Introduction
Americans Abroad are crumbling under the weight of the application of US citizenship taxation to their “every day lives”. Pursuant to America’s “citizenship taxation regime”, the United States is actually imposing a more punitive and more penalty laden reporting regime on US citizens who do NOT live in the United States than on those who do live in the USA.
Think of it:
For every other country in the world, if one ceases to be a resident of the country and establishes residence in another country, one ceases to be taxed by the first country. US citizens who move from the United States: (1) not only continue to be subject to US taxation, but (2) are “subject(s)” to a more punitive taxation than if they remained in the United States!
In 2010 President Obama signed FATCA into law. The effect of FATCA was to (1) institute a “world wide search” for US citizens living outside the United States and (2) to create significant public awareness of US citizenship taxation. I have previously argued that the effect of FATCA was to expand the US tax base into other countries.
FATCA applies to Americans abroad because and only because of US citizenship taxation (the rule that says that Americans abroad are treated as US tax residents even if they don’t live in the United States). Because FATCA created awareness of US citizenship taxation many people have trouble understanding the difference between US citizenship taxation and FATCA. It is understandable that many believe that FATCA and citizenship taxation are the same.
How to understand how/why citizenship taxation is different from FATCA:
1. US citizenship taxation is the rule that says that all US citizens regardless of where they live are subject to all the provisions of the US Internal Revenue Code. These provisions include taxation, reporting penalties and of course full US taxation on all income earned earned while they are living outside the United States. Many US residents do NOT end up actually owing any US tax. Similarly, many US citizens living outside the United States do NOT end up owing any US tax.
2. FATCA is part of the Internal Revenue Code. Because the Internal Revenue Code applies to all US citizens, FATCA (as part of the Internal Revenue Code) applies to all US citizens (including US citizens living outside the United States). Generally FATCA is a provision to require non-US financial institutions to identify their US citizen customers and report their identity to the Internal Revenue Service. FATCA also imposes additional “reporting requirements” on US citizens (including those who live outside the United States) who have non-US bank and financial accounts.
Ending FATCA Would NOT End Citizenship Taxation, But Ending Citizenship Taxation Would – Under The Internal Revenue Code – Likely End The Application Of FATCA To Americans Abroad
The US Internal Revenue Code applies to ALL “individuals”. Because US citizens are “individuals”, the Internal Revenue Code applies to US citizens wherever they live. FATCA is just one part of the Internal Revenue Code. Even if FATCA were repealed the Internal Revenue Code would continue to apply to all US citizens AND its discriminatory impact on Americans abroad would continue.
But, if the United States ended citizenship taxation by severing citizenship from US tax residency (people can no longer be taxed by the United States just because they are a US citizen) the application of FATCA to US citizens abroad would (under the Internal Revenue Code) likely end.
Here is why – some technical “mumbo jumbo” for those interested
1. The Existing Statute Which Under The Citizenship Tax Regime: IRC 1471 (the operative FATCA section) refers to IRC 1473 for the definition of “Specified United States Person” which is defined partly in terms of “United States Person”. The point is that by ceasing to be a “United States Person”, one ceases to be a “Specified United States Person” for FATCA purposes.
The sequence of reasoning under the existing Internal Revenue Code is:
1. If “United States Account” then FFI has FATCA reporting obligations (1471(b)).
2. If account held by “specified United States Person” then “United States Account” (1471(d)(1)
3. If individual “United States Person” then “specified United States Person” (1473(3)).
4. If US citizen or resident then “United States Person” (7701(a)(30)).
The key point is that if an individual is a “US Citizen” (or resident) the FFI must treat the account as a “United States Account”. A “United States Account” exists if and only if there is a US citizen or US resident which triggers the sequence of 1. Becoming a “US Person” and 2. Then becoming a “Specified United States Person” 3.Then becoming a “United States Account” and 4. As a “United States Account” subjecting the FFI to reporting obligations.
The statute is written so that “United States Accounts” that are reportable. By changing the definition of “US Person” one changes whether an account is a “United States Account”. If Congress were to amend the definition of “United States Person” to include “All Blue Eyed Individuals” then accounts held by “Blue Eyed Individuals” would become United States accounts and therefore subject to FATCA reporting.
Bottom line: The disclosure obligations of FFIs applies to “United States Accounts”. Accounts held by “United States Persons” are “United States Accounts”. But any change in the definition of “United States Person” will change the characteristics/definitions of “United States Accounts”. Congress controls the meaning of “United States Account” by controlling the definition of “United States Person”.
2. A Proposed Statute Pursuant To Which The US Transitions To Residence-based Taxation: As part of ending citizenship taxation IRC 7701(a)(30) would be amended to exclude “citizen” from the definition of “United States Person”:
(30)United States person
The term “United States person” means—
(A)a citizen or resident of the United States,
(B)a domestic partnership,
(C)a domestic corporation,
(D)any estate (other than a foreign estate, within the meaning of paragraph (31)), and
(E)any trust if—
(i)a court within the United States is able to exercise primary supervision over the administration of the trust, and
(ii)one or more United States persons have the authority to control all substantial decisions of the trust.
By changing the definition of “United States Persons” to be “residents” the FATCA obligations imposed on FFIs would be determined under the following sequence of reasoning:
1. If “United States Account” then FFI has FATCA reporting obligations (1471(b)).
2. If account held by “specified United States Person” then “United States Account” (1471(d)(1)
3. If individual “United States Person” then “specified United States Person” (1473(3)).
4. If US resident then “United States Person” (7701(a)(30)).
A change to the definition of “United States Person” which defines a “United States Person” as a “resident” would mean that FFIs would no longer be required to disclose accounts held by US citizens but only by US residents.
Conclusion
Ending “citizenship taxation” AKA “severing US citizenship from US tax residency” should solve the FATCA problem for Americans abroad. That said, ending FATCA for Americans abroad would leave the citizenship taxation problem intact!
Ending FATCA would solve “A problem” for Americans abroad. Ending “citizenship taxation” would solve “THE problem” for Americans abroad! At, least under the Internal Revenue Code.
In Part 2, I will explore why ending citizenship taxation under the Internal Revenue Code would NOT solve the FATCA problem for Americans abroad under the FATCA IGAs!
John Richardson – Follow me on Twitter @Expatriationlaw
Appendix – How Severing Citizenship From Tax Residency Would Impact The FATCA IGAs
The definitions section of the Canada US FATCA IGA (see page 7) includes:
ee) The term “U.S. Person” means
(1) a U.S. citizen or resident individual,
(2) a partnership or corporation organized in the United States or under the laws of the United States or any State thereof,
(3) a trust if
(A) a court within the United States would have authority under applicable law to render orders or judgments concerning
substantially all issues regarding administration of the trust, and
(B) one or more U.S. persons have the authority to control all substantial decisions of the trust, or
(4) an estate of a decedent that is a citizen or resident of the United States.
This subparagraph 1(ee) shall be interpreted in accordance with the U.S. Internal Revenue Code.
For the full text of the US Canada FATCA IGA see:
FATCA-eng
Assuming citizenship were severed from US tax residency, either:
1. The definition of “U.S. Person” would require amendment to exclude “U.S. citizen” in (1); and/or
2. The FATCA IGA would simply be interpreted to exclude “U.S. citizen” from the definition of U.S. tax residency.
In other words, the IGAs might require amendment to ensure that its provisions are not triggered by and only by a finding of U.S. citizenship.
