Panel session – US Expat Tax Conference from Deborah Hicks on Vimeo.

Should taxation be based on the “circumstances of your birth” or the “circumstances of your life”? President Obama doesn’t think (apparently) that the “circumstances of your birth” birth should determine the “outcome of your life”. Should the “circumstances of your birth” determine your tax residency?

This is a second post exploring what is the true meaning of U.S. citizenship-based taxation. In an earlier post – “Toward A Definition Of Citizenship Taxation” – I explored the contextual meaning and effect of U.S. “citizenship taxation”. The only “contextual effect” and “practical meaning” of U.S. citizenship taxation may be described as:

Therefore, the practical meaning of “citizenship taxation” is the United States imposing taxation on the non-US source income earned by people who live in other countries. To be clear: citizenship taxation means that the United States is claiming the residents of OTHER countries as US residents for tax purposes!

That’s amazing stuff! Most countries believe that they are sovereign and that includes sovereignty over matters of taxation. Yet, any country that is a party to a U.S. tax treaty has actually agreed that a subset of the treaty partner’s tax residents are ALSO U.S. tax residents! Although nobody questions the right of the United States to prescribe its own definition of tax residency, few would agree that the United States has the right to claim the residents of other countries as U.S. tax residents. Yet, this is what the U.S. citizenship taxation regime means. This U.S. extraterritorial claim of taxation is at the root of the FATCA administration problems and at the root of the the events that led to Treasury Notice 2023-11 (released on December 30, 2022).

The first post explained the meaning and effect of U.S. citizenship taxation. This second post is to argue that U.S. citizenship taxation is taxation based on “the circumstances of your birth” rather than the “circumstances of your life”. To put it another way, U.S. citizenship taxation is taxation based (mostly on) how you were defined at birth rather than how you have lived your life. It is the absolute reverse of how EVERY other country in the world (yes even Eritrea) approaches tax residency. It is the mechanism that the U.S. uses to claim that the residents of other countries are actually U.S. residents for tax purposes. Therefore, U.S. citizenship taxation operates as a sanction against any country that has residents that happen to have U.S. citizenship.

Citizenship-based taxation or Taxation-based citizenship?

Many people believe that when U.S. citizenship (a constitutionally protected right) collides with FATCA and citizenship taxation, citizenship must give way to facilitate taxation. It’s as though, what the US calls “citizenship-based taxation” is actually “taxation-based citizenship”. Millions of people outside the United States are suffering from U.S. “citizenship taxation”. Some are “pushing back”!

What kinds of people are “pushing back”?

Unsurprisingly, the “push back” against U.S. citizenship taxation is from those who have/had little physical presence or economic connection to the United States. These are typically individuals who:

– were born in the United States and moved permanently from the United States as children; or

– were born outside the United States to a US citizen parent(s) and never lived in the United States

The US claim of tax residency is based on the “circumstances of their birth”. The “push back” is based on the “circumstances of their life”.

Their claim of unfairness is that the taxation should be based on the “circumstances of life” and not “circumstances of birth”. Because of the focus on the “circumstances of life” and not on the “circumstances of birth”, the latter is rarely developed and is absent in the discussion. The claim is that the “circumstances of life” do not justify taxation regardless of the “circumstances of birth”. Although (obviously) correct, it creates a situation where the goal becomes removing “some” individuals taxable because of “circumstances of birth” from the U.S. tax net (leaving the rest behind).

What is an Accidental American?

Post from @1040Abroad (includes) attempts to define who is an ”Accidental American” (not defined in US law). US Treasury has made consistent attempts to help them without defining them. How should “Accidental American” be defined? https://t.co/ghGdfhNhIs via @TaxConnections

— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) January 18, 2023

(The post referenced in the above tweet has (in my opinion) a very narrow definition of what is an “Accidental American”. Accidental Americans are easy to recognize but hard to define.)

The most visible group claiming their “circumstances of life” do not justify U.S. taxation refers to itself as “Accidental Americans”. The term “Accidental American” has no meaning or relevance in either U.S. tax or U.S. immigration law. The term is intended to be descriptive of individuals who (under US Immigration/Nationality law) meet the requirements of “circumstances of birth” (citizenship) but do NOT have the “circumstances of life” that typically should justify U.S. taxation. Anecdotal evidence suggests that few of them have ever filed U.S. taxes. It is obvious that the application of US taxation to these individuals is clearly and visibly unjust. (But, citizenship taxation is unjust in application to all individuals.) The application of U.S. taxation to “Accidental Americans” reinforces the fact that US “citizenship taxation” is NOT (necessarily) triggered by any physical/economic connection to the United States but (can be) IS based solely on “circumstances of citizenship at birth”. Rather than refer to this group as “Accidental Americans” (absent naturalization all US citizenship is “accidental”), it would make more sense to refer to them as individuals who:

(1) Lack any “Circumstances of Life” that would justify U.S. taxation and (2) are nevertheless “Taxable By Circumstances OF Birth”.

(The use of the term “Accidental American” distorts the context and true impact of FATCA and citizenship taxation.)

The danger is that …

By focusing primarily on “circumstances of life” at the expense of “circumstances of birth”, the goal is that taxation based on “circumstances of birth” should NOT apply because of the “circumstances of life”. The claim is NOT that taxation based on “circumstances of birth” is necessarily unjustified.

Clearly: If the United States were to cease imposing taxation based on “circumstances of birth” (CBT) and start imposing taxation based on “circumstances of life” (RBT) all the problems would be solved for all people.

To put it another way:

– the use of the term “Accidental American” suggests that a group that should be exempt from US citizenship taxation because of a lack of connection to the United States and is otherwise neutral on the concept of taxation based on “circumstances of birth”; and

– the use of the term “Taxable By Circumstances Of Birth” focuses on the arbitrariness, unfairness and absurdity of imposing US taxation based on the “circumstances of birth” rather than the “circumstances of life”.

“Circumstances of birth” as an immutable characteristic

No person can change where they were born. No person can change who their parent(s) were. Absent “naturalization” the “circumstances of birth” can never be changed and are therefore immutable. Therefore “tax residency” based on “circumstances of birth” is tax residency defined based on an immutable characteristic.

To put it very simply:

U.Ss taxation which is based on the immutable characteristic of “circumstances of birth” is unfair to ALL individuals. It is unfair to those who moved permanently from the United States as children. It is unfair to those who moved from the United States as adults. It is unfair to every individual in the world. It is unfair to countries that who have U.S. citizens as part of their tax base. The unfairness and absurdity is reflected in the fact that:

1. No other country in the world claims tax residency based on “circumstances of birth”. Although Eritrea employs a mild form of “citizenship taxation”, Eritrea does NOT confer citizenship based solely on birth on Eritrean soil.

2. Every other country in the world defines tax residency in terms of “circumstances of life”.

3. Every other country allows an individual to sever tax residency from that country without relinquishing their citizenship.

What needs to happen …

Clearly the only solution that will solve the problems of all people, in all circumstances all the time will be for the U.S. to cease making citizenship (“circumstances of birth”) a sufficient condition for U.S. tax residency. To be clear: the U.S. must sever citizenship from its definition of “tax residency”. Unfortunately every proposal (with the exception of SEAT) is a proposal to either (1) exempt certain groups or individuals from the application of citizenship taxation or (2) to change the rules of “citizenship taxation” to make “citizenship taxation” a kinder more gentler form of taxation.

The simple fact is that nobody but SEAT is advocating for the complete severance of citizenship from tax residency. Other proposals will allow for an improvement of the situation for some people at some times in their lives. But, as long as the United States of America continues to make citizenship a sufficient condition for tax residency, the problems will continue.

Conclusion

U.S. citizenship taxation is based on “circumstances of birth” and not “circumstances of life”. It’s practical impact is that it allows the U.S. to impose taxation on the non-U.S. source income earned by non-US residents who live outside the U.S. The application of U.S. tax rules to them makes it very difficult for them to engage in life, financial and retirement planning.

No person whose life is impacted by taxation based on “circumstances of birth” should be left behind!

John Richardson – Follow me on Twitter @Expatriationlaw