Guest Post By Dr. Suzanne de Treville – Switzerland
Discussions about eliminating double taxation for U.S. citizens abroad often focus on reducing the significant compliance burdens these individuals face. When the U.S. taxes income or assets already taxed in a citizen’s country of residence, the resulting complexity is substantial while the extra tax revenue to the IRS that results from this double taxation by ordinary taxpayers is quite low. This complexity is particularly burdensome for the 80% of expat taxpayers with an Adjusted Gross Income of $100,000 or less.
The IRS requires expatriates to file intricate returns and is responsible for providing necessary assistance. However, while resources are available to domestic taxpayers, similar support is lacking for those abroad, despite their greater need.
Case Study: Gabriel Morrow
Gabriel Morrow relocated from the U.S. to Canada in 2020. After filing his 2020 U.S. tax return in 2021, he expected a $1,800 refund that never arrived. The IRS had flagged his 2020 return for potential fraud, causing subsequent returns to be similarly tagged. After numerous calls, he resolved the fraud issue by early 2024 but still hadn’t received his refund. The National Taxpayer Advocate’s office, which handles expatriate cases through its Puerto Rico office, faced significant backlogs so did not respond to his request for help. Hiring legal assistance would have cost more than the refund itself, leaving Mr. Morrow with limited options.
As a last resort, he sought help from a Low-Income Taxpayer Clinic in Washington State. The clinic was willing to help him even though he didn’t meet the income criteria. After a student lawyer spent several hours troubleshooting and interacting with the IRS on his behalf, he finally received his refund. This outcome highlights the lack of IRS support for U.S. citizens abroad in resolving basic tax issues. Note that the clinic was able to help him because his issue concerned a domestic problem: Had his issue stemmed from one of the multitude of complex issues that only affect expats, the clinic would not have had the required expertise to help.
Challenges Specific to Expats: The Case of Investing for Retirement
U.S. citizens abroad often face difficulties when investing for retirement. U.S. investment opportunities are limited, and investing locally in the country of residence makes more sense for their circumstances. Mutual funds are generally recommended as a good way for investors of modest means to appropriately select a level of risk. Suppose that a U.S. citizen who resides outside the U.S. purchases four non-U.S. mutual funds totaling $5,000 through a local bank. They report the income on Schedule B and list the funds on the FBAR, but later learn (typically through social media) that non-U.S. mutual funds might be considered Passive Foreign Investment Companies (PFICs) for tax reporting.*
The IRS doesn’t explicitly state whether non-U.S. mutual funds are PFICs. Form 8621, used to report PFICs, is complex, with the IRS estimating:
Learning about the form: 11 hours, 24 minutes
Completing the form: 20 hours, 34 minutes
Recordkeeping: 16 hours, 58 minutes
This totals approximately 49 hours to complete the first form, with over 20 hours required for each form. For our hypothetical individual, the filing burden for this single form (with essentially no tax revenue arising) is over 100 hours. Consequently, many individuals must hire tax professionals, costing between $1,000 to $3,000, to report a $5,000 investment.
In 2024, the IRS received 1,150 comment letters during a call for comments on Form 8621, indicating widespread concern among expatriates. Organizations like SEAT, Democrats Abroad, and ACA highlighted that PFIC rules, intended to prevent tax deferral through foreign funds, inadvertently penalize ordinary taxpayers abroad. The IRS acknowledged the burden but indicated that, in its view, simplifying tax returns for expatriates requires legislative action by Congress.
Challenges Arising from Non-U.S. assets: The Case of Form 3520
U.S. citizens abroad also face challenges with Form 3520, used to report transactions with foreign trusts and receipt of certain foreign gifts. One taxpayer with a foreign pension learned that the pension might possibly require Form 3520. To ensure compliance, the taxpayer filed the form late under the streamlined filing procedure. The IRS rejected the streamlined filing procedure because no additional revenue was declared, and automatically imposed a penalty equivalent to a year’s income for the taxpayer. Appealing was too difficult and costly from abroad because of the lack of IRS support for expats. To make matters even more unfair, it later emerged that the pension didn’t require Form 3520 filing. Appropriate IRS support would begin with the ability to contact the IRS and ask for guidance about reporting obligations, and would also include making it possible for ordinary taxpayers to present reasonable-cause arguments rather than limiting that possibility to those who are able to afford to hire international lawyers to help them get fair treatment.
Lack of IRS Support
The IRS’s limited assistance for expatriates in basic tax filing, understanding tax treaties, accessing online accounts, resolving issues like lost returns, and helping U.S. citizens living abroad to avoid and correct misunderstandings so as to avoid huge penalties is a significant concern. What if we could establish an IRS International Taxpayer Service Center where IRS employees would be available by video call to provide this assistance? While this would be a huge benefit to expats, our estimates suggest that providing adequate support could cost over $350 million, nearly half of the total tax liability for expatriates with an Adjusted Gross Income (AGI) of $100,000 or less. In other words, the cost of doing what it takes to make it possible for an expat to complete their tax return would devour half of the tax revenues for the 80% of expats with an AGI of less than $100,000.
Conclusion
Simplifying the tax filing process for U.S. citizens abroad is crucial. The promise by President Trump to eliminate double taxation gives hope that these challenges can be resolved. Until then, expatriates from around the world must join forces to advocate for the necessary support to ensure fair and manageable tax compliance.
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* Although the question of whether a non-U.S. mutual fund might need to be reported as a PFIC has been on the table for well over a decade, it was only at the end of 2024 that the IRS added a mention of this possibility—without providing guidance as to what non-U.S. mutual funds might be involved—in Publication 54, which is the comprehensive resource to advise U.S. citizens residing outside the U.S. on what is required to file their tax return from abroad.This change was made based on a request to the IRS by Democrats Abroad seeking to reduce the number of expats that accidentally invest in non-U.S. mutual funds because of lack of warning.
Dr. Suzanne de Treville
Professor (emeritus) of Operations Management, University of Lausanne
Here is a pdf of Dr. de Treville’s article: