This is the fifth of a series of posts focussing on the need to end US citizenship-based taxation (practised only by the USA) and move to a form of pure residence-based taxation (practised by the rest of the world). The first post was titled “Toward A Definition Of Residence-based Taxation For Americans Abroad“. The second post was titled “Toward A Movement For Residence-based Taxation For Americans Abroad“. The third post was “Toward An Explanation For Why Some Americans Abroad Are Complacent About Citizenship Taxation“. The fourth post explains why some Americans Abroad actually OPPOSE changes to citizenship-based taxation. This fifth post in the series is to begin a discussion of what would be the basic changes (to the existing Internal Revenue Code) that would move the United States toward the world standard of pure residency-based taxation.
It’s about “pure residency-based taxation” and not citizenship-based taxation with a “carve out”
I have previously advocated that the United States should move to to a system of pure residence-based taxation. A system of pure residency-based taxation, means that:
Citizenship is NOT a sufficient condition for tax residency. If citizenship is not a sufficient condition for tax residency, income sourced outside the United States, which is received by people who are not residents of the United States, should not be taxable by the United States.
Note that pure residency-based taxation is NOT citizenship-based taxation with a “carve out” for US citizens living abroad. To put it another way: US citizens, simply because they are US citizens, would NOT be defined as US tax residents and subject to US worldwide taxation. This is different from US citizens being defined as US tax residents, but allowing (like the FEIE) for their foreign income to be excluded from US taxation. Note also that this is a legislative proposal. It is therefore different from our earlier proposal for “A Regulatory Fix To Citizenship Taxation“.
It is my opinion and the opinion of the members of SEAT, that only a system of pure residency-based taxation will solve the many problems of Americans abroad!
How is residency to be determined?
Residency is commonly determined in various ways. For example, Canada determines residency based on an objective deeming provision (number of days spent in Canada and through a “facts and circumstances” test described as ordinary residence). Generally, citizenship (if it is a factor at all) is not a significant issue in determining ordinary residence. The Canadian experience is proof that it is possible to have very sticky tax residency without citizenship being an issue.
Purpose of this post:
The purpose of this post is to propose some simple amendments to the Internal Revenue Code which would provide a foundation for the United States to transition from citizenship-based taxation to pure residence-based taxation. The goal is modest. The post is not intended to (I will write a separate post) deal with those who are CURRENTLY US citizens living outside the United States. It is NOT to address all the issues. That said, most of the Internal Revenue Code focuses on the taxation of those who are US tax residents. Little in the Code focuses on the actual definition of US tax residency.
The purpose of this post is begin with the fundamentals and ask:
How could the existing Internal Revenue Code be modified to provide a framework for residency-based taxation? Of course, readers will be left with many questions. But, the proposed foundation would allow for:
1. US citizens to move from the United States and sever tax residency with the United States.
2. US citizens to move from the United States and continue to be treated as tax residents of the United States.
Under either scenario, US citizens would remain US citizens. They would NOT be required to relinquish US citizenship in order to sever tax residency.
Obviously there will be many complications. But, every journey begins with a modest beginning. This is intended to be only a modest beginning. It is to begin digging the foundation to build the house of “residency-based taxation”.
The post is composed of the following parts:
Part A – Residents Are Subject To Worldwide Taxation
Part B – Nonresidents Are Not Subject To Worldwide Taxation
Part C – Definition Of Resident and Nonresident- 7701(b)
Part D – Definitions That Require Change “US Person”, “Relinquishment Of Residency”, etc.
Part E – Relinquishment Of Residence
Part F – Living abroad without relinquishing US residence
Generally, I believe that amendments to a small number of sections of the Internal Revenue Code provide the foundation from which to grow. Note that this proposal solves the problems of the “Retirees Abroad” (they don’t give notice under the new 877(a)(g)) and the problems of accidentals (they were never tax residents in the first place). There would be regulations (like the Canada Revenue Agency folio) for what constitutes residence. In Canada tax residency is defined largely by “ordinary residence” – a concept that is very sticky).
I am identifying the building blocks that could define tax residency under a US system of residency-based taxation, with few modifications to the Internal Revenue Code. (These building blocks are generally compatible with the existing Internal Revenue Code.) Once the foundation has been built we would then build our way out. This initial foundation solves the PFIC problem, the CFC problems and most problems related to foreign source income. The FinCEN 114 (FBAR) rules currently reference Internal Revenue Code 7701(b). Therefore, the proposals in this post would solve the FBAR problem.
I will discuss other issues impacting Americans abroad in subsequent posts.
I have included only the sections of the Internal Revenue Code that I consider the foundation of US tax residency. When a word is IN CAPS that means that there has been a change to facilitate a change to pure residence-based taxation.