefore, they live in “Foreign” countries. They will have bank accounts and retirement accounts that (although local to them) are “Foreign” to the United States. A FATCANatic (true believer in FATCA) would refer to your bank accounts as being “offshore”.
- Most U.S. citizens abroad are required to BOTH earn a living and invest for retirement.To this end they may have a pension from their place of employment (“foreign”). They may invest in mutual funds in their country of residence (foreign – PFIC). They may invest in retirement planning vehicles that are appropriate in their country of residence (foreign – PFIC). If you own an investment vehicle that is a PFIC, you should avoid either buying or selling without getting specialized counseling.
- All U.S. citizens abroad are required to pay taxes in their country of residence.This point is neither understood nor acknowledged in the United States. Yes, it’s true (I can personally confirm this) that U.S. citizens abroad are required to pay taxes to their country of residence. Furthermore, (to add insult to injury), they are often required to pay VAT (value added taxes) in their country of residence. These VAT taxes are significant. In Canada they are 13%. In some European countries they are 20%. The point is that U.S. citizens abroad may pay significant taxes of a kind that often don’t exist in the United States. (Therefore, for purposes of “foreign tax credits”, the U.S. doesn’t regard them as real taxes.) In addition, they pay (usually at a higher rate) the usual income and property taxes that Americans understand.
- U.S. citizens abroad may have “non-U.S. citizen spouses”.It is true that there are many unmarried U.S. citizens living in the United States. Nevertheless, it’s common for a U.S. citizen abroad to enter into a marital relationship with a non-U.S. citizen (AKA an “alien”). It is NOT common for a U.S. citizen abroad to return to the United States to seek a spouse. U.S. law is premised on the assumption that a marriage between a “U.S. citizen” and an “alien” is for the purpose of tax evasion. This is reflected in punitive taxation (see below) and requirements that a U.S. citizen who shares a financial account with an “alien” spouse is required to report those accounts to the IRS. It is no surprise that “U.S. citizenship” is the only citizenship in the world that is becoming grounds for divorce. On the other hand, the “alien spouse” does present some possible U.S. tax planning opportunities.
- U.S. citizens abroad may start and develop businesses.In addition to marrying “aliens”, many U.S. citizens abroad enter into other forms of “business relationships” with other “aliens”. This is clearly subversive and is required to be reported to the Internal Revenue Service. In addition, if the form of the business is a “Foreign (non-U.S.) Corporation” extremely punitive tax and reporting rules apply.
- U.S. citizens abroad may be “self-employed”. In the absence of a “totalization agreement” (fortunately, Canada has one) U.S. citizens abroad will be liable for “self employment taxes” to the U.S. government.
So far it appears that it would be prudent for a U.S. citizen abroad to NOT marry, not have an income, not create businesses or engage in self-employment.
But, let’s imagine that a U.S. citizen abroad does one or more of these things. What does it mean? How will it affect his life? “Tax compliant” U.S. citizens abroad are required to consider how the “Bible of the Homelander” (the Internal Revenue Code) impacts these relationships. Once the principles of the “Bible of the Homelander” are understood, one will understand what one is NOT permitted to do, and the draconian penalties associated with doing so.
The “Bible of the Homelander” is based on two basic principles:
Principle 1: The “Bible of the Homelander” hates anything that is foreign. In fact, if the word “Foreign” appears in the “Bible”, the word “penalty” (generally starting at $10,000) is sure to follow.
Principle 2: The “Bible” is designed to punish all forms of “tax deferral” that are not “Homelander Permitted Tax Deferral” (think IRA).
Now, from these two great principles, we will develop the “Ten Commandments” of living a clean American life outside the United States.
“Living Clean” – The Life of a U.S. citizen abroad
Here are the ten commandments of “Living Clean” that apply to U.S. citizens abroad. They are designed to ensure that:
If a U.S. citizen lives outside the United States that he lives according to the principle that:
When in Rome, live as a Homelander does, when elsewhere, live as they live elsewhere.
- Thou shalt NOT have a bank or brokerage account outside the United States. If you do so, it must be reported to U.S. Financial Crimes on an annual basis. Failure to disclose is “Form Crime”. You may be fined an amount that is more than 300% of the value of the account.
- Thou shalt NOT marry an “alien”. If you do so, you will have difficulty leaving your estate to him or her. Better to return to the Homeland to search for a suitable spouse.
- Thou shalt ensure that your “alien” spouse agrees to be a U.S. taxpayer. Failure to do so, will result in your having the punitive filing status of “married filing separately”. This will guarantee greater exposure to the Alternative Minimum Tax, the new 3.8% Obamacare surtax, higher tax brackets and lower thresholds for reporting (including FATCA Form 8938) requirements.
- Thou shalt NOT believe that the sale of your principal residence is a “tax free capital gain”. In fact, the sale of your principal residence will trigger a 23.8% capital gain which means that your house cannot be used as a retirement investment.
- Thou shalt NOT buy non-U.S. mutual funds. If you do, you will have your gains confiscated in the form of an “Excess Distribution” Tax. Buy American. Buy U.S. mutual funds.
- Thou shalt buy ONLY “term insurance”. Any other form of “insurance that has cash value” will be treated as a sacred instrument of tax evasion. Furthermore, if you purchase a “foreign insurance policy” thou shalt pay a special excise tax.
- Thou shalt NOT buy or participate in an RESP, RDSP, employer pension plan, or any other kind of retirement planning vehicle which will be considered to be a TAXABLE “Foreign Trust” (with all the attendant penalty laden reporting requirements).
- Thou shalt neither be self-employed NOR carry on business through a non-U.S. (AKA “Foreign”) corporation. If you do, punitive taxes, deemed income, and expensive reporting requirements will descend on you.
- Thou shalt NOT relinquish U.S. citizenship. In the event that you do, you may be subjected to an “Exit Tax” which applies to your “non-U.S.” pension, “non-U.S.” assets, and assets that accumulated after you ceased to live in the United States. In addition, there are certain “Form People” who claim that you may be banished from the Homeland forever.
- Thou shalt file, every year, file the following forms with the IRS: 1040 and all required schedules, FBAR, FATCA, 8938, 8965, 3520, 3520A, 709 (up to a maximum of up to about 45 forms). Understand that this will cost you thousands of dollars.
And this ladies and gentlemen, is why your problem is NOT “coming into U.S. tax compliance”. Your problem is “living as a tax compliant U.S. citizen abroad”. It really can’t be done (if you want any kind of life).
What does all of this mean practically?
Punitive Taxation – Think PFIC and Foreign Investments
U.S. citizens abroad also are subjected to the most punitive aspects of both the U.S. tax system and the tax system of their country of residence. In other words, it is NOT possible for them to get a “tax break”.
- double taxation (example Obamacare 3.8% surtax)
• tax payable to the U.S. that is not payable in Canada (sale of principal residence or TFSA)
• deemed income that you haven’t received (Avoid Canadian controlled private corporations)
• payment of taxes in Canada that are not available as tax credits in the U.S (think HST)
• taxation of currency exchange rate based gains
Intrusive Reporting Requirements – All of your life is reportable – There is NO financial (or any other kind of) privacy for Americans
U.S. citizens abroad are required, under threats of draconian penalties, to disclose almost every aspect of their financial lives to the IRS annually.
FATCA and Banking Restrictions – Many U.S. citizens are being dropped from their banks and brokerage accounts because they are U.S. citizens. It’s simply too expensive and dangerous for some financial institutions to have “U.S. person” clients.
FBAR – Including children – The simple fact is that, by April 15 (as of 2016) of each calendar, EVERY “U.S. person” (citizen or resident), to the extent that he or she has “foreign financial accounts” (including but NOT limited to bank and brokerage accounts), which (in aggregate) have a highest balance exceeding $10,000 USD, is required to report those financial accounts to the U.S. Financial Crimes (FINCEN). Incredibly, as a recent post describes, this requirement applies to children as well. In fact, the filing of “Your First FBAR” is a right of passage for American citizens abroad. Yup, it’s true. (I won’t get into the draconian penalties for failure to file in this post.) That said, the problem is serious. In fact, an adoption agency in British Columbia has publicly warned people of the dangers of adopting U.S. born children because of the problems of FBAR and citizenship taxation. To learn more: Google “FBAR”.
and more …
The preceding includes “some examples” of why, for U.S. citizens abroad:
The problem is NOT coming into “U.S. tax compliance”.
The problem IS living as a “U.S. tax compliant person”.
Conclusion and the message for Americans abroad:
“Tax compliant U.S. citizens abroad” will live their whole life in the “penalty box” – starting at $10,000 a penalty. As long as they have paid their penalties they will be released to continue to experience the profound injustice of “double taxation”.
You have been warned!
P.S. The Foreign Earned Income Exclusion (Form 2555) and the Foreign Tax Credit (Form 1116) do NOT and are not intended to eliminate all of the problems. They apply to narrow classes of income.
P.P.S. Some Americans abroad mistakenly believe that the tax treaties protect them from U.S. double taxation. This is incorrect. U.S. tax treaties contain a “savings clause”. The purpose of the “savings clause” is to obtain the agreement of other countries that the U.S. can tax it’s citizens while they are resident in that other country.
And finally …
This post has focused on the taxation of U.S. citizens abroad while they are alive. Did you know that U.S. citizens abroad, (like Homelanders) die? Did you know that when they die they may be subject to the U.S. Estate Tax? Yup, it’s true.
Original Post By: John Richardson – Citizenship Solutions
Now Read The Posts Receiving More Than 150 Comments
The United States Imposes A Separate And Much More Punitive Tax On U.S. Citizens Who Are Residents Of Other Countries
AND READ THIS…..
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