A fundamental injustice of US tax law is that it discriminates against the approximately nine million Americans who live in other countries.
These citizens must continue filing US tax and information reporting returns, even if they’re paying tax in their resident countries. Any local businesses they’re associated with become ensnared into the spiderweb of US tax laws. (The only other country that imposes similar rules is the totalitarian dictatorship of Eritrea.)
With the enactment of the Foreign Account Tax Compliance Act (FATCA) in 2010, things got even worse for overseas Americans. The law requires foreign banks and other financial institutions with US customers to act as unpaid informants for the IRS. If they fail to do so, US-source income they have in the form of interest, dividends, rents, and similar payments becomes subject to a 30% withholding tax.
FATCA’s working assumption is that all Americans with investments outside the US are tax evaders, including those who live full-time overseas. But that’s simply nonsense. For instance, the most popular destination for Americans living abroad is Canada. As many as two million US citizens live there. The top combined federal and provincial income tax rate in Canada can approach 50%. In one province – Newfoundland and Labrador – the top combined rate is 51.3%.
Does Canada sound like a tax haven to you?
Despite FATCA’s flawed premise, the IRS has ratcheted up the pressure on foreign financial institutions (FFIs) to enforce it. Unsurprisingly, most FFIs don’t want anything to do with the law. They’ve closed hundreds of thousands of accounts held by US citizens instead.
With their local accounts closed, many overseas Americans increased their reliance on US accounts. But US banks and brokerages have started to close accounts owned by non-resident citizens as well. These include Morgan Stanley, Fidelity, Merrill Lynch and Wells Fargo. In the US financial institutions that still accept business from non-resident citizens, the minimum account values have increased astronomically. Millions of overseas Americans are now effectively locked out of banking relationships anywhere in the world.
What’s more, because the SEC forbids solicitations by US mutual funds to individuals living outside the US, it’s become nearly impossible for non-resident citizens to own them. In addition, US citizens generally can’t purchase non-US mutual funds without disastrous tax consequences. As a result, Americans living abroad are effectively locked out of all mutual funds, US or non-US.
Another way Congress and the IRS have made life miserable for overseas Americans is to make it practically impossible for them to retire in their adopted countries. For instance, contributions to a foreign pension plan are usually tax-deductible in the country offering it. And growth in the plan is generally tax deferred. But in most cases, the US Tax Code doesn’t offer a deduction for the contribution and taxes the growth in the plan. Overseas Americans often wind up paying two sets of income tax on their pensions: one to the US and a second to their adopted countries. Similarly, US citizens generally can’t own foreign life insurance policies that have a cash value without disastrous tax consequences.
The situation for many Americans living abroad got even worse after Congress enacted President Trump’s tax reform bill in 2017. The law lowers tax rates for both individuals and domestic corporations. But anyone with deferred profits in what the Tax Code refers to as a CFC or controlled foreign corporation (a foreign corporation with more than 50% US ownership), is subject to a mandatory one-time repatriation tax of 15.5%. For less liquid assets like real estate, the tax rate is 8%.
The problem is especially acute for overseas Americans who use foreign corporations as a savings vehicle and have no intention of repatriating the profits to the US. For instance, many Canadians use corporations to operate small businesses and set up pension plans. Net profits in these corporations are taxable in Canada only when they’re distributed. The repatriation tax confiscates a portion of deferred profits of these corporations owned by US citizens, with no provision in Canadian law to offset the tax. Up to 15.5% of the profits are subject to double taxation.
As bad as conditions are now for US citizens living abroad, they’re about to get even worse. In just one country – France – the Banking Federation has warned its members they must close as many as 40,000 additional accounts held by US citizens living there by the end of the year. Many of them are held by “accidental Americans;” individuals born in the US who left the country as children or born to US parents in France. By law, they’re US citizens, although according to the Banking Federation, they "lack any concrete link with the United States, where they no longer reside."
Indeed, the European Banking Federation, which represents around 3,500 European banks, told the US Treasury that up to 300,000 more US citizens living in Europe could lose access to banking services by the end of the year.
The law forcing their hand is FATCA, which requires FFIs to provide the IRS with the Social Security Numbers of their US citizen customers. Until now the IRS has waived this requirement in certain cases. The waiver ends December 31, 2019. But accidental Americans often don’t have SSNs and often find it difficult to come up with the required documentation to get one.
Since Congress and the IRS have declared war on overseas Americans, it’s no wonder why the number of US citizens expatriating – giving up their citizenship and passport – has skyrocketed in recent years. Unless Congress ends or substantially modifies citizenship-based taxation, that’s the only alternative overseas Americans have to live normal lives in their adopted countries.