THE CASE FOR FAIRER TAXATION OF NON-RESIDENT US CITIZENS
By Laura Snyder
For over 150 years, US citizens residing outside the United States have lived subject to two different tax systems: that of their countries of residence as well as that of the United States. While many countries tax their residents (citizens or not) on the basis of their worldwide income, the United States is just one of two countries in the world that taxes the foreign (non-US) income of their non-resident citizens (and green card holders). The United States adopted this policy during the Civil War, when lawmakers justified the action by typecasting US citizens living overseas as wealthy draft and tax dodgers seeking to avoid their military and financial obligations to the United States.
Living subject to the tax systems of two different countries is difficult. While the potential for double taxation can be a problem, an even bigger problem is that the two systems cannot be reconciled, such that financial steps—notably investments and retirement plans—that are favored in the US citizen’s country of residence are financially penalized under US tax laws. Further, the US tax returns of US citizens living overseas are complicated and many are unable to complete them correctly without professional assistance.
Brochure AAWE Tax SurveyThis problematic situation was further complicated with the 1970 adoption of the Bank Secrecy Act, requiring US citizens to report to the Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) all bank and other financial accounts meeting a minimum threshold value and held in financial institutions outside the United States, in a form referred to as “Report of Foreign Bank and Financial Accounts” (FBAR). This meant that US citizens living outside the United States became required to report to an agency responsible for the investigation of crimes what for those US citizens are local bank accounts needed in order to live ordinary lives in the places where they live.
The aberrational nature of the taxation of non-residents combined with the difficulty of compliance and the initial lack of enforcement of the FBAR meant that for those 150 years compliance rates were low. This was especially the case among those who did not even realize they were US citizens (they were born in the United State but left as small children and have spent nearly all their lives outside the country). Those US citizens who had some level of awareness of their obligations had little incentive to openly challenge them for so long as the United States did not attempt to enforce compliance, leaving US citizens in peace —albeit an awkward one—to live ordinary lives in their countries of residence—and notably leaving them in peace to plan for retirement, invest, and bank in the same manner as the other residents of the countries where they live.
All this changed first in 2001 with the Patriot Act which directed the Treasury Department to enforce FBAR. This direction was reinforced under the 2004 American Jobs Creation Act, which increased the penalties for failure to comply with FBAR to as much as the greater of $100,000 or 50% of the account balance.
The 2010 HIRE Act had an even more significant impact: in order to meet the requirements of the recently adopted Pay-As-You-Go Act (PAYGO), the HIRE act sought to compensate for the tax breaks and incentives it granted to businesses to hire unemployed workers by looking outside the United States for tax revenue. However, it did this not by creating any additional tax or by organizing for the collection of any tax. Instead, under the section known as FATCA, the HIRE Act obliges foreign financial institutions to report to the IRS detailed information about all accounts held by “US persons.” Foreign financial institutions that fail to comply are subject to severe penalties—a withholding tax of 30% on all payments of the institution’s US-sourced income. FATCA also imposes complex reporting requirements upon US taxpayers: these requirements are in addition to but mostly duplicative of those required for FBAR.
FATCA places enormous burdens upon foreign financial institutions. As result, many of them are (i) refusing to open new and closing existing accounts for “suspected US persons,” (ii) pressuring non-US persons holding joint accounts with “suspected US persons” to remove the US person as account holder, and (iii) refusing to grant mortgages to “suspected US persons,” or imposing higher rates.
US citizens and green card holders are also being refused (i) employment opportunities that entail signature authority for the employer’s accounts, (ii) investment and entrepreneurial opportunities with non-US investors and partners, and (iii) opportunities to serve a not-for-profit in any position entailing account signature authority. Americans living overseas have become persons to be avoided because their involvement will result in the need to report to US tax authorities and to a US crime investigative agency accounts that have nothing to do with the United States.
Additional Burdens Placed Upon Small Business Owners
The international provisions in the Tax Cuts and Jobs Act adopted in December 2017 were intended to target large multinational companies like Google and Apple. However, those provisions are having effect upon US citizens who live outside the US and who own small or medium-sized businesses in their countries of residence. These provisions are referred to as the “Repatriation Tax” or “Transition Tax,” on one hand and “GILTI,” on the other.
The Repatriation Tax requires the US-citizen shareholders of a non-US company to pay a one-time tax of at least 15.5% of the post-1986 retained earnings of the company. The tax is due in the absence of any distribution by the company or any other realization event. This tax imposes an especially serious burden on small and medium-sized business owners who live in countries where such companies are used as retirement vehicles: the tax means that they will lose a large percentage of the funds they had counted on for retirement. Furthermore, the distribution of these retained earnings to the shareholder enabling him/her to pay the Repatriation Tax will trigger distribution and income taxes in their country of residence and limited credit for these taxes will be allowed.
Global Intangible Low Taxed Income (“GILTI”) requires that, on an ongoing basis, US-citizen shareholders of foreign companies include in their personal tax base a share of certain types of the company’s earnings. In a manner similar to the Repatriation Tax, this tax must be paid regardless of whether or not the company actually pays out such amounts to the shareholder in dividends. And, if the company does indeed pay out any amounts in order to enable the US citizen to pay the GILTI tax, those dividends will also be subject to local taxes for which only limited US tax credits will be allowed.
Understanding the Non-Resident US Citizen
When US citizens living overseas object to US non-resident taxation and banking policies they are often told that any problems are eliminated by the foreign-earned income exclusion and tax credits, that they should “pay their fair share,” that (echoing the Civil War lawmakers) if they live overseas it can only be because they are wealthy and are seeking to avoid US taxation, that if they are so unhappy then they should just move back to the United States or renounce US citizenship.
These responses show, at best, lack of knowledge regarding Americans who live outside the borders of the United States.
To begin, the foreign-earned income exclusion ($104,100 for 2018) applies only to earned income. It does not apply to unearned income such as unemployment compensation, retirement benefits, capital gains, or insurance proceeds. To the extent the income in question is not earned income, a US citizen living overseas cannot benefit from the foreign-earned income exclusion.
Foreign tax credits offer limited relief at best: The formulas applied to calculate them are highly complex, and they often fail to produce an amount that is actual dollar-per-dollar of the tax paid. Further, a foreign tax credit applies only to the extent that the foreign tax paid is equal to or greater than the taxes otherwise owed to the United States with respect to the same income. For example some countries either do not tax retirement benefits or tax them at a very low rate. If the non-US resident taxpayer lives in a country that applies lower rates of taxation to retirement benefits than the United States the non-US resident will end up paying in tax not the amount owed by other retirees who live in the same country, but instead a higher amount: the amount owed under US tax rules. And the taxpayer will pay that tax in part or in whole not in the country where he/she accrued that retirement benefit and lives but instead will pay it to an entirely different country: the United States.
With respect to the claim that US citizens living overseas should “pay their fair share:” it’s not clear just what those US citizens are paying for: US citizens pay taxes in the countries where they live and in doing so they fund public services such as police and fire fighting, schools, roads, and other infrastructure. So calling upon those who do not live in the United States to “pay their fair share is essentially asking them to pay their fair share twice: once to the country where they live and then again to the United States. This is a burden unique to US citizens living outside the United States: Neither the citizens of other countries living outside the United States nor persons living inside the United States (citizens or not) are called upon to “pay their fair share” twice.
Most of the returns filed by US citizens living overseas show they owe no tax and, accordingly, no tax is paid. On the other hand, those same US citizens living overseas often pay hundreds if not thousands of dollars each year for the preparation of their lengthy and highly complex US tax returns. In fact, the principal beneficiary of the claim that non-resident US citizens should “pay their fair share” is not the US Treasury—it is the professional tax compliance industry.
There is nothing in the available data to support the preconception that Americans living overseas are wealthy or that they moved overseas in order to avoid US taxation. To the contrary, one-fifth of the participants in one study were freelance English teachers and one-fifth worked in IT or communications. Of the remainder, many were veterans of the US armed forces who remained overseas after retirement or the end of a tour of duty, and many were retirees, often living in low-cost locations like Mexico or rural Portugal. Further, while US citizens live in at least 100 countries, the large majority of them live in high-tax countries such as the United Kingdom, Canada, Germany, Australia and France. Indeed, of the top ten countries hosting US citizens, only one—Mexico—has a lower total tax burden as a percentage of GDP as compared to the United States.
Especially troublesome is the response that if US citizens living overseas are so unhappy then they should just move back to the United States or renounce US citizenship. Contained in this response is the implicit acknowledgement of the burdens that US banking and taxation policies impose upon US citizens.
Americans live overseas for valid and enduring reasons, such as in order to share their life with a spouse or partner and other family members or in order to pursue professional opportunities. These reasons have led them to build lives in their countries of residence: raising families, pursuing careers, creating businesses, etc. The suggestion that they simply “move back to the United States” is a suggestion that they break up their families and turn their backs on their livelihoods. Further, many US citizens either have never lived in the United States or they left when they were very young.
Renunciation of US citizenship is equally problematic. The renunciation fee alone is $2,350 – the highest in the world. Add to this the expense of ensuring tax compliance for previous years and of preparing a complex form detailing income and assets in order to determine if the individual is a “covered expatriate, together with the payment of the exit tax due in the event the individual is a “covered expatriate.” In sum, renunciation of US citizenship costs at a minimum several thousands of dollars and potentially much more. (Since the implementation of FATCA renunciations have increased: in 2012 fewer than 1000 people renounced US citizenship; in each of 2016 and 2017 more than 5000 people did). (Appendix 1, Part IVD).
Even more significant, renunciation of citizenship means that US citizens who are not citizens of another country would be left stateless. Stateless persons are highly vulnerable: considered a foreigner by every country in the world, they may lose the right to work, to vote, to hold public office, or even to live in any country. Statelessness may also mean losing rights to attend school, to have a bank account, to own real estate, to access healthcare, to get married. Statelessness is such a serious condition that it is considered to be a human rights violation; the right to a nationality is a fundamental human right.
As for those who are citizens of one or more other countries, citizenship is an integral part of their identity. Suggesting they give it up is akin to suggesting they give up a limb. Those who have renounced, in many cases because they felt they had no choice, describe the experience as “gut-wrenching,” and “it hurts my heart.” Further, many US citizens overseas have close family members living in the United States. Those family members often include aging parents and/or others who are unable to undertake international travel. Renunciation of US citizenship incurs the risk of not being able to enter the United States even on a temporary visit let alone on a long-term basis in order to visit or care for a family member, because only current US citizens have the right to enter the United States. Placing US citizens living overseas in the position where they must choose between either moving (back) to the United States or renouncing their US citizenship violates Article 13 of the Universal Declaration of Human Rights which provides: “Everyone has the right to leave any country, including his own, and to return to his country.”
In sum, for most US citizens living overseas, there are huge if not insurmountable barriers to moving “back” to the United States as well as to renouncing US citizenship. Suggesting these highly consequential actions as solutions to the problems created by FATCA and non-resident taxation both: (1) acknowledges the severe hardships these policies create, and (2) exposes the fundamental injustice of the policies.
AAWE member Laura Snyder was born and raised in the United States. She holds a JD from the University of Illinois College of Law, a DEA in droit privé from the University of Paris 1 (Panthéon-Sorbonne), and she completed the TRIUM Executive MBA program. Laura currently practices law in France, is a member of the bars of Illinois, New York, and Paris, and is the international representative on the Taxpayer Advisory Panel (TAP), a Federal Advisory Committee to Internal Revenue Service.