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Expat Briefing Editorial Team, 23 July, 2013
Expat Americans are already in a uniquely horrible position when it comes to taxation, but under legislation pending in Congress, things could get even more uncomfortable for some of them.
The Current Tax Position of US Expats
Unlike citizens of many other countries, Americans never really escape the attentions of the Internal Revenue Service because the United States taxes its citizens on the basis of their nationality and not on the basis of their residence. There is an income tax concession available during non-residence, but all other respects the international tax situation of an individual citizen is about the same whether they are in or out of the US.
US expatriates who meet the Physical Presence Test or meet the Bona Fide Resident Test may be able to take advantage of the Foreign Earned Income Exclusion and or the Foreign Housing Exclusion. This exclusion entitles US expats to exclude for US income tax purposes a certain amount of foreign earnings that is adjusted annually for inflation (USD91,500 for 2010, USD92,900 for 2011, USD95,100 for 2012, and USD97,600 for 2013). In addition, they can exclude or deduct certain foreign housing amounts, which are based on the total of your housing expenses for the year minus the base housing amount. The computation of the base housing amount is tied to the maximum foreign earned income exclusion. The amount is 16% of the maximum exclusion amount (computed on a daily basis), multiplied by the number of days in your qualifying period that fall within your tax year.
You are considered physically present in a foreign country (or countries) if you reside in that country (or countries) for at least 330 full days in a 12-month period. You can live and work in any number of foreign countries, but you must be physically present in those countries for at least 330 full days. The qualifying period can be any consecutive 12-month period of time. A "full day" is 24 hours; days of arrival and departure are generally not counted in the physical presence test.
A person is considered a "bona fide resident" of a foreign country if they reside in that country for "an uninterrupted period that includes an entire tax year." A tax year is January 1 through December 31. Brief trips or vacations outside the foreign country will not jeopardize status as a bona fide resident. If the foreign government concerned has determined that a person is not subject to their tax laws as a resident, the Exclusions will not be available.
US citizens and resident aliens who are outside the United States (and its possessions) have the same requirements to file tax returns as anyone living in the United States. Income from worldwide sources must be considered when determining if a federal tax return must be filed. In general, foreign earned income is income received for services performed in a foreign country.
If you pay foreign taxes, it may be possible to offset these against US taxes if there is a double tax treaty with the country in which you are resident.
The concept of 'tax home' is used in connection with foreign residence. Generally, a person's tax home is the general area of her main place of business, employment, or post of duty where she is permanently or indefinitely engaged to work. A person is not considered to have a tax home in a foreign country for any period during which their abode (the place where they regularly live) is in the United States.
Additional legislation also places comprehensive reporting requirements on US citizens with income from foreign bank accounts, as well as the financial institutions with which they hold investments. Each United States person must file a Report of Foreign Bank and Financial Accounts (FBAR), if the person has a financial interest in, or signature authority (or other authority that is comparable to signature authority) over one or more accounts in a foreign country, and the aggregate value of all foreign financial accounts exceeds USD10,000 at any time during the calendar year. Furthermore, the Foreign Account Tax Compliance Act (FACTA), enacted on March 18, 2010 as part of the HIRE Act, expands the information reporting requirements imposed on foreign financial institutions with respect to accounts held abroad by US residents.
The HEART Act and the Ex-Patriot Bill
Given the above tax rules, the only real option for long-term US expats who want to avoid being doubly taxed is to take the drastic step of changing their nationality. Recent figures suggest that this is a step that more Americans are taking. However, even this avenue is starting to look unattractive as a result of recently enacted, and newly proposed, legislation.
The Heroes Earnings Assistance and Relief Tax (HEART) Act 2008 was directed at serving military personnel, but contained several stings in the tail for expatriates. One provision requires US employers doing federal contract work for the US government, and using foreign subsidiaries to compensate their US employees working abroad, to begin paying Social Security and Medicare taxes on behalf of these employees. The provision is designed to make sure that defense contractors in Iraq, Afghanistan and elsewhere meet their legal obligation to pay payroll taxes on behalf of the people who work for them.
Another provision seeks to make certain that individuals who relinquish their US citizenship or long-term US residency pay the same Federal taxes for appreciation of assets, such as stocks or bonds that they would pay if they sold them as US citizens or residents. Under this legislation individuals are treated as if they sold all of their property for its fair market value on the day before they expatriate or terminate their residence.
However, on June 12, 2013, two US Senators filed an amendment to a bill on immigration reform reviving proposals introduced in the run-up to the 2012 presidential elections automatically barring former citizens eligible to pay the exit tax from re-entering the USA unless they can show the Department of Homeland Security that they did not renounce US citizenship for tax purposes.
The amendment was put forward by Senators Jack Reed, a Democrat representing Rhode Island, and Chuck Schumer, a New York Democrat, and is described by Reed as a measure against "expatriate tax dodgers."
Reed introduced a similar law in 1996, after a billionaire businessman renounced US citizenship, became a citizen of Belize, and then returned to his hometown in Florida as a Belizean consular official, and last year, but its drafting has inhibited its enforcement. This led to Schumer proposing the "Ex-PATRIOT" Bill (Expatriation Prevention by Abolishing Tax-Related Incentives for Offshore Tenancy), following the decision of Facebook co-founder and partial owner Eduardo Saverin to renounce US citizenship.
As with the Ex-PATRIOT Bill, the new amendment, known as the Reed-Schumer amendment, will apply an automatic exclusion to ex-citizens with either a net worth of USD2m, or an average income tax liability of at least USD148,000 over the last five years. However, while the Ex-PATRIOT Bill included a provision by which the exclusion would be waived if the ex-citizen could demonstrate to the IRS that he or she had not in fact renounced citizenship primarily to avoid tax, the new amendment requires the ex-citizen to provide "clear and convincing evidence" to the Department of Homeland Security.
Reed stated: "American citizenship is a privilege. But it seems that a privileged few are trying to game the system by accumulating wealth and benefiting from the greatness of the United States and then renouncing their citizenship to avoid paying their fair share of taxes. They are welcome to leave our country, but they should not be welcomed to return without playing by the rules and paying what they owe."
Last year, a political furore erupted over the decision of Facebook co-founder and partial owner Eduardo Saverin to give up his US citizenship in order, it was said, to avoid taxes on profits he expected to collect after the social-networking company recently went public. Saverin has lived in Singapore since 2009 and had dual citizenship, but then renounced his US citizenship in September 2011.
By taking that action, he is reported to have avoided at least USD67m in taxes since Singapore, unlike the US, has no capital gains tax, and he will only pay a lower exit tax. The amount of his effective tax saving could increase if Facebook’s share price rises.
“We simply cannot allow the ultra-wealthy to write their own rules,” said Bob Casey (D - Pennsylvania), a co-sponsor of the Ex-PATRIOT bill. “Saverin has benefited greatly from being a citizen of the US but he has chosen to cast it aside and leave US taxpayers with the bill.”
“Saverin has decided to ‘defriend’ the US just to avoid paying his taxes. We aren’t going to let him get away with it so easily,” Schumer added. “It’s infuriating to see someone sell out the country that welcomed him and kept him safe, educated him and helped him become a billionaire. There should be no financial gain from renouncing your country.”
Saverin himself has denied that he has renounced his US citizenship to avoid paying taxes. In a statement he has stressed that his decision “was based solely on my interest in working and living in Singapore.”
“I am obligated to and will pay hundreds of millions of dollars in taxes to the US government. I have paid and will continue to pay any taxes due on everything I earned while a US citizen. It is unfortunate that my personal choice has led to a public debate, based not on the facts, but entirely on speculation and misinformation,” he added.
Saverin confirmed that he “will continue to invest in US businesses and start-ups, and believe and hope that those investments will create many new jobs in the US and globally”.
While the Ex-PATRIOT bill and its follow-up are reflective of the Democrats’ tax fairness agenda, the proposals found an unlikely ally in the shape of the Republican Speaker of the House of Representatives, John Boehner, who felt obliged to admonish Saverin when he was asked a question on ABC television. He called Saverin’s move “absolutely outrageous” and said he would support the Schumer/Casey bill, if such legislation was found to be necessary.
Other Republicans slated the legislative proposals as another example of Democrat “class envy,” and many right-wing Congressmen would be unlikely to support if it came to a stand-alone vote. This is one of the reasons that Reed and Schumer decided to tack the proposals onto the larger immigration bill to give it a better chance of succeeding.
Nonetheless, some argue that the bill is unconstitutional, and given the seeming inability for the Senate and the House of Representatives to agree on virtually all proposed legislation linked to raising taxes, the future of the bill remains uncertain.
An Alternative ‘Win-Win Solution’?
In a new tax reform proposal, American Citizens Abroad (ACA) has proposed a “win-win solution” that streamlines United States tax law and raises additional tax revenue, by recommending that Americans residing abroad have the option to elect to be taxed on the same basis as non-resident foreign nationals.
ACA calls this option Americans Abroad Taxation (AAT), which would, it says, resolve the current incompatibilities between citizenship-based taxation and the Foreign Account Tax Compliance Act (FATCA) that is intended to ensure that the Internal Revenue Service (IRS) obtains information on financial accounts held by US taxpayers.
ACA believes that current IRS practices are “creating more problems than they are solving.” As a general rule, Americans abroad pay taxes to their local country of residence, and they are also subject to US taxation. It points out that the combination of US taxes and the onerous filing requirements under the FBAR, as well as the “extremely complex and burdensome” FATCA legislation “is a lethal model, making life for Americans residing overseas extremely difficult”.
It adds that tax reform is necessary as recent US tax policies now prevent an increasing number of Americans abroad from opening and maintaining a local bank account, signing mortgages or insurance contracts, obtaining employment, and entering joint-ventures and partnerships with foreigners. "These policies are forcing increasing numbers of Americans to renounce their US nationality in order to function in a global society,” the ACA warns.
AAT would allow Americans abroad, if they so elect, to be taxed by the IRS on the same basis as the US currently taxes non-resident aliens.
Under the ACA’s proposal, US source income would thereby be taxed through withholding taxes determined by US tax law and US income tax treaties. This would include withholding taxes on all US source unearned income (including dividends, interest, royalties, pensions and passive rents from US properties).
On the other hand, income earned in the US by Americans abroad, income from participations in US partnerships and compensation for self-employment services performed in the US would be taxed, as the case may be, either by a withholding tax at source or by reporting income under the same rules that apply to non-resident aliens who have 'effectively connected' income.
“This recommendation,” the ACA confirms, “is totally consistent with the tax policy practiced throughout the world; it levels the competitive playing field which is currently tipped against Americans abroad.”
ACA has calculated that AAT would produce USD35bn in additional revenue for the IRS over ten years, compared with the current system, largely because the US would collect withholding taxes on US source income, thereby pre-empting tax revenue which presently goes to foreign governments under the current citizenship-based taxation (as higher tax rates in OECD countries presently generate foreign tax credits that cancel most US tax liability).
According to the ACA, the new system would also: provide anti-abuse measures; define the taxation of Americans abroad (as proposed by the House of Representatives Ways and Means Committee) on a territorial basis; enhance the competitiveness of the US; stimulate job creation for Americans at home and abroad; and rationalize and reduce the administrative burden of the IRS in a cost-effective way.
AAT would be made available as an option to Americans, including green card holders, who have established residence overseas and are not residents in a country determined by the IRS to be a tax haven, and who provide proof of being subject to taxation in the country of residence. To qualify, they would have to pay a one-time administrative fee of USD500, and have paid US taxes due up to the date of AAT election.
For most Americans abroad, a form electing to be subject to AAT would be the last IRS or Treasury form to be filed during their lifetime. Contributions to US Social Security and Medicare by self-employed Americans abroad would become voluntary, unless required by a Social Security agreement, and AAT taxpayers who return to the US, or who establish residence in the US for the first time, would be automatically subject to ordinary tax rules for US residents.
However, as it rolls out yet more extraterritorial tax legislation in the form of FATCA, this is advice that the US Government is unlikely to take up in a hurry. Indeed, from the outside at least, the administration certainly gives the impression that it assumes all Americans living overseas, or with foreign financial arrangements, are intent on dodging US taxes. That there is a movement within Congress to repeal FATCA shows that there is some hope for US expats on the tax front. There have also been calls for the US to switch to a more “territorial” system of taxation as part of a bipartisan effort to reform the US tax code. However, these campaigns are being driven mainly by Republicans, and they control neither Congress nor the White House at present, so the tax misery for many Americans living abroad looks likely to continue for the foreseeable future.
For further information on the tax situation for US citizens abroad, foreign expats in the US and many other aspects of US taxation, please visit our partner website, usataxnetwork.com.