Denunciation of U.S. Citizenship – From the perspective from a U.S. Senator
.@SenGillibrand thinks Americans "Denounce" US citizenship in order to "escape taxes". As JFK once said the great enemy of the truth is NOT the lie but the "myth". #FATCA is #Americansabroad don't "Renounce" bc they want to, but bc they feel they have to! https://t.co/2NbVTUfTbh pic.twitter.com/WWcSXyQHCC
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) November 14, 2023
Renunciation of U.S. Citizenship – From the perspective of a U.S. journalist
.@AnaTeresaSola Please contact me if you are open to discussing your article about cit renunciation. It seems to be based on: 1. Retirees abroad with US income sources 2. Bad info about how tax treaties help US citizens. – Perhaps write a Part 2? https://t.co/l0wg4YAR95
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) November 13, 2023
It’s hard to have a discussion about why Americans abroad are renouncing U.S. citizenship. There are many different perspectives about renunciation. There is very little “shared reality”. Tax academics (who have the resources to know better), “pensioned intellectuals”, politicians and most journalists see this from a “U.S. resident perspective”. They don’t understand the reality of the lives of Americans abroad. But, Americans abroad are NOT a monolith. The ONLY thing they have in common is that they live outside the United States. Their circumstances vary widely. There is little “shared reality” among Americans abroad of what the issues are. AT the risk of oversimplification, I have attempted to divide “Americans abroad” into four categories (as defined below). The categorization will explain why different groups of “Americans abroad” experience the U.S. extra-territorial tax regime differently.
Hint: Americans abroad aren’t renouncing U.S. citizenship because they want to. They are renouncing U.S. citizenship because they feel they have to.
Politicians, tax academics, “pensioned intellectuals” and many journalists deal in the world of opinions. The opinions they hold are often “myths”. They are not “facts”. They are entitled to their opinions (as misguided and ignorant as they may be). They are NOT entitled to their “facts”.
This post is to describe the facts about how the extra-territorial application of the Internal Revenue Code and the Bank Secrecy Act pressure many Americans abroad to renounce U.S. citizenship. Interestingly a large percentage of those renouncing owe ZERO taxes to the U.S. government. They renounce anyway!
First, a bit of background to the problem – what is the problem and who is affected?
They do NOT meet the test of being “nonresident aliens” under the Internal Revenue Code
The people most affected by the U.S. extraterritorial tax system are not a monolithic group. Some left the United States recently, some left years or decades ago. Some left as adults (some young, some middle-aged, and some retirees), while others left as children (with their families), and some have never lived in the United States (they are U.S. citizens by virtue of the U.S. citizenship of at least one parent). Some intend to live in the United States (again) in the near or distant future, while others do not intend to ever live in the United States (again). Some identify as Americans while others do not. Many are also citizens of the country where they live (dual citizens) while others hold triple or even quadruple citizenships. In referring to this group, there is no one term that sufficiently reflects its full diversity. What unites them is that they do not meet the test of “nonresident alien” under the Internal Revenue Code. Depending upon the context, this series of papers will use terms such as “persons,” “individuals,” “affected individuals,” and “overseas Americans.” The latter term has a drawback, however: it emphasizes connections to the United States while minimizing the important connections that such persons have to the countries and communities where they live.
That said, what divides Americans abroad may be greater than what unites Americans abroad!
Like citizens of most other countries, many U.S. citizens who live outside the United States. Their life outside the United States may be temporary, may be permanent or the length may be unknown. Many of those U.S. citizens are working people. Not only do they live in other countries but pay taxes to those other countries. Very often their income and assets are foreign to the United States. Many of them also consider themselves to be permanent residents (and are often citizens) of those other countries and (this is important) engage in their retirement planning according to the laws of those other countries.
The U.S. extra-territorial tax regime impacts Americans abroad most harshly when IN ADDITION TO BEING TAX RESIDENTS OF THE UNITED STATES they are:
– tax residents of other countries; and
– have income and assets that are foreign to the United States.
This often results punitive taxation on non-U.S. income, double taxation and circumstances where the United States taxes income that is not taxed in the country of actual residence.
You see what one country giveth the U.S. usually taketh!!
The Genesis of the problem …
1. There are few countries in the world that impose worldwide taxation on the basis of only citizenship.
2. There are few countries that confer citizenship based on birth in the country.
The United States is the ONLY country that does both!!
Bottom line: The United States claims the right to impose the full force of the Internal Revenue Code (Income Tax, Estate/Gift Tax, Social Security Tax and reporting requirements) on the residents of OTHER countries who happen to be U.S. citizens. (“U.S. citizens include people who were born in the U.S., born outside the U.S. to a U.S. citizen parent(s) or naturalized as U.S. citizens.) To be clear, the United States claims the right to impose taxation on income that is received by people who do NOT live in the United States and is NOT sourced in the United States!!! Think about it. But, it gets worse! The United States also claims the right to force the disclosure massive amounts of information (“information returns“) from people who live in other countries.
These requirements affect different kinds of Americans abroad in different ways.
Considering the U.S. Extra-territorial tax regime from the perspectives of four different groups of people
Before defining the four different groups I acknowledge that there is some overlap among the circumstances of the group. Nevertheless, these four groups are generally descriptive of the circumstances of the majority of U.S. citizens who live outside the United States.
1. Retirees abroad: I am defining “Retirees abroad” as people who worked in the United States, retired and them moved outside the United States. (I am NOT defining “Retirees abroad” as U.S. citizens who moved from the United States, continued to be employed and then retired.) “Retirees abroad” have many different reasons for moving from the United States. What defines them as a group is that their income sources are primarily U.S. based. Although it is possible for them to have non-U.S. income sources it is unlikely.
Retirees abroad do not experience many problems because their income sources are sourced in the United States and their primary tax obligation is to the United States on their U.S. source income. Sure, the other country may tax their U.S. source income, but it will allow a tax credit for taxes paid to the USA. Americans living in Mexico, Spain, Portugal (and other retirement destinations) are often in this category. They are usually ONLY U.S. citizens and therefore couldn’t really renounce U.S. citizenship even if they wanted to.
2. Expats: I am defining “expats” to be U.S. citizens who are living outside the United States (U.K., France, Germany, Japan, etc.) for what they consider to be a finite period of time. Most often their reason for living outside the United States is related to their careers. Most significantly they see themselves as retiring in the United States. Their centre of retirement and financial planning is based in the United States. Although they may have pension plans or other financial products in their country of temporary residence, they see their retirement as being funded primarily by U.S. pensions, financial products, etc.
Although they are temporary tax residents of their country of residence, their primary retirement planning is NOT in accordance with the tax system of their country of temporary residence. They may have cross border tax problems. But, their stay abroad is finite. They usually are ONLY U.S. citizens and therefore couldn’t really renounce U.S. citizenship even if they wanted to.
3. Emigrants: These are Americans who left the United States as adults and live permanently outside the USA. Not only are they tax residents of the other country. But, because they are not returning to the United States their centre of financial gravity/planning is primarily outside the United States. Because they are subject to two tax systems and the majority of their income streams and assets are “foreign” to the United States, they are very very negatively impacted by U.S. citizenship taxation. Unlike “expats” and “retirees abroad” they usually do NOT have U.S. financial/retirement asses. This group will find it very difficult to retain U.S. citizenship. Because they are often citizens of their country of residence, they have the opportunity to renounce (and often feel they must in order to survive).
4. Accidental Americans: This group is composed of people who were either (1) born in the United States and moved from the United States as children or (2) born to a U.S. citizen parent(s) outside the United States. They typically have no connection (residential or financial) to the United States. In many cases they don’t even speak English. Like emigrants, because their income and assets are outside the United States they feel they must renounce U.S. citizenship in order to survive.
I understand that there is overlap among these categories. My purpose is categorizing Americans abroad is only to underscore that U.S. citizenship taxation affects different groups differently. Those with income and assets that are foreign to the United States are impacted most negatively. The United States imposes a distinctly different and more punitive tax regime on the non-U.S. income streams and assets of U.S. citizens living outside the United States.
The problems are magnified when U.S. citizens are tax residents of both the United States and another country and their income streams and assets are primarily foreign to the United States.
“Facts Are Stubborn Things” – Ten categories of facts about the combination of “dual tax residency” coupled with “foreign” income streams and assets …
Part 1 – Addressing the question of double taxation and Americans Abroad – there may or may not be double taxation:
When both countries tax the same income which is sourced outside the USA there may or may not be double taxation:
FEIE (“Foreign Earned Income Exclusion”): Only a narrow source of income is excludable under the Foreign Earned Income Exclusion. Only: 1. Employment income and 2. A portion of self-employment income is excludable. Income that is not excludable is fully taxable by the United States (and in most circumstances the country of residence). When income is taxed by more than one country there is the potential for double taxation.
Note that the following sources of income are NOT excludable under the FEIE: Subpart F, GILTI, Dividends, Interest capital gains, PFIC, Income attributed under the grantor trust rules, phantom capital gains, government benefits of all types (unemployment insurance, welfare benefits, etc. Yes the USA taxes the welfare benefits of Americans abroad).
Some of these income streams (described below) are almost certain to result in double taxation which cannot be offset by the FTC rules.
FTC (Foreign Tax Credits): May or not allow an American abroad to avoid double taxation – examples ….
NIIT – definite double taxation in most countries: This is a straight 3.8% tax on investment income (interest, dividends, capital gains) where the use of FTCs are specifically not allowed under the IRC. Under specific tax treaties with certain countries a foreign tax credit against the NIIT is allowed (France and possibly some other countries). This is pure double taxation.
Subpart F, GILTI, Transition Tax – almost certain double taxation in most countries: Because these are forms of U.S. “deemed income” the US taxes this before a distribution is made in the other country. The timing difference in the receipt of income frequently results in double taxation. (The transition tax confiscated the pensions of many Americans abroad.)
877A Exit Tax – almost certain double taxation and erosion of assets: The U.S. may tax foreign pensions before the pension is paid out in the other country which results in pure double taxation. The rules also require the deemed sale of assets. This can be mitigated by ONLY (as far as I know) the Canada and Australia tax treaties.
Denial of a tax credit because what is a tax in one country is not considered to be an income tax in the USA – the fact that it’s called a tax doesn’t make it a tax: IRS refusal to recognize certain foreign taxes as income taxes: In some cases the IRS has simply refused to allow certain taxes paid in other countries as meeting the definition of income tax to be used as a FTC. A recent example (that was reversed was a French Social tax …)
Part 2 – Perhaps NOT double taxation, but U.S. taxation of things that the country of residence does not tax – MAKING RETIREMENT PLANNING SOMEWHERE BETWEEN DIFFICULT AND IMPOSSIBLE
Countries have different tax system which are designed to facilitate both the countries revenue needs but also facilitating retirement planning. When the U.S. taxes things the other country doesn’t, this creates an additional tax on the U.S. citizens. But, the primary effect of the tax is often to make retirement planning in the country of residence more difficult.
– Noting that the US often imposes taxation on things that other countries do NOT tax and specifically how this leads to problems with retirement planning UK ISA, CDN TFSA, etc. … Problem of sale of principal residence (a principal residence is often a retirement planning vehicle in a certain country)
– certain ACTUAL distributions from corporations may not be subject to taxation in the country of residence but may be subject to U.S. taxation (this is further complicated by the fact that corporations in some countries can be treated as “disregarded entities” and in other countries not).
– certain DEEMED distributions from corporations that are first taxed in the USA and then later when there is an actual distribution in the country of residence (this is often a double taxation problem)
– depending on the treaty in place with the country the growth in foreign pensions while NOT taxable in the country of employment may be taxable by the USA (what if it is considered to be a grantor trust?)
– PFIC incredibly punitive taxation of non-U.S. mutual funds
– phantom capital gains on the sale of a principal residence and a deemed income inclusion on the discharge of a mortgage
Part 3 – Why tax treaties generally do NOT prevent double taxation but actually facilitate double taxation
– the “Saving Clause”: All U.S. tax treaties include a “saving clause” which (1) generally denies treaty benefits to U.S. citizens and (2) allows the U.S. to impose U.S. taxation on the residents of the treaty partner country.
– the double taxation Article: Generally the treaty provides that double taxation is prevented ONLY to the extent that it would result under the application of U.S. domestic law. There are ONLY a small number of treaties (newer tax treaties) that contain specific relief provisions for U.S. citizens who are resident in the Treaty partner country.
Therefore, tax treaties prevent double taxation ONLY to the extent that the U.S. domestic Internal Revenue Code allows it!!
Bottom line: Because of the “saving clause” (which gives the U.S. right to tax U.S. citizens without regard to the treaty) U.S. tax treaties facilitate double taxation which is enforced by FATCA.
Part 4 – U.S. Penalty Laden reporting requirement triggered by Foreign source income and interests
– Form 5471 – $10,000 penalty
– Form 8938 – $10,000 penalty
– Form 3520 and 3520A – Foreign Trusts (whatever “trust” means) – penalty of 1/3 of value
– Form 3520 Receipt of gifts from a foreign person/spouse – penalty 1/3 of value
– Form 8621 – no monetary penalty
– FinCEN 114 FBAR – by far the most confiscatory
Without regard to taxation per se, Americans abroad live life “In The Penalty Box”.
Part 5 – Direct Compliance Costs
– the complexity and cost of tax returns depends on personal circumstances
– every Form is in effect a separate return. A Form 5471 is in effect a separate corporate tax return.
– it is not unusual for Americans abroad to have U.S. tax compliance costs that exceed $1000 per year (and this is low end). I met one American abroad last week who claims to pay $40,000 USD for compliance.
Part 6 – Indirect Compliance Costs – “Married Filing Separately” – do you want your foreign spouse to enter the U.S. tax system? Maybe yes and maybe no, but probably no!
– a U.S. citizen using the “married filing separately” is required to file a tax return with only $5 USD of income
– the requirement to file a tax return will necessitate filing a Form 8938 which requires disclosure of joint accounts held with the nonresident alien spouse (providing more incentive to keep the accounts separate!!)
– MFS means that the reporting thresholds for Form 8938 are lower
– MFS means the person enters the higher U.S. tax brackets at lower levels of income
Bottom line: It is usual for resident Americans to file jointly. It is usual for a U.S. citizen abroad to use the married filing separately category which is actually a hidden tax on being married to a non-U.S. citizen.
Part 7 – Property transfers to or from a noncitizen spouse
Note separately that when it comes to gifts between a U.S. citizen and a nonresident alien spouse:
1. Gifts RECEIVED from a spouse who is neither a U.S. citizen nor U.S. resident are subject to reporting if they exceed $100,000 (and subject to high penalties if not reported)
2. Gifts MADE to a spouse who is NOT a U.S. citizen have an annual limit and beyond that limit (approx $170,000 USD) are required to be reported on a gift tax return
Part 8 – Career and Social Costs
– a U.S. citizen in a family imposes costs (both actual and opportunity) on the family unit
– U.S. citizens are frequently not included on joint accounts in marriages and denied formal ownership in the family home
– U.S. citizens may be barred from employment because of FBAR requirements
– U.S. citizens may be denied bank and financial account access because of FATCA
– In certain cases U.S. citizens are asked to renounce U.S. citizenship prior to marriage
– U.S. taxation makes a divorce between a U.S. citizen and a non-citizen far more expensive.
Part 9 – The ball and chain of having to live life tied to the U.S. dollar and fluctuating exchange rates
– Americans abroad are “prisoners” of the U.S. dollar. Their tax, information return and FBAR reporting are required to be in the U.S. dollar
– All tax or reporting relevant transactions must be converted to the USD at different exchange rates (depending on the date) and type of reporting
Examples of different relevant dates for exchange rate purposes:
… FBAR and Form 8938 are the last day of the calendar year using the U.S. Treasury prescribed rate on that date (Some people don’t even know whether they are required to file these formscuntil into the subsequent year.)
… Employment income average exchange rate of year
… Purchase and sale of house or discharge of mortgage (actual date of transaction)
– the requirement to use the USD creates gains/losses from a US perspective that are not gains/losses from the perspective of the country of actual residence
Resident Americans will never know what it’s like to live life as a prisoner of a foreign currency!
Part 10 – The “fear” of penalty and uncertainty of filing properly and not understanding the requirements
A recent comment (adapted a little bit) from a U.S. citizen living outside the United States in discussing these issues:
“One of the ladies at the meeting was so scared and frustrated that she felt she had to go and renounce her U.S. citizenship. She was incredibly tormented and saw no way out. I don’t think you (meaning me) understand now bad the psychological impact and fear really is. Please try to understand how we all feel!”
This (as Keith Redmond says) is for many, “the reality on the ground”.
Conclusion, so Why do U.S. citizens renounce U.S. citizenship?
It’s NOT because of the SEAT survey!! (People were renouncing way before the survey was published)!
In fact renunciations have been increasing since the advent of FATCA in 2010.
Some renounce U.S. citizenship because of double taxation as described in Part 1.
Most renounce U.S. citizenship because of the factors described in Parts 2 – Part 10.
It’s not the taxation that causes the renunciation. It’s the life restrictions that the tax code imposes on Americans abroad.
Renunciation is a difficult decision. It can be very financially costly. The financial costs include a $2350 renunciation fee and a possible Exit Tax.
The bottom line is that:
People are NOT renouncing because they want to. They are renouncing because they feel they have to in order to live a normal “form free” life, where they don’t have live in fear of noncompliance with the laws of a country they don’t live in!
Facts are stubborn things!!
Unfortunately for U.S. citizens living permanently outside the United States:
“All Roads Lead To Renunciation!!”