Last week, I was in Florida attending a conference for tax professionals sponsored by the Heckerling Institute on Estate Planning.
As you might guess, at a conference of this type there are all manner of tax geeks attending. And as a tax geek myself, I sought out practitioners who were focusing on my own specialization: international tax law.
One presentation I attended was a panel discussion on “International Recent Developments.” And one thing that was examined was the US Treasury’s longstanding campaign against US citizens living abroad.
While there’s uncertainty about the exact numbers, the State Department estimates that approximately nine million US citizens live outside American borders. In recent years, the IRS has made their lives a living hell.
One big reason is that the US, uniquely among major nations, imposes the same tax and reporting obligations on its citizens living in another country as those living within its territory. If you’re careful, it’s generally possible to avoid being taxed twice on the same income. But income that’s legally tax deferred in, say, a French pension plan, might not be tax deferred in the US. And you still need to complete two sets of tax documents annually, a time-consuming and often expensive task.
That’s bad enough. But the IRS is making matters worse, courtesy of FATCA, the Foreign Account Tax Compliance Act.
Although you’ve probably heard about FATCA, most Americans haven’t. US residents who don’t invest abroad aren’t affected by the law. But if you’re one of those nine million Americans living abroad, this law is very bad news indeed.
In short, FATCA demands that every foreign financial institution (FFI) in the world sign and strictly comply with an agreement with the IRS to turn over account information with respect to its US clients. FFIs that fail to do so are subject to a 30% withholding tax on certain “withholdable payments” from US sources.
FATCA has given the IRS carte blanche to adopt a scorched earth policy with respect to US citizens living abroad. The agency’s working presumption seems to be that all these millions of citizens are tax evaders. This policy has led to unexpected and occasionally tragic results, as I discussed in this piece.
And don’t forget that a US citizen who owes more than $50,000 in taxes or tax-related penalties now faces having their passport revoked. That’s a minor inconvenience to most Americans – indeed, fewer than 50% of US citizens even have a passport. But as I learned when I lived in Austria a decade ago, a foreigner must use their passport regularly to identify themselves in many everyday situations. And the visa giving a foreigner official permission to live in another country is issued only in conjunction with a valid passport. Take away that passport, and unless you have a second passport, you can no longer live in that country.
Are Americans living abroad really evading paying taxes, as the IRS seems convinced they are? There’s absolutely no evidence to suggest that they do. The main reason is that most US citizens abroad live in countries with income tax rates as high as or higher than the US. For instance, at least 660,000 US citizens live in Canada, which is hardly a “tax haven” – the top combined federal and provincial income tax rate can approach 50%. In one province – Newfoundland and Labrador – the top combined rate is 51.3%.
Does that sound like a “tax haven” to you?
A report from the IRS “National Taxpayer Advocate,” suggests a policy to ease the plight of overseas Americans called the “Same Country Exception” (SCE). The idea is that FATCA would no longer apply to accounts held in the country in which a US taxpayer is a bona-fide resident. US taxpayers would no longer need to report such relationships as “foreign accounts.” Financial institutions would no longer be required to report details of these accounts to the IRS.
Unfortunately, as I learned in the Heckerling International Recent Developments discussion, the IRS recently rejected this proposal. In other words, the IRS believes that a US citizen living in Canada with a local bank account might somehow evade paying tax.
That’s extremely unlikely, not only because interest rates in Canadian banks are very low, but also since Canada taxes this income itself. In turn, to avoid double taxation, the US allows taxpayers to credit most categories of tax paid in a foreign country against their US tax obligations. So even with the SCE, there’s virtually no “tax loss” to the Treasury.
In the meantime, as repeatedly documented, US citizens living in other countries continue to suffer from “lockout” – not being able to carry on ordinary financial relationships in their adopted countries. Lockout occurs because foreign banks and other financial institutions are terrified of FATCA. The easiest way for a financial institution to avoid its worst impact is to forbid Americans from conducting business with it.
As the group American Citizens Abroad puts it:
“[F]ATCA continues to put the community of… Americans overseas at risk of lock-out from access to financial accounts needed for the management of basic living expenses (paying bills, paying rent, receiving paychecks).”
The good news is that relief from FATCA may be on the way, courtesy of the new Republican-controlled Congress. As I discussed in this article, the 2016 Republican Platform calls for the repeal of FATCA and a change to residence-based taxation for US citizens living overseas.
If Congress doesn’t act, though, the IRS has demonstrated it has absolutely no intention to relax its iron grip over the Americans living abroad. It’s no wonder why the number of US citizens expatriating – giving up their citizenship and passport – has skyrocketed since FATCA was enacted in 2010. And without much-needed relief from Congress, that’s the only real alternative non-resident US citizens have to end their onerous tax and reporting obligations.
