The article highlights the dilemma faced by US citizens living overseas. These challenges are leading to a record number of Americans renouncing their citizenship — with 2,909 doing so in the first three months of 2020 alone.
The Passport Predicament
US citizens living abroad rely on their US passport as their main travel and identification document. But the US government can refuse to issue or renew a passport for various reasons, including having a “seriously delinquent tax debt” of $53,000 or more to the IRS.
If a US citizen’s passport is revoked, they will have to return to the US, leaving behind their family, property, and business relationships in the country where they reside. This creates a significant hardship.
Citizenship-Based Taxation
The US is one of only two countries in the world (the other being Eritrea, a totalitarian dictatorship) that imposes income tax on its citizens’ worldwide income. This is true even if they live in another country. This policy makes it uniquely difficult for US citizens living abroad.
The Dilemma with FATCA
Dual Tax Reporting Requirements: For Americans living abroad, complying with US tax rules is very challenging. They have to file two sets of tax forms each year – one for the US and one for their country of residence.
FATCA’s Impact on Financial Relationships: The situation has been made even more difficult by a law called the Foreign Account Tax Compliance Act (FATCA). FATCA requires foreign financial institutions (FFIs) to follow US tax and reporting rules for their American clients. If the FFIs don’t comply, they face a 30% withholding tax on certain US-source income and transfers.
As a result, many overseas financial institutions have simply closed the accounts of their American clients, including those living in the same country as the institution. This makes it nearly impossible for Americans abroad to maintain basic financial and business relationships in their adopted countries.
The intention behind FATCA was to crack down on Americans hiding money in tax havens. But the claim that the US Treasury loses $100 billion annually from offshore tax evasion has been shown to be false.
Nonetheless, the impact of FATCA has been significant for law-abiding Americans living overseas.
Living Abroad as an American
Imagine you live in a country with higher taxes than the US, not considered a tax haven, and join a pension plan there. You believe the income from this plan is tax-deferred until retirement, following the local tax laws.
But the IRS complicates things. By simply participating in a pension plan like those around you, you unknowingly get involved in a complex part of the US tax law related to foreign trusts.
In some situations, you may have to pay US taxes on your pension income as it grows. Additionally, you might not be able to offset the US tax against what you paid in your home country. When you start receiving pension payments, your home country will tax that income as well.
In addition, if you are part of a foreign retirement scheme, you are typically required to file two unfamiliar US tax forms: Form 3520 and Form 3520-A. While some foreign pensions are exempt from these filings, many are not.
If you don’t file the required tax forms, like Form 3520 for foreign trusts, the penalties can be very heavy. The IRS can impose a 35% penalty on any unreported transfers to or from the foreign trust.
You may be able to avoid the penalties if you can prove you didn’t realize you had to file the form. The IRS has also issued some new, slightly less strict rules. But you’ll still likely need to hire an expensive international tax specialist to help you navigate this complex process.
And if you didn’t file Form 3520 and don’t qualify for a penalty exemption, you could end up with a “seriously delinquent tax debt” to the IRS. This could then lead to the revocation of your US passport.
Leaving America… for Good?
Despite the many challenges faced by Americans living abroad, only 2,909 people gave up their US citizenship and passport in the first quarter of 2020. This is the highest quarterly total ever, but it’s still a small number compared to the estimated 9 million Americans living outside the country full-time or almost full-time.
One reason expatriation (giving up US citizenship) is relatively rare is that it’s a sensitive topic. When someone expatriates, they stop being obligated to report or pay taxes to the IRS on non-US income, although they still have to pay any previous taxes, interest, and penalties.
This has led some US politicians to strongly criticize expatriation, calling it a “despicable act” and describing expatriates as “Benedict Arnolds” selling out their country to maintain their wealth.
As a result, the laws and penalties around expatriation have become increasingly severe over the years. For example, the 2008 law imposes an “exit tax” on the unrealized gains in an expatriate’s worldwide estate. There are also concerns about potential double taxation, and avoiding these traps requires expert (and expensive) advice.
Despite the harsh rhetoric and penalties, the media often focuses on high-profile expatriates like Facebook’s Eduardo Saverin or singer Tina Turner when reporting on this issue.
But almost all individuals who give up US citizenship or permanent residence pay at least some tax in their adopted country. In popular expat destinations like Canada and the UK, they typically pay more.
Leaving America: Is Expatriation Right for You?
The decision to give up US citizenship is a serious one. It requires that you get a second passport if you don’t already have one. You must also live permanently outside the US if you don’t already.
Are You A Good Candidate for Expatriation
To expatriate is a big decision. One that has implications far beyond possibly paying an “exit tax” upon your permanent departure.
Expatriation means, for example, that you no longer have the automatic right to enter or live in the United States. You’ll need to get a visa to do so, unless your non-US passport qualifies you for visa-free entry.
Before making this decision, review several key factors to ensure it’s the right choice for you.
You can find more information here: Are you a good candidate for expatriation?
How to Get a Second Passport: 7 Legal Ways
Thinking about a second passport? There are just seven official (legal) ways to get one. Find out which one is the best option for you: How to get a second passport.
Need Help?
We can assist in every phase of giving up your US citizenship or long-term residence. This includes helping you get a second passport before giving up US citizenship.
And if you’re not ready to expatriate, we can help you take advantage of tax breaks in the Tax Code that apply to US citizens and permanent residents living overseas.
Schedule a free no-obligation consultation with a Nestmann Associate to see if expatriation is right for you.
