Category Archives: Americans abroad

Part 45 – “Some” examples where the U.S. creates unrealized “foreign income” before a realization event in the source country

Let There Be Income And There Was Income!

The United States has an increasing propensity to create “deemed income” in circumstances where the taxpayer has received no income to pay the tax.

In some cases the “deemed income” created is “foreign source” income. In other cases it is purely domestic source.

When the “deemed income” is “foreign source” income over which the other country has primary taxing rights, the “deemed income” event creates a U.S. tax owing before an actual realization event in the foreign country.

The implications are experienced by both the country of source and the individual taxpayer.

1. Impact on country of source: The U.S. collecting tax owing before the source country has the opportunity to tax it

2. Impact on individual taxpayer: The U.S. creating a deemed realization event resulting in real taxation means that the taxpayer is more likely to experience double taxation. The taxpayer will first pay the U.S. tax and then (when an actual realization event takes place) pay the tax in the country of source.

“Some” examples of “deemed realization” of foreign source income

Note that each of these examples in found in Subtitle A of the Internal Revenue Code (income tax)

877A Exit Tax,

951 Subpart F

965 Transition Tax,

951A GILTI

1291 PFIC

988 Phantom Capital Gains

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Interested in Moore (pun intended) about the § 965 transition tax?

Read “The Little Red Transition Tax Book“.

John Richardson – Follow me on Twitter @Expatriationlaw

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U.S. Canada Tax Treaty – 1980

7. Where at any time an individual is treated for the purposes of taxation by a Contracting State as
having alienated a property and is taxed in that State by reason thereof and the domestic law of the
other Contracting State at such time defers (but does not forgive) taxation, that individual may elect in
his annual return of income for the year of such alienation to be liable to tax in the other Contracting
State in that year as if he had, immediately before that time, sold and repurchased such property for an
amount equal to its fair market value at that time

https://www.irs.gov/pub/irs-trty/canada.pdf

Paragraph 7 provides a rule to coordinate U.S. and Canadian taxation of gains in circumstances where an individual is subject to tax in both Contracting States and one Contracting State deems a taxable alienation of property by such person to have occurred, while the other Contracting State at that time does not find a realization or recognition of income and thus defers, but does not forgive taxation. In such a case the individual may elect in his annual return of income for the year of such alienation to be liable to tax in the latter Contracting State as if he had sold and repurchased the property for an amount equal to its fair market value at a time immediately prior to the deemed alienation. The provision would, for example, apply in the case of a gift by a U.S. citizen or a U.S. resident individual which Canada deems to be an income producing event for its tax purposes but with respect to which the United States defers taxation while assigning the donor’s basis to the donee. The provision would also apply in the case of a U.S. citizen who, for Canadian tax purposes, is deemed to recognize income upon his departure from Canada, but not to a Canadian resident (not a U.S. citizen) who is deemed to recognize such income. The rule does not apply in the case death, although Canada also deems that to be a taxable event, because the United States in effect forgives income taxation of economic gains at death. If in one Contracting State there are losses and gains from deemed alienations of different properties, then paragraph 7 must be applied consistently in the other Contracting State within the taxable period with respect to all such properties. Paragraph 7 only applies, however, if the deemed alienations of the properties result in a net gain.

https://www.irs.gov/pub/irs-trty/canatech.pdf

Protocol to Canada/U.S. Tax Treaty 2007 – Article VIII – Replacing Article XIII Paragraph 7 in the 1980 Treaty

3. Paragraph 7 of Article XIII (Gains) of the Convention shall be deleted and replaced by the following:

7. Where at any time an individual is treated for the purposes of taxation by a Contracting State as having alienated a property and is taxed in that State by reason thereof, the individual may elect to be treated for the purposes of taxation in the other Contracting State, in the year that includes that time and all subsequent years, as if the individual had, immediately before that time, sold and repurchased the property for an amount equal to its fair market value at that time.

https://home.treasury.gov/system/files/131/Treaty-Canada-Pr2-9-21-2007.pdf

Technical explanation of the 2007 Protocol

Paragraph 3

Paragraph 3 of Article 8 of the Protocol replaces paragraph 7 of Article XIII.

The purpose of paragraph 7, in both its former and revised form, is to provide a rule to coordinate U.S. and Canadian taxation of gains in the case of a timing mismatch.

Such a mismatch may occur, for example, where a Canadian resident is deemed, for Canadian tax purposes, to recognize capital gain upon emigrating from Canada to the United States, or in the case of a gift that Canada deems to be an income producing event for its tax purposes but with respect to which the United States defers taxation while assigning the donor’s basis to the donee. The former paragraph 7 resolved the timing mismatch of taxable events by allowing the individual to elect to be liable to tax in the deferring Contracting State as if he had sold and repurchased the property for an amount equal to its fair market value at a time immediately prior to the deemed alienation.

The election under former paragraph 7 was not available to certain non-U.S. citizens subject to tax in Canada by virtue of a deemed alienation because such individuals could not elect to be liable to tax in the United States. To address this problem, the Protocol replaces the election provided in former paragraph 7, with an
election by the taxpayer to be treated by a Contracting State as having sold and repurchased the property for its fair market value immediately before the taxable event in the other Contracting State. The election in new paragraph 7 therefore will be available to any individual who emigrates from Canada to the United States, without regard to whether the person is a U.S. citizen immediately before ceasing to be a resident of Canada. If the individual is not subject to U.S. tax at that time, the effect of the election will be to give the individual an adjusted basis for U.S. tax purposes equal to the fair market value of the property as of the date of the deemed alienation in Canada, with the result that only post-emigration gain will be subject to U.S. tax when there is an actual alienation. If the Canadian resident is also a U.S. citizen at the time of his emigration from Canada, then the provisions of new paragraph 7 would allow the U.S. citizen to
accelerate the tax under U.S. tax law and allow tax credits to be used to avoid double taxation. This would also be the case if the person, while not a U.S. citizen, would otherwise be subject to taxation in the United States on a disposition of the property.

In the case of Canadian taxation of appreciated property given as a gift, absent paragraph 7, the donor could be subject to tax in Canada upon making the gift, and the donee may be subject to tax in the United States upon a later disposition of the property on all or a portion of the same gain in the property without the availability of any foreign tax credit for the tax paid to Canada. Under new paragraph 7, the election will be available to any individual who pays taxes in Canada on a gain arising from the individual’s gifting of a property, without regard to whether the person is a U.S. taxpayer at the time of the gift. The effect of the election in such case will be to give the donee an adjusted basis for U.S. tax purposes equal to the fair market value as of the date of the gift. If the donor is a U.S. taxpayer, the effect of the election will be the realization of gain or loss for U.S. purposes immediately before the gift. The acceleration of the U.S.
tax liability by reason of the election in such case enables the donor to utilize foreign tax credits and avoid double taxation with respect to the disposition of the property.

Generally, the rule does not apply in the case of death. Note, however, that Article XXIX B (Taxes Imposed by Reason of Death) of the Convention provides rules that coordinate the income tax that Canada imposes by reason of death with the U.S. estate tax.

If in one Contracting State there are losses and gains from deemed alienations of different properties, then paragraph 7 must be applied consistently in the other Contracting State within the taxable period with respect to all such properties. Paragraph 7 only applies, however, if the deemed alienations of the properties result in a net gain.

Taxpayers may make the election provided by new paragraph 7 only with respect to property that is subject to a Contracting State’s deemed disposition rules and with respect to which gain on a deemed alienation is recognized for that Contracting State’s tax purposes in the taxable year of the deemed alienation. At the time the Protocol was signed, the following were the main types of property that were excluded from the
deemed disposition rules in the case of individuals (including trusts) who cease to be residents of Canada: real property situated in Canada; interests and rights in respect of pensions; life insurance policies (other than segregated fund (investment) policies); rights in respect of annuities; interests in testamentary trusts, unless acquired for consideration; employee stock options; property used in a business carried on through a permanent establishment in Canada (including intangibles and inventory); interests in most Canadian
personal trusts; Canadian resource property; and timber resource property.

https://home.treasury.gov/system/files/131/Treaty-Canada-Pr2-TE-9-21-2007.pdf

Model U.S. Tax Treaty 2016

The following provision appears first in the 2016 Model Tax Treaty. There is at present no technical explanation discussing the treaty. Therefore, it must be interpreted based on the presumed intent (which can be gleaned in part from the Canada U.S. Tax Treaty). Significantly, this provision is intended to prevent double taxation resulting from the deemed “alienation” of property upon severing tax residency. It is far narrower than the Article XIII – Paragraph 7 of the Canada U.S. Tax Treaty.

Article 13 – Paragraph 7

7. Where an individual who, upon ceasing to be a resident (as determined under paragraph 1
of Article 4 (Resident)) of one of the Contracting States, is treated under the taxation law of that
Contracting State as having alienated property for its fair market value and is taxed in that
Contracting State by reason thereof, the individual may elect to be treated for purposes of
taxation in the other Contracting State as if the individual had, immediately before ceasing to be
a resident of the first-mentioned Contracting State, alienated and reacquired such property for an
amount equal to its fair market value at such time.

https://home.treasury.gov/system/files/131/Treaty-US-Model-2016_1.pdf

“Dual citizenship affords unique opportunities for cross-border tax evasion” claims report issued by @SenateFinance

As described by AARO (“Association of American Residents Overseas”) in an April 7, 2023 blog post:

On March 29 the Senate Finance Committee Democratic staff issued a report titled “Credit Suisse’s Role in U.S. Tax Evasion Schemes of its investigation of Credit Suisse’s compliance with a 2014 plea agreement with the Department of Justice involving the bank’s participation in a conspiracy to hide offshore accounts from the IRS.

Per Committee chair Senator Ron Wyden’s (D-OR) press release, the report details Credit Suisse’s role in a “potentially criminal tax conspiracy” involving accounts of a U.S. based family that were closed 10 years ago, recycles the Clinton/Bush era tax evasion case by U.S. businessman Dan Horsky, and discusses large undeclared accounts belonging to 23 ultra-high net worth U.S. citizens.

We are surprised that such a large and well-resourced committee working for two years was unable to unearth so little misconduct at a mega-bank that has now collapsed due to mis-management. Most outrageously, the report states that “Dual citizenship affords unique opportunities for cross-border tax evasion,” which gives the impression that ordinary Americans living abroad are prone to criminal tax evasion.

AARO has a meeting scheduled with Senator Wyden’s office in May during our annual Overseas Americans Week, during which we will express our extreme dissatisfaction with this characterization. We will let you know if there are any developments.

AARO deserves thanks and credit from all Americans overseas for publicly pushing back on the report created and published by the Democrat led Senate Finance Committee. The report is outrageous, a waste of public funds and appears to be a “back handed attempt” to justify the hiring of more IRS agents and increasing/justifying the imposition of FBAR penalties. The report is NOT (contrary to media reports) really about Credit Suisse. The report uses Credit Suisse as a “prop” to remind the people of America, that there are some people in America (it all took place ten years ago), who deliberately attempt to evade the payment of U.S. tax. The modus operandi includes moving their money to financial institutions and entities outside the United States. Yes, it’s true. Of course, as an added benefit the Senate Finance Committee gets to demonize Swiss banks (in general) and Credit Suisse (in particular). But make no mistake. The Senate Finance report is NOT about Swiss banks. It’s an advertisement to justify the hiring of more IRS agents funded by the Inflation Reduction Act, to legitimize the imposition of more FBAR penalties and to suggest that Republicans are (somehow) soft on tax evasion.

Why this report is dangerous for U.S. citizens generally and for Americans abroad specifically

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How U.S. Citizenship Tax, The Treaty “Saving Clause” and FATCA Create A Fiscal Prison For Dual Tax Residents

Introduction – The Problem Of Dual Tax Residency For U.S. Citizens

A “Hell greater than the sum of the parts”

There are people in the world who really don’t understand (or say they don’t) what exactly is the problem with U.S. citizenship based taxation. They claim to not understand why defining “tax residency” based on the “circumstances of birth” rather than the “circumstances of life” is a problem. They fail to consider how taxation based on “circumstances of birth”, interacts with U.S. tax treaties and FATCA to create a “hell that is greater than the sum of the parts”.

This is the third post in a series designed to explore and facilitate the understanding of the U.S. “citizenship based” extra-territorial tax regime. The first post explored the practical meaning of U.S. citizenship-based taxation (it’s primary effects are on people who live outside the U.S.). The second post explored the fact that tax residency based on “citizenship” is tax residency based on the “circumstances of one’s birth” rather than the “circumstances of one’s life” (its effects are primarily based on the circumstance of birth in the U.S.). The conclusion drawn from these first two posts was that the U.S. citizenship based extra-territorial tax regime is one in which:

The circumstance of a U.S. birthplace is used as a justification to regulate the lives of people with no connection to the United States and impose U.S. taxation on income that has no connection to the United States and is received by someone who does not live in the United States.

Citizenship taxation has practical and contextual meaning only its application to tax residents of non-US countries. The U.S. uses the circumstance of a “U.S. birthplace” to reach out and “claim” the tax residents of other countries as U.S. “tax residents”.

The purpose of this post is to explain how the interaction of U.S. citizenship taxation (claiming those with a U.S. birth place as U.S. tax residents when they are tax residents of other countries), the “saving clause” (not allowing U.S. citizens with dual tax residency to assign tax residency to the country where they actually live) and FATCA (the tool to hunt, find and enforce the extraterritorial U.S. tax and regulatory regime on the residents of other countries) creates a whole hell greater than the sum of the parts.

Many people understand the three components of “citizenship taxation”, the “saving clause” and “FATCA” as separate entities. Few appear to understand how those three components interact together to destroy the lives of U.S. citizens with dual tax residency. The U.S. has created a “fiscal prison” for its citizens. Seven video accounts of the impact of the U.S. citizenship tax regime are available here.

This problem can be solved ONLY by the United States redefining its rules for “tax residency” so that “citizenship” (the circumstances of one’s birth”) is not relevant to “tax residency” (the circumstances of one’s life).

This post is to identify the component “Part”(s) of the problem. It is organized in “Sections” and “Parts” as follows:

Section I – How The Problem Was Created

Part A – Tax, Residency and Tax Residency
Part B – The general problem of dual tax residency
Part C – Introducing the treaty tie break and how it can be used to end “dual tax residency” under a relevant Canadian tax treaty”
Part D – The general principles of the U.S. Canada “tax treaty tie break – How “circumstances of life” are used to assign tax residency
Part E – Food for thought – Citizenship the least important factor for the treaty tie break
Part F – Two possible examples of assigning residence to one country by using the “treaty tie break” – Green Card Edition
Part G – U.S. Citizens CANNOT Benefit From The “Tax Treaty Tie Break” – Hello “Saving Clause”
Part H – The “Saving Clause” And The Inability For U.S. Citizens To Use The “Treaty Tie Break” Is How The United States Captures The Residents Of The Treaty Partner Country And Claims Them As U.S. Tax Residents
Part I – The Tax Treaty Tie Break And Implications For U.S. Tax Compliance And For FATCA And The CRS Reporting

Section II – How Dual Tax Residents Experience The Extraterritorial Tax Regime

Part J – The U.S. exports a more punitive from of taxation to tax residents of other countries
Part K – The Problem Of Investing, Retirement planning and Retirement Planning – The Punitive Taxation And Reporting Requirements of PFICs and Foreign Trusts
Part L – The Problem Of Non-U.S. Pensions – How Are They Treated Under The Internal Revenue Code? – Different Rules For Different Countries
Part M – Discouraging U.S. Small Business Abroad – The Treatment Of Small Business Corporations Generally And On A Country By Country Basis
Part N – The “FBAR Marriage”: How Marriage To An Alien Results In Higher Taxation, More Reporting, Difficulties With Asset Transfers, Higher Divorce Costs And Possibly A Requirement To File A Tax Return With As Little As $5 Of Income

Section III – How The U.S. Extraterritorial Tax Regime Attacks The Sovereignty Of Other Countries

Part O – The U.S. taxation of residents of other countries attacks and erodes the tax base of those other countries

Section IV – Solving The Problem: Regulatory And Legislative Solutions

Part P – Regulatory Solution: “A Regulatory Fix For Citizenship Taxation
Part Q – Regulatory Solution: Amending The “Saving Clause” In U.S. Tax Treaties
Part R – Territorial Taxation For U.S. Citizen Individuals
Part S – Redefining U.S. Tax Residency To Move To Residence-based Taxation”

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Should tax residency Be Based On The “Circumstances Of Your Birth” Or The “Circumstances Of Your Life”?

Panel session – US Expat Tax Conference from Deborah Hicks on Vimeo.

Should taxation be based on the “circumstances of your birth” or the “circumstances of your life”? President Obama doesn’t think (apparently) that the “circumstances of your birth” birth should determine the “outcome of your life”. Should the “circumstances of your birth” determine your tax residency?

This is a second post exploring what is the true meaning of U.S. citizenship-based taxation. In an earlier post – “Toward A Definition Of Citizenship Taxation” – I explored the contextual meaning and effect of U.S. “citizenship taxation”. The only “contextual effect” and “practical meaning” of U.S. citizenship taxation may be described as:

Therefore, the practical meaning of “citizenship taxation” is the United States imposing taxation on the non-US source income earned by people who live in other countries. To be clear: citizenship taxation means that the United States is claiming the residents of OTHER countries as US residents for tax purposes!

That’s amazing stuff! Most countries believe that they are sovereign and that includes sovereignty over matters of taxation. Yet, any country that is a party to a U.S. tax treaty has actually agreed that a subset of the treaty partner’s tax residents are ALSO U.S. tax residents! Although nobody questions the right of the United States to prescribe its own definition of tax residency, few would agree that the United States has the right to claim the residents of other countries as U.S. tax residents. Yet, this is what the U.S. citizenship taxation regime means. This U.S. extraterritorial claim of taxation is at the root of the FATCA administration problems and at the root of the the events that led to Treasury Notice 2023-11 (released on December 30, 2022).

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Afroyim v. Rusk – A New Perspective: Do The Specific Rules Of US Citizenship Taxation Result In The Forcible Destruction Of US citizenship?

Prologue

The United States of America is the ONLY country in the world that both:

1. Confers citizenship by birth inside the country; AND

2. Imposes worldwide taxation and regulation based on citizenship.

Therefore, it is reasonable to conclude that:

US citizenship is the world’s only true “taxation-based citizenship”.

Afroyim – Should extending constitutional status to US citizenship be understood as a new gift or exacerbating an old curse?

US Citizenship Stripping Before 1967 – The Significance Of Afroyim

The US government was stripping US citizens of their citizenship if they committed various “expatriating” acts. This was codified in statutes that mandated that certain kinds of conduct would result in the loss of US citizenship. At various times the expatriating conduct included (but was not limited to): naturalizing as a citizen of another country, voting in a foreign election, serving in the armed forces of a foreign country and even marrying a non-citizen.

US Citizenship Stripping After 1967 – Afroyim

The 1967 US Supreme Court decision in Afroyim clarified that Congress lacked the power to strip US citizens (who were born or naturalized in the United States) of their citizenship. The Afroyim ruling clarified that:

1. US citizenship belonged to the citizen and could be lost by the citizen only if the citizen voluntarily relinquished US citizenship by voluntarily committing an expatriating act with the intention of relinquishing US citizenship; and

2. Congress cannot enact laws or engage in practices that result in the forcible destruction of citizenship.

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How US Tax Treaties And The “Saving Clause” Prevent Countries From Establishing Retirement Programs For US Citizen Residents

Prologue – The Circumstances Of Your Birth Should Not Determine The Outcome Of Your Life …

The above tweet references a “human interest” story where US citizen children are denied benefits in their country of residence that are available to all people who are NOT US citizens.

The description includes:

New Zealand children born to parents’ who are citizens of the United States face a difficult KiwiSaver choice: Give up your US citizenship, or face a KiwiSaver tax compliance bill of $750​ or more a year courtesy of the US taxman.

A petition has been started at Parliament asking MPs to change the KiwiSaver Act to allow people with KiwiSaver accounts facing the unreasonable demands from US tax authorities to close their KiwiSaver accounts.

The issue surfaced as a result of the plight of Auckland dual national Kira Bacal and her four New Zealand-born children, Harper, 13, Rowan, 10 and twins Malachi and Elias, 8.

It appears that the poor (New Zealand born) Bacal children are finding that the US (or at least US tax preparers in New Zealand) consider their KiwiSaver to be a possible vehicle for US tax evasion! Not only is the KiwiSaver a “trust”, but it’s a “foreign trust” which comes with all kinds of penalty laden reporting obligations and no tax advantages. An excellent analysis of the US tax implications of the New Zealand KiwiSaver is here. The story is somewhat comical in that one gets the feeling that the blame should be placed on New Zealand (and not the United States) for New Zealand’s failure to legislate special exceptions for US citizens living in New Zealand.

So what! They’re Americans and therefore they deserve it (you say)!

A previous post explained that for Americans abroad, changes in the laws of their country of residence can change their tax relationship with the United States. The purpose of this post is to expand on that theme by demonstrating that:

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Extradition Is One Way That Changes In Another Country’s Tax Laws May Change Your Tax Relationship With The US

Prologue

As long as the US continues to employ citizenship taxation any changes in US tax law will continue to have unintended consequences on Americans abroad. In March of 2022 I outlined how some of the tax changes proposed in the 2023 Biden Green book would impact US citizens who live outside the United States. As important as US tax changes are, Americans abroad must be aware of how changes in the laws of their country of residence may also impact their “tax relationship” with the United States.

The purpose of this post is provide five simple examples. Some of the examples are based on Canada’s tax laws and others are of a more general nature.

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New Location: John Richardson – Information Session – London, UK – Thursday Oct. 13/22 – 19:30 – 21:30

John Richardson – Information Session – London, UK – Thursday Oct. 13/22 – 19:30 – 21:30

What: John Richardson informal information and discussion session for those impacted by US extraterritorial overreach

When: Thursday October 13, 2022 – 19:30 – 21:30

Where: Sutton Arms – Wine Room
6 Carthusian Street, London, EC1M 6EB

Cost: No charge for the session. You may wish to purchase a beverage at the location.

How to get there: There is a map at the bottom of the home page of the Sutton Arms Site:

https://www.sutton-arms.co.uk/

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John Richardson – Information Session – London, UK – Thursday Oct. 13/22 – 19:00 – 21:00

Attention!! Date, time and location updated!! – Thursday Oct. 13/22 – 19:30 – 21:30 – New location! See here.

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John Richardson – Information Session – London, UK – Thursday Oct. 13/22 – 19:00

What: John Richardson informal information and discussion session for those impacted by US extraterritorial overreach

When: Thursday October 13, 2022 – 19:00 – 21:00

Where: Pret A Manger – Directly Across From Russell Square Tube (careful to choose the correct Pret)
40 Bernard Street, London, WC1N 1LE
https://www.pret.co.uk/en-GB/shop-finder/l/london/40-bernard-street/284

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