Before moving to the post, if you believe that Americans abroad are being treated unjustly by the United States Government: Join me on May 17, 2019 for a discussion of U.S. “citizenship-based taxation” as follows:
"What Is The Future Of Citizenship-Based Taxation?" Prof. William Byrnes (Texas A&M Law), Prof. Edward Zelinsky (Cardozo Law), John Richardson (Canadian attorney who represents US-Canada dual nationals), Kat Jennings (CEO Tax Connections) https://t.co/LP63MHEFYS
— William Byrnes (@williambyrnes) May 5, 2019
You are invited to submit your questions in advance. In fact, PLEASE submit questions. This is an opportunity to engage with Homelanders in general and the U.S. tax compliance community in particular.
Thanks to Professor Zelinsky for his willingness to engage in this discussion. Thanks to Kat Jennings of Tax Connections for hosting this discussion. Thanks to Professor William Byrnes for his willingness to moderate this discussion.
Tax Connections has published a large number of posts that I have written over the years (yes, hard to believe it has been years). As you may know I oppose FATCA, U.S. citizenship-based taxation and the use of FATCA to impose U.S. taxation on tax residents of other countries.
Tax Connections has also published a number of posts written by Professor Zelinsky (who apparently takes a contrary view).
This is the sixth of a series of posts that reflect views and experiences of Americans abroad who are experiencing the reality of living as an American abroad in an FBAR and FATCA world. (The first post is here.) The second post is here. The third post is here. The fourth post is here. The fifth post is here. I think it’s important to hear from people who are actually impacted by this and who have the courage to speak out. The “reality on the ground” is quite different from the theory.
I hope that this series of posts will give you ideas for questions and concerns that you would like to have addressed in the May 17, 2019 Tax Connections – Citizenship Taxation discussion.
The last post in this series made the point that U.S. “citizenship-based taxation” impacts people who are dual citizens and tax residents of other countries. Many of of these people do NOT view themselves as U.S. citizens at all. The suggestion that they are U.S. citizens is not welcome and is (because U.S. citizens are subject to a vast regulatory scheme) an intrusion in their lives. Fair enough.
Most of the posts in this series describe the effect of U.S. regulation on those who ARE U.S. citizens. What about the effect of “citizenship-based taxation” on those who are NOT U.S. citizens? The marriage of Meghan Markle to Prince Harry has generated an awareness of the regulatory requirements on U.S. citizens who live outside the United States. This is only part of the problem. To focus on how U.S. citizenship-based taxation affects ONLY U.S. citizens is selfish and misguided. After all, by marrying Prince Harry, Meghan Markle is now part of a family which includes non-resident aliens. As I recently suggested on Twitter:
Forget Meghan and the baby. Time to ask: How might being the father of a U.S. citizen and the husband of a U.S. citizen create a link between Harry and the IRS? "American expats hoping global spotlight on royal baby’s U.S. tax affairs will drive change" https://t.co/KttTaNaswL
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) May 6, 2019
My thinking along these lines began with:
What about Internal Revenue Code Section 318? This would deem “Baby Sussex” to be (for IRS purposes) the owner of any the shares of any U.K. corporations that Harry might own. This is only one of many instances where (to put it simply) the U.S. citizenship of one family member can become a problem for the whole family. In any event, this series really needs a post, describing what could happen, when a U.S. citizen becomes part of what is otherwise, a family of “non-resident aliens”.
In order to assist with this, I realized that I needed the input of a “U.S. Tax Anthropologist”. I turned to Peter Megoudis who is the director of the expat tax division at Trowbridge. Peter astutely recognised that the United States invented the concept of the “expat”. See the following video clip.
Trowbridge's Peter Megoudis, Director, Expatriate Tax, explains that America invented the concept of the "Expat" and how it relates to U.S. taxation of Americans living outside the United States.
— Trowbridge Tax (@trowbridge_tax) April 15, 2019
I asked Peter if he would share the results of his research on how one U.S. citizen family member could impact the whole family. In other words: How do the rules of U.S. “citizenship-based taxation” affect people who are not U.S. citizens, but have chosen to interact with U.S. citizens?
Peter replied to me with the following …
How does Meghan’s marriage complicate her US tax situation?
When a prospective client walks through the door, I always ask them three questions:
(1) Would you like a cup of tea or scones?
(2) Were you able to easily find our office elevators through the King Street West hotel lobby?
(3) Are you or any members of your family US citizens or residents?
I have learned never to assume that there are no US citizens in a family. After all, the worst thing you can do is to come up with a brilliant structure only to find out at the last moment that it will cause US tax complications because of the presence of that lone US citizen.
And, you never know where you may find a US citizen. You can find them in the unlikeliest of places – even in the British Royal Family.
The client herself may not even be aware that she, or her spouse, is a US citizen, but then casually mentions that she will be attending a Rams game, and that she hasn’t visited LA since she left there at the age of 2 months.
And even if Harry and Meghan’s son was born in an undisclosed British hospital, Harry II may still be a US citizen if his mom spent sufficient time in the US, not counting the days spent in the King Street West Residence in Toronto filming Suits
Why is this relevant?
Well, for one, Meghan’s US filing requirements became a whole lot more complicated as of May 19, 2018
First off, she will have to file, for the 2018 US taxation year, a separate Form 5471 for each UK (or other non-US) corporation in which Harry has at least 10% ownership of.
So if, under the Magna Carta, as subsequently amended, being sixth in line to the throne, Harry is entitled to 11% of 3294 UK corporations, 367 Canadian corporations, and 89,356 BVI corporations, Meghan has to file a separate 5471 for each such corporation in 2018, the year in which she was attributed (for 5471 filing purposes) Harry’s 11% shares (ie in 2018 when she became legally married – it should be noted that she could have avoided all of this by simply shacking up with Harry, as the IRS does not generally recognize common law, but that would have put a fine May day in Windsor Castle to waste).
The penalty for not filing these forms is typically $10,000 per form; we are thus talking $US 930,170,000 in IRS penalties alone
The Royal Family would have to sell at least 6 horses, 3 corgis, and a couple of crown jewels to raise that kind of funds (or at least sublet Balmoral Palace for Elton John parties twice a year).
In addition, she will have to get a 2018 balance sheet and income statement from the Queen for each of those entities, to report on her 5471 forms.
The Queen would thus have to value all of her assets held in corporate form.
This may not be that difficult for all those Amazon shares bought 10 years ago, but how do you value a bog in the Shetland Islands? Or Stonehenge? (after all, what would an independent third party pay for Stonehenge? And do the Druids have that much money?)
Further, there is a risk that Congress may subpoena Meghan’s tax returns and someone may leak all of her 5471s. The whole world may now see how much salaries are received by the Royals, and may eventually find out which Royal receives how much. Wouldn’t it be embarrassing if it was discovered that Fergie is receiving more in wages than Prince Andrew? Does the Queen want the world to find out if she is playing favorites?
Then there is the FBAR. Meghan will have to report all the accounts in which she has either a financial interest or signing authority over. Ok, maybe she doesn’t have to disclose Harry’s non-joint accounts if she doesn’t file a married filing joint return, but if Kate has joint ownership with William on all of his accounts, do you think Meghan would not also want that for Harry’s accounts?
Is Meghan the “Head Of The Household”?
In addition, if she is not going to be filing as married filing joint, she will have to decide whether she will file as “Head of Household”. While she will be entitled to do so as of 2019, since Archie came into the picture and since Harry I is a non-resident alien, can you just imagine the field day the British tabloids will have when they discover that Meghan is thinking of herself as the Head of Household (thus confirming their suspicions all along).
Are there really U.S. taxes owing?
At this point you may ask: “well that is just filing headaches; yes, she will have to pay some ecstatic accounting firm hundreds of dollars in compliance fees, but there is no tax liability impact”
U.S. Estate and Gift Tax
Not so fast. Take the US estate tax. If Harry dies leaving all of his assets to her, or to Archie, then on their deaths, they will only have a (say) $US 11.4m estate tax exemption.
Just that Shetland Island bog alone can expose Meghan or Harry II to US estate tax.
Further, if she ever takes pity on her father and transfers one of the amphibians in Loch Ness to him, that will likely attract US gift tax.
(A word of caution though: Meghan should probably obtain proper Scottish legal advice before trying to gift a Scottish amphibian).
Then, take the punitive trust accumulation distribution rules.
Where a US citizen or resident receives a distribution of prior year undistributed income from a foreign trust, they are taxed at graduated rates (ie the income or gains do not retain their character) and they have to pay an interest charge going back to the year in which the trust earned the income.
Thus, in any year in which Meghan or Harry II receive a distribution from the William the Conqueror Family Trust, set up in 1067, that relates to income earned by the Trust in (say) 1071, they have to pay interest on the resulting tax as if the tax was payable on April 15, 1072.
It is not clear that the trustees of the Trust (be they the original or successor trustees) have kept detailed records going back that far, as who would have thought a US citizen would be a beneficiary (at least, since 1776).
What about the passive foreign investment corporation (PFIC) rules?
Say that the Queen wants Meghan or Archie to have some walking around money so that they can shop at Marks and Spencer, and makes them shareholders of some of the entities.
They will have to determine whether all those UK corporate entities that earn rental income from UK estates are PFICs or not (if they are, they would be subject to punitive taxation on distributions); to do so, they will have to prove to the IRS that the Royal Family is actively involved in managing the rental properties, and is not subcontracting that out to an independent contractor. The IRS will thus have to subpoena the Royal Secretary for the Royal Calendars.
(Of course, they can avoid this by having the entities treated as partnerships by the IRS. Without a check the box election, they will have to argue that the Royal Family has unlimited liability for the activities of the entities. It may be difficult to find a British legal authority to testify to this (or even to get the Royal Family to assume liability for the actions of, say, members of the British Parliament – there is no cap to such exposure). Thus, each of the entities will have to file check the box elections to avoid corporate (and hence PFIC) status. For Archie, he has until July 20, 2019 to make that election and have it applied retroactively to his date of birth)
What if Meghan or Archie form their own (or inherit some of Harry’s) UK consulting companies and continue to earn consulting income from them (ex for services to various charities)
Unless there are a lot of tangible assets in the companies, their consulting income would be includible on their US tax return as GILTI income, even if not distributed to them.
They will thus need a bit more of that walking around money to pay the IRS
And then we get to expatriation. Would swearing allegiance to a foreign sovereign (ie themselves) constitute an expatriating act, so that they automatically lose their US citizenship?
In other words, if given the choice between Trump and Elizabeth they chose Elizabeth, does that make them ipso facto aliens?
Can an ICE agent seize their citizenship? Does their jurisdiction extend to the British Isles?
If so, Meghan would be subject to the US expatriation penalties on a surrender of her US citizenship, if she had a net worth of more than $US 2 million on the date of surrender (leaving aside the engagement gifts, the royalties from Suits syndication would put her above the threshold).
These would include a deemed distribution of all her non-US pensions. She would thus need to hire a pretty good actuary to determine the present value of all the pensions and deferred compensation that she, as a member of the royal family, would be entitled to receive over her lifetime.
Further, there would be no discounts for the fact that some of that deferred compensation may not have vested yet.
And we have just scratched the surface . . .
As you can see, Meghan’s and Archie’s tax life has become quite a bit more complicated.
While the wedding and the royal birth were brilliant, the tax aftermath will be bloody difficult to navigate.
I sincerely hope they have good US tax accountants!
Peter’s answer covers a wide range of topics. You don’t need to understand all the topics to see that the life of a non-resident alien can be profoundly impacted if he/she marries a U.S. citizen. The rules of U.S. “citizenship-based taxation” affect the family unit as a whole. To be forewarned is to be forearmed.
All of these complications because Harry married a U.S. citizen … A later post will detail more problems in the “FBAR Marriage”.
This post has focused on how U.S. “citizenship-based taxation” impacts the non-resident alien family members. Those interested in how U.S. “citizenship-based taxation” might affect “Baby Sussex” see this:
John Richardson – Follow me on Twitter @ExpatriationLaw