By Karen Brooks
The Tax Fairness for Americans Abroad Act, or HR7358, introduced on December 20, represents a watershed moment for American citizens residing outside of the U.S. You can read more about the bill at Citizenship Solutions – where a draft has also been posted. The official bill should be posted on congress.gov soon.
The bill, introduced by North Carolina Republican Congressman George Holding, is a huge step forward in the fight for equal taxation rights for U.S. expats. For the record, the U.S. is one of only two countries in the world that taxes foreign-earned income that is also taxed by the country in which it is earned (the other country with this policy is Eritria).
While the naysayers are already active on Facebook and Twitter complaining that this bill was introduced too late to pass the current Congress, they fail to realize that any step toward equal rights for expats is a victory. Enormous effort has gone into getting sufficient support in Congress to get this far and there appears to strong support from both Democrats and Republicans entering Congress in 2019.
We need to acknowledge the significant time and effort that has been expended by organizations such as American Citizens Abroad, Republicans Overseas and Democrats Abroad. They have been working consistently over a period of years to get this far. Someone in Congress now recognizes the problem – this is the first step in ultimately achieving a solution.
So, does the bill deliver what it promises? I think the answer is mostly yes.
Essentially, any U.S. citizen who qualifies for the foreign earned income exclusion (FEIE) and has filed all required U.S. tax returns for the prior three years can elect to be treated as a qualified nonresident citizen. Qualified nonresident citizens can exclude not only foreign earned income, but also foreign-source unearned income. There is a small exception: only that portion of gains on personal property that accrued while the taxpayer was a qualified nonresident citizen can be excluded. So, if you bought shares in 1980 for $100, moved out of the U.S. in 2019, and sold the shares for $1 million the day after you became a qualified nonresident citizen, the entire gain would still be taxable in the U.S.
As written, the bill applies only to U.S. citizens residing outside the U.S. There is no relief for green card holders living outside the US who have not properly terminated permanent resident status. Furthermore, the 3 year compliance requirement will mean that any current expat who has avoided U.S. compliance due to the devastating impact of PFIC, CFC, the US taxation of their foreign retirement savings, or other US tax rules, will have to weigh up whether three years of compliance is possible and whether the future benefit and peace of mind is worth the cost.
So what’s the compliance burden? Based on the plain language of the bill, most qualified nonresident citizens will have either no obligation to file Form 1040, or their taxes will be substantially simplified. The bill simply excludes foreign source income from gross income for U.S. tax purposes. The Form 1040 filing thresholds are based off of gross income. So, add up all of your U.S. source income (dividends from US mutual funds and U.S. domiciled companies, rent on U.S. real property, U.S. trade or business income, etc.) and compare that to the threshold for your filing status.
Information returns are a bit trickier. The intent behind the bill was to avoid all U.S. tax filing except for taxes on U.S. source income and an annual election to confirm eligibility for qualified nonresident citizen status. The bill’s proponents appear to be relying on the good will of the U.S. Treasury to exempt qualified nonresident citizens from filing forms 5471, 8865, 3520, 3520A, 8621, and 8938. Perhaps it would be better to make that explicit.
How about FATCA and FBAR? The bill makes no changes to FFI reporting under FATCA or to FBAR requirements under the Bank Secrecy Act. These changes are left for a subsequent bill when, hopefully, Congress will realize that FFI and FBAR reporting of the foreign accounts of qualified nonresident citizens is superfluous as these accounts will not generate any U.S. taxable income.
Concluding Thoughts: This bill is not a panacea. It does not establish residence based taxation – the U.S. is still clinging on to emigrants and long-term nonresidents and insisting on an annual check-in. The Estate and Gift tax regime remains unchanged. Qualified nonresident citizen status will be denied to those who live in sanctioned countries. And three years of compliance is required to get out of the current system of worldwide taxation. As a result, there will be people who are not helped by this bill.
Another concern is what happens to the qualified nonresident citizen if they decide to become a U.S. resident. While it appears that one portion of the bill is meant to exclude from U.S. taxation those gains accrued while nonresident, I do not believe this section has been drafted effectively.
An even bigger worry for the repatriating citizen, though, is how the U.S. tax system will cope with all of those “foreign” assets that were acquired as a qualified nonresident. What happens to your “foreign” retirement account? Does it become a foreign trust filled with PFICs? Even if you can exclude the gain accrued prior to repatriation, you’re still stuck with reporting current gains and all of the associated information returns.
However, it is important not to throw the baby out with the bath water. HR7358 provides an important framework on which the 116th Congress can construct a bipartisan solution to the problems that have plagued U.S. expats for decades; problems which were exacerbated by the passage of FATCA in 2010. The bill will clearly undergo some transformation before it is actually passed into law. Introduction of a bill is a HUGE step forward, but there’s still a long way to go.