— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) May 12, 2015
Part 1 – The Evolution of Taxation
As goes taxation, so goes society
As Charles Adams argued in his classic book, “For Good and Evil: The Impact of Taxes On The Course Of Civilization“, as go the taxing practices of a nation, so goes the nation. Given that taxes are a certainty, tax laws are a certainty, and those laws speak volumes about the “state of the nation” and the “values of the nation”. Tax laws evolve on an almost daily basis. The changes in tax laws reflect changes in societal values.
In 1924, the Supreme Court of the United States, per Justice McKenna ruled in Cook v. Tait that U.S. “citizenship taxation” was constitutional. Since that time Cook v. Tait has been cited to justify the constitutionality, although not necessarily the propriety, of “citizenship taxation”. Note that “citizenship taxation” contains both the words “citizenship” and “taxation”. As a result, Justice McKenna’s decision along with the relevant statutes, may tell us a great deal about what “taxation” and “citizenship” meant in 1924.
This is Part 1 of a two part series. Part 1 will focus on the evolution of taxation. Part 2 will focus on the evolution of citizenship.
Cook v. Tait – Justice McKenna’s decision
Cook v. Tait was argued on April 15, 1924 and decided on May 5, 1924 (those were the days). The taxpayer plaintiff “Cook” was described by Justice McKenna as:
a native citizen of the United States, and was such when he took up his residence and became domiciled in the city of Mexico.
Note that there is no evidence that Cook had become a naturalized citizen of Mexico or that he had taken an oath of allegiance to Mexico. (The relevance of this will be clear later.)
In holding that Cook was a taxable U.S. citizen, Justice McKenna ruled:
The contention was rejected that a citizen’s property without the limits of the United States derives no benefit from the United States. The contention, it was said, came from the confusion of thought in ‘mistaking the scope and extent of the sovereign power of the United States as a nation and its relations to its citizens and their relation to it.’ And that power in its scope and extent, it was decided, is based on the presumption that government by its very nature benefits the citizen and his property wherever found, and that opposition to it holds on to citizenship while it ‘belittles and destroys its advantages and blessings by denying the possession by government of an essential power required to make citizenship completely beneficial.’ In other words, the principle was declared that the government, by its very nature, benefits the citizen and his property wherever found, and therefore has the power to make the benefit complete. Or, to express it another way, the basis of the power to tax was not and cannot be made dependent upon the situs of the property in all cases, it being in or out of the United States, nor was not and cannot be made dependent upon the domicile of the citizen, that being in or out of the United States, but upon his relation as citizen to the United States and the relation of the latter to him as citizen. The consequence of the relations is that the native citizen who is taxed may have domicile, and the property from which his income is derived may have situs, in a foreign country and the tax be legal—the government having power to impose the tax.
I have bolded the parts that I think are most important.
Cook v. Tait is now almost 100 years old. The case was decided in the context of the world as it was in 1924. The world has changed and changed a great deal. The concepts of both “taxation” and “citizenship” have evolved.
The purpose of this post is to explore:
1. How “taxation” has evolved since 1924.
2. How “citizenship” has evolved since 1924.
3. How the changes in each of “taxation” and “citizenship” would and should lead to a different result in 2015.
1. How “taxation” has evolved since the Revenue Act of 1921
Cook v. Tait was decided under the Revenue Act of 1921. Taxation was much simpler in the 1920s.
See the Revenue Act of 1921 and read it here.
For those who want a PDF version for your library of “Great Books”:
The 2021 U.S. tax return (which specifically referenced citizenship taxation) was much simpler:
Highlights of the Revenue Act of 1921 include:
– first and foremost, it is only 238 pages in total with the Act itself composed of 205 pages (Could it be read in a morning?)
– it is divided into 14 Titles
– “Income Tax” is in Title 2
– Title II is only 87 pages
– Title XIII contains the “General Administrative Provisions” which are only 24 pages and include: a requirement of compliance with “regulations in S. 1300, Penalty provisions (there is mention of a $10,000 penalty even then), the creation of a “Tax Simplification Board” in S. 1357 and more.
– Title XIV contains the “General Provisions” which seem to be only two pages. The “General Provisions” include
– There is an Appendix on page 203 describing individual tax rates are found here.
Title II deals with the “Taxation of Individuals” S. 210 specifically reads:
‘That, in lieu of the tax imposed by section 210 of the Revenue Act of 1918, there shall be levied, collected, and paid for each taxable year upon the net income of every individual a normal tax of 8 per centum of the amount of the net income in excess of the credits provided in section 216: Provided, that in the case of a citizen or resident of the United States the rate upon the first $4,000 of such excess amount shall be 4 per centum.’
Note that $4000 was an enormous amount of money in 1924. This means that most people did NOT pay Federal Income Tax anyway. (Of course today many don’t pay Federal Income Tax either.)
S. 210 of the Revenue Act does not specifically say that a citizen abroad is subject to taxation. Therefore, we look to the relevant regulation which Regulation 62 from the IRS Commissioner” rel=”noopener” target=”_blank”>is
Regulation 62 from the IRS Commissioner which provides in part:
3: ‘Citizens of the United States except those entitled to the benefits of section 262, * * * wherever resident, are liable to the tax. It makes no difference that they may own no assets within the United States and may receive no income from sources within the United States. Every resident alien individual is liable to the tax, even though his income is wholly from sources outside the United States. Every nonresident alien individual is liable to the tax on his income from sources within the United States.’
Clearly U.S. citizens were taxable under the Revenue Act of 1921. But, (some things never change), the question was:
what is a citizen?
Article 4 or Regulation 262 comes to the rescue.
4. A citizen is defined as follows: “An individual born in the United States subject to its jurisdiction, of either citizen or alien parents, who has long since moved to a different country and established a domicile there, but who has neither been naturalized in or taken an oath of allegiance to that or any other foreign country, is still a citizen of the United States.”
This appears to mean that if Cook HAD become a naturalized citizen of Mexico OR taken an oath of allegiance to Mexico, that he would NOT have considered to be a “citizen”. Fascinating. More on this later.
Academic reaction to the decision in Cook v. Tait
I discovered a law review article, published in 1925 by Washington and Lee law Professor Albert Levitt. In an extensive and excellent scholarly article Professor Levitt concluded that:
The decisions of the United States Supreme Court is fully supported by reason and authority. The writer is glad that this is so. There was, and is, entirely too strong a tendency on behalf of selfish citizens of the United States to call loudly for their rights to protection when abroad and at the same time to seek by legal and illegal means to evade their responsibilities and duties as citizens. A citizen who demands protection from his government should be compelled to pay for the maintenance of that protection.
Albert Levitt – Washington and Lee Law School – June 1925
(Sound familiar? Some things never change.)
What is NOT in the Revenue Act of 1921
It’s clear that taxation was much simpler in 1924. It’s also clear that it was about taxation and NOT about the gathering of information. I see no section of the 1921 Revenue Act that mandates the collection of information under threat of penalties. To be clear Cook v. Tait was decided in a context where the Revenue Act was much simpler and NOT about “Information Returns”.
Significantly, many of the provisions which have been so destructive to U.S. citizens abroad were enacted later.
The metamorphosis of the Revenue Act of 1921 to the modern day (now archaic and antiquated) Internal Revenue Code of the United States
I will highlight a small number of very significant changes. I suspect that Charles Adams would view these changes as significant events in the history of the United States. After all, when it comes to history:
As goes the taxation of the nation, so goes the history of the nation.
The 1962 CFC (Controlled FOREIGN Corporation) Rules
At the risk of oversimplification, the Controlled Corporation Rules:
– imposed massive and expensive reporting requirements on any U.S. citizen who had any connection to a non-U.S. corporation
– created a new class of “Deemed Income” (Subpart F) which forced the inclusion of income earned at the corporate level in the incomes of U.S. citizen shareholders. These rules exist today and are the reason why Canadians who are also U.S. citizens should NOT carry on business through a Canadian Controlled Private Corporation
– are designed (this is what Subpart F is about) to punish “TAX DEFERRAL”.
Sir John Templeton, the famous international investor (Templeton Growth Fund) renounced his U.S. citizenship in 1964. I suspect (but don’t know) that his renunciation of U.S. citizenship was a direct result of the CFC rules.
Relevant Penalty Laden Form: 5471 (American’s deadliest form)
The 1970 FBAR (“FOREIGN Bank Account Report”) Rules – Title 31 – Bank Secrecy Act
When these rules were enacted, nobody imagined that 39 years later, IRS Commissioner Shulman would discover these rules and impose them on U.S. citizens abroad. Commissioner Shulman will be remembered as the creator of “The FBAR Fundraiser”.
The PFIC Rules of 1986 – (“Passive FOREIGN Investment Companies”)
Everybody has heard of PFICs. Few people understand PFICs. A large segment of The tax community takes the position that Canadian mutual funds are PFICs and are therefore subject to incredibly punitive taxation and reporting requirements.
The PFIC rules are designed in large part to punish investment vehicles that allow for “TAX DEFERRAL”.
Relevant Form: 8621
The “FOREIGN Trust” Rules of 1976 – Internal Revenue Code S. 679 (as changed in 1996)
These are the rules that are the authority for Forms 3520 and 3520A. They are also the rules that are understood (correctly or incorrectly) to deem many non-U.S. pension plans to be “Foreign Trusts”. Think in Canadian RESP, RDSP, etc.
Relevant Penalty Laden Forms: 3520 and 3520A
FATCA 2010 – (“FOREIGN Account Tax Compliance Act”)
FATCA is the vehicle to enforce “citizenship taxation”. Whether by accident or design FATCA is a factor in the increasingly large number of U.S. citizens abroad renouncing U.S. citizenship. The key point is that U.S. citizens feel FORCED (and I agree with them) to renounce U.S. citizenship.
Relevant penalty laden form: 8938
It’s about the punishment of things “FOREIGN” and that involve “TAX DEFERRAL”
Since Cook v. Tait, U.S. tax laws have evolved in a way that have imposed both punitive taxation and reporting requirements on both things that are foreign FOREIGN things that have the potential to create “TAX DEFERRAL”.
The lives of U.S. citizens abroad are “FOREIGN”.
The retirement plans of U.S. citizens abroad are based on “TAX DEFERRAL”.
Conclusion – Evolution of taxation
The whole concept of taxation has changed since 1921. Since 1921, the tax laws of the United States have evolved to the point that what used to be the “reality of citizenship taxation” has become (for Americans abroad) the “prison of citizenship taxation“.
This concludes Part 1. Time to read Part 2 which is about “the evolution of U.S. citizenship“.