Cuenca High Life logo
Click here to subscribe to daily news sent to your inbox!

Other News

New U.S. tax law didn’t do any favors for expats; It maintains taxation on foreign-earned income

By Karen Alpert

Since Congress began taxing incomes, American citizens have been unable to escape the reach of Uncle Sam: They must report their income, no matter where they live or where it’s earned. It’s known as a worldwide citizenship-based tax system.

Most other countries, however, have a residence-based system. That means their citizens are only taxed where they live or where their income is earned. The U.S. income of a British expat living in New York, for example, is off limits to Her Majesty’s Treasury.

The Tax Cuts and Jobs Act, passed in December, was supposed to change how the U.S. treats Americans abroad. Instead, it only addressed a similar issue faced by American multinational corporations by allowing their foreign subsidiaries to send home certain profits without paying U.S. taxes on them.

Meanwhile, Congress left U.S. citizens living overseas under the old, punitive system even though, as my research shows, it puts them at a significant disadvantage.

Fortunately, there’s a chance to fix this. The new law included many inadvertent errors and omissions, and lawmakers are working on legislation to fix them. In my view, switching the individual income tax to a residence-based system should be part of any repair effort.

Birth of the income tax

Since first taxing individual incomes during the Civil War, the U.S. has targeted its citizens’ income regardless where they live.

By at least 1914, a year after states ratified the 16th Amendment, which made the income tax constitutional, Americans abroad were complaining of double taxation and renouncing their citizenship as a result.

While current law offers exclusions and credits to prevent double taxation for most Americans, many other provisions are punitive to long-term expats by targeting foreign investments, businesses and retirement savings.

The reporting requirements and incompatibility with local tax laws create significant compliance costs for nonresident Americans that often greatly exceed the amount of U.S. tax they owe, which is zero for most expats.

In 2010, the U.S. further complicated their financial lives by enacting the Foreign Account Tax Compliance Act, which required banks to report to the IRS on all accounts held by U.S. taxpayers.

The act had two consequences: First, many banks closed accounts held by U.S. citizens because the banks were scared of the significant penalties for noncompliance. And second, many people learned for the first time that they were subject to U.S. taxation.

This resulted in a spike in the rate of U.S. citizenship renunciations, from under 800 per year before 2010 to over 5,000 in both 2016 and 2017.

The GOP even included a provision to repeal the act in its 2016 election platform, which also supported moving to a residence-based system of taxation for individuals and a territorial system for corporations.

‘Accidental Americans

The main problem with a citizenship-based taxation is that the U.S. is taxing the foreign income of an American or a dual citizen working, living and paying tax in another country, without a dime going through any entity under U.S. jurisdiction.

Currently, the U.S. is the only country – apart from Eritrea – to do this.

In addition, many of the American nonresidents being taxed are “Accidental Americans,” who have few or no ties to the United States but are U.S. citizens due to an accident of birth. Accidental Americans exist because the U.S. grants citizenship broadly, based on both place of birth and parentage.

They have all the tax responsibilities of U.S. citizenship but often don’t even know it.

Kate’s situation

My own research focuses on tax issues faced by Americans and dual nationals living in Australia.

To illustrate the impact of the U.S. tax system, let’s take the situation of “Kate,” a U.S.-Australia dual citizen living in Sydney. She earns AU$70,000 (US$54,900) per year as a marketing manager at a locally owned company. Fortunately for her, she’s able to exclude this income from U.S. taxation, yet she still must file a 1040 every year and report the AU$20,000 in her local bank account to the Financial Crimes Enforcement Network or face a hefty fine.

Most of Kate’s problems emerge when she tries to take part in a variety of other normal aspects of living somewhere for any significant period of time, from saving for retirement to buying a home. And in general, the exclusions and credits intended to prevent double taxation won’t be sufficient.

For example, Australia has one of the best retirement systems in the world available to all residents, with mandatory employer contributions and low taxes. Withdrawals after age 60 are tax-free in Australia.

Unfortunately, Kate will face lots of complexity and uncertainty when it comes to the U.S. treatment of her Australian retirement savings. If she chooses to contribute more to her retirement fund than her employer, the U.S. could tax some of the income accumulating inside her account, even though she has no access to that income. And when she eventually retires, a portion of her withdrawals will also be subject to U.S. taxation.

Let’s say Kate buys a home. She’ll confront the U.S. taxman again if she eventually wants to sell, depending on fluctuations of the exchange rate between the purchase and sale. If the Australian dollar falls, that will mean the mortgage will be smaller in U.S. dollars, triggering a taxable gain upon repayment. If the Australian dollar appreciates, it increases the likelihood Kate will have to pay U.S. tax on any gain from the sale itself. (The U.S. excludes only the first $250,000.) Either way, Kate will likely lose.

Kate will face similar complexity and potential tax liability if she simply wants to invest in a local mutual fund or start a business in Sydney.

Essentially, every transaction that Kate enters into will be seen as a cross-border transaction by the IRS, even though all parties may be Australian citizens resident in Australia.

Seeking redress

Kate’s situation is not unique. A survey of U.S. expats shows that about one-third of respondents were actively considering renouncing their U.S. citizenship, with open-ended responses indicating that tax compliance- and bank-related issues were major factors.

These tax and reporting obligations have cost them the ability to bank and invest, the ability to save for retirement and even jobs, when employers and potential business partners are not willing to allow their accounts to be reported to the IRS.

That’s a shame because overseas Americans are important business, trade and cultural representatives for the U.S.

Now that Congress has recognized the problems of worldwide taxation for U.S. corporations, I hope lawmakers take this opportunity to address the unintended consequences of U.S. tax policy toward American citizens living abroad as well. The likelihood of positive action appears to be growing with increased recognition of this problem.
____________________

Credit: The Conversation, https://theconversation.com

14 thoughts on “New U.S. tax law didn’t do any favors for expats; It maintains taxation on foreign-earned income

  1. Sadly, this is all true. IF any US government (regardless of party) cared about individuals, these laws would be repealed. Sadly, as usual, corporations got their break, for individuals, nothing.

  2. Well done. Despite the title, the content of the article shows where the burden is the most unjust. Dual citizens are most often so by “accident”.. by having a parent who is American or by being born in the US while their parents were traveling as tourists there, (like Boris Johnson, the current UK Minister of External Affairs.) They have never lived in the USA, a large contingent have never even visited. Of these, Canada and Mexico have almost a million each, but there are everywhere…just as you will find dual citizens in the USA.

    But the US now requires their bank account info and reports from the banks where they live. And if this is not forthcoming, from their banks, the US threatens to seize the bank’s assets in the USA. This puts these nations into a quandary, as their Bank Act and Bill of Rights prohibits the divulging of customer information. Even their national governments cannot access that information without subpoenas.

    But not to worry, one can simply give up the US citizenship they never asked for or benefited from. But the US has made it complex to do so. It requires the victims to file “their missing” US tax returns. Of course, this means they have to find a US accountant who treat it these customers as a one-time killing. The average cost is 30k to be to tell the IRS that nothing is owed. (The US has always paid one of the lowest personal tax rates in the developed world.) Lastly, concurrently with this new and extraordinary tax regime, the US increased the fees for a declaration of non-citizenship from $75 to 2500. (most countries are around $100).

    It is measures like these that shape the opinion the world has of the USA. It is measures like these that are the reason that nations both inside and especially outside the US realm of financial influence (which is 86% of the world) now refuse to open accounts for Americans. And if anyone is interested, this was an Act passed under Obama with the full support of the Republicans as well.

    1. Excellent summary Globetrotter, but you have barely scratched the surface regarding how onerous this situation truly is. For a deeper exploration of the issue, check out the Isaac Brock Society website at https://isaacbrocksociety.ca/. It’s devoted to discussion and advocacy for resolution of this issue primarily as it relates to Canadians but the problems apply equally worldwide.

      “We’re from the government and we’re here to help you.” R-i-i-i-g-h-t.

  3. Good article, but it leaves out that Americans may earn about $96K of foreign income per year, tax-free.

    While the concept that I *could* be taxed in a double-taxation sort of way might be conceptually bothersome, I am happy as a clam paying ZERO dollars in income tax because of this generous benefit that is available to us.

    1. I agree Tamara, for normal day to day living for those of us who do not have to deal with double taxation for earnings, this is not a problem. HOWEVER, if I want to sell my home in Vancouver, this will present a significant problem, as my assessment for 2017 has indicated that I have accrued $800,000+ in equity over the 27 years I have lived here. I have not lived in the US since 1983, yet I will owe US taxes on the transaction. I have lived and worked in Canada exclusively since then.

      1. Umm, if you have lived in it for more than 2 years you may escape through capital gains exclusion…talk to a CPA…

        1. Umm. Yes, by all means talk to a CPA but they will tell you that the maximum exclusion is $250K for single filers and $500K for joint filers.

          Pretty hefty tax bill for someone who hasn’t lived in the US for 35 years on a house that is located in Canada, not the US.

      2. Where it gets truly criminal is when you realize that you would be paying taxes on 800K of gains that only exist on paper. Were you to buy another home in Vancouver those imaginary paper gains would disappear in a second. The globalists plan for the long term, they don’t need to effect your every day living if they can steal a huge chunk every now and then.

    2. I believe you are referring to the Foreign Earned Income Exclusion (FEIE) which is $102,100 for 2017 and $104,800 for 2018. Here’s the schedule for the last few years.

      * $92,900 for 2011
      * $95,100 for 2012
      * $97,600 for 2013
      * $99,200 for 2014
      * $100,800 for 2015

  4. It’s a bit surprising that this article doesn’t even mention the Foreign Earned Income Exclusion (FEIE). The FEIE allows an American who lives outside the United States for 335 days out of 365 days in a year to pay zero taxes on the first $102,100 in 2017 to $104,800 in “earned income”. Social Security benefits do not qualify as earned income.

    This means that a couple can earn $104,800 each and pay zero in federal income tax when they are permanent, legal residents of a foreign country. Currently, there are three basic requirements:

    To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must have foreign earned income, your tax home must be in a foreign country, and you must be one of the following:

    1) A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year,

    2) A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or

    3) A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

    Here are a few links to more information on the FEIE:

    https://www.irs.gov/individuals/international-taxpayers/foreign-earned-income-exclusion

    http://www.escapeartist.com/blog/qualify-feie-2018-beyond/

    http://premieroffshore.com/foreign-earned-income-exclusion-2018/

    I wonder why this information isn’t mentioned in this article? It sort of makes one wonder what the point of the article might have really been.

    In a way, we see the FEIE as a “subsidy” from the US government. It’s almost as if they are paying us to leave. Now, if they would just get smart and extend Medicare coverage to Senior expats. The potential savings to the Medicare system would be incredible and the income to the healthcare system in a place like Ecuador would be amazing as well.

    For example, can you imagine the savings if 20% of the Medicare covered surgeries for a 12 month period were billed at Ecuadorian healthcare cost?

    Here’s a link to a study the Rand group did on expanding Medicare to cover expats in Mexico.

    https://www.rand.org/pubs/periodicals/health-quarterly/issues/v2/n3/05.html

    Here’s another article that has some interest insights into the question.

    http://www.americasquarterly.org/content/help-boomers-retire-latin-america

    Anyway, just a thought…I apologize for going off the original subject.

    1. Steve– As per your usual, you have written a thoughtful, well-documented and supported analysis. However, your comments fail to address a very large number of US citizens (many of them “accidental” dual citizens as discussed in the original article) who have been terribly mistreated by the US government, many through no fault of their own.

      In my comment above I mentioned the Isaac Brock Society. If you’re truly interested in this subject, I would strongly encourage you to check out their website. There you will find a “train of abuses” far longer than any King George III might have imposed even in his most delusional, brain-addled moments.

      The issue is not foreign earned income. That’s just one small piece of the puzzle. For a pretty good synopsis, you might check out this article on the Isaac Brock website: https://isaacbrocksociety.ca/2018/02/23/comment-2-on-think-you-can-leave-the-u-s-think-again/

      And–if you have more time on your hands, track back through the thread to the original article posted here:
      https://www.thomhartmann.com/users/laurainparis/blog/2018/02/think-you-can-leave-us-think-again#comment-382068

      After reading through the litany of horror stories recounted on these websites about how Uncle Sam has totally ruined so many people’s lives (many of whom haven’t lived in the US since they were infants), it will truly make you proud to be an American.

      Not.

      1. I will check it out tonight…thanks for reminding me. I meant to the other day and forgot.

        We are fortunate in that most of our income is covered by the FEIE. This will be the first year we qualify for the full benefit and it’s exciting to think about not contributing my “uncle sam’s” problem any more than necessary.

        Have a great day.

  5. Very interesting information. I am particularly interested in the notes about US citizens giving up their citizenship. I have been told that if one does that, that they are put on a “no entry” list and can never return to the US. So, it sounded to me like giving up citizenship puts you in the same category as a terrorist??? Anyone have information about this?

    1. Five Common Misconceptions About Giving Up US Citizenship

      https://www.expatinfodesk.com/expat-guide/relinquishing-citizenship/renunciating-your-us-passport/misconceptions-about-renunciation-of-a-us-passport/

      3) Renunciation means that you will never be permitted to visit the US again

      When you give up US citizenship you do forego the right to enter the
      country. However, providing you have a passport from a country that
      allows you visa-free entry to the U.S., then you can enter the country
      just like any other visitor; you simply apply for a tourist or business
      visa at a U.S. embassy or consulate. It’s called a B1/B2 visa, and it
      typically lasts for ten years.

Comments are closed.