The following was submitted in the form of a comment:
I’d like to have some opinions about the bill that I’m writing to replace citizenship with residence-based taxation. Maybe someone could move this to a different page if it gets too long. By the way, I’m about one third of the way through with the relevant sections in the Internal Revenue Code.
1. To define residence, I am using the current substantial presence test with all of its rules and exceptions. This is the definition that is currently used for foreigners without a green card, so I am just applying it to everyone. I am also adding an exception to consider US government or military employees abroad as residents, because their salaries are sourced in the US and they would pay higher taxes if they were considered nonresidents. I am also adding that US citizens and permanent residents who don’t satisfy the substantial presence test may elect to be treated as residents for tax purposes by simply filing the normal resident tax forms (1040). I understand that there are some cases where this may be beneficial, and I don’t want to increase taxes on anyone.
2. Because some people may elect to be treated as US residents even if not acually residing in the US, I am keeping the foreign earned income exclusion and the exclusion of income from US possessions available. It may be hard for you to imagine, but there are situations where using the exclusions is better than being a nonresident. For example, this occurs for those residing in a low-tax country or US possession who have income from US sources and a low total income.
3. To be consistent with the concept that citizenship should not be used for taxation, I am removing the requirements that certain dependents be “citizens or residents”. If I changed the requirements to only “residents”, some people might not be able to claim dependents that they currently claim, and again I don’t want to increase taxes on anyone.
4. Also to be consistent with eliminating the use of citizenship, I am repealing the sections that allow higher taxes on those whose country of citizenship or residence impose higher taxes on Americans. (I don’t think this provision has ever been used anyway.)
5. Again to be consistent, I am removing the requirement that the spouse be a US citizen for the estate tax exemption. I am also allowing the exemption from US estate taxes to all residents of US possessions, not just who were born there.
6. I was trying to restructure the exit tax based on termination of residence, but I decided to repeal it completely. My understanding is that the main reason for the exit tax in the US is not to collect revenue on unrealized gains, but to penalize rich people who renounce US citizenship to avoid taxes, because certain dual citizens, permanent residents with less than 8 years of residence, any residents only by virtue of the substantial presence test, and any people not considered “rich” are exempt from it, while those who do not certify current tax compliance are not exempt even if not “rich”. The whole idea of renouncing citizenship because of taxes does not exist in a residence-based system. One could argue that taxes would then be a motivation for terminating residence, but I’m not aware of any US state that imposes an exit tax. Some countries have foreign exchange control but not an exit tax per se. As far as I know, only Canada has a real exit tax, and the Netherlands can only impose it under a treaty with the new country of residence. I also don’t agree with taxing unrealized gains because they are not final and could decrease, just like what happened to Eduardo Saverin’s Facebook shares. Besides, the gains may be taxed by the new country of residence once realized; if it doesn’t tax capital gains, it probably collects more revenue from other taxes or other sources instead, or it spends less. Likewise, I decided to repeal the estate tax on inheritance from “covered expatriates”.
7. I am getting tempted to include in the bill a complete repeal of FBAR, FATCA and even the whole estate tax. It’s very easy to write “section #### is repealed”. But those are separate issues and I guess I shouldn’t try to fix everything, I don’t even know if my bill will be introduced at all. I think it’s better leave the unconstitutionality of the FBAR penalties for the courts to decide, a repeal of FATCA for the banks to lobby, and a repeal of the estate tax for the Republicans in Congress. Citizenship-based taxation is the issue that no one else cares about.
Shadow Raider, you have done so much — prepared and as effective as could be with time constraints. Thanks for all your incredible work!
Thanks, Shadow Raider. Good that there were some assistants who handle immigration. They might see the problem with the immigrants.
Thank you Shadow Raider, and thank you Roger Conklin for making me laugh!
Jim McDermott, senior member on the House W&M Committee, is my rep.
I faxed him a letter about two young US persons in Toronto I happened to meet at the consulate who were renouncing because of IRS and suggested that he consider RBT rather than the present Reed amendment as a better solution to our problems.
His response:
“Thank you for your recent letter concerning the tax burden on US citizens abroad. I appreciate your taking the time to raise your concern about this complex issue.
I strongly believe that our current tax code can be a confusing labyrinth for citizens residing within the US and abroad. I will continue to work with my committee to reform and simply [sic] the tax code to make it clear and navigable for all Americans. Rest assured that I will keep your comments in mind as Congress considers tax reform in the future….”
–Not quite the response I would have liked, but I will try again at a meeting with his people.
@IrsCompliantForever – That’s great news! I met with his staff (and met him in passing) last week. My mother also filled me in a bit on how he is perceived locally (Seattle). Turns out that he has overseas experience. Africa to be precise http://mcdermott.house.gov/index.php?option=com_content&view=article&id=2&Itemid=9
I think he would be a great addition to the Americans Abroad caucus.
Sounds like an excellent contact, Experience in living abroad is important although, US Giovernment employees are spared the tax trials and tribulations of ordinary Americans. Their cost of living allowances, reimbursements for tuition for their kids in overseas schools, home leave transportation, PX ppriveliges, etc. are all tax free whereas to ordinary Americans these sort of things are taxed as in-kind regular income. And of course they are not required to pay taxes to the government of their host country..
It’s actually a good response. Most letters have Little commitment. The one you received is similar to those I have been receiving, which means the Rebloodlicans are talking to each other about these issues.
You are absolutely correct, Roger. On the other hand I get positively giddy when I find a US politician with a passport and some foreign travel under his/her belt. When I find one who actually lived abroad I am ecstatic – they are rare birds.
Stunning, inspirational work Shadow Raider. Thank you so much. Wonder what will happen next???
@Mark Twain, I agree that the response I received from McDermott was positive. Also, being on House W&M is very important.
I just reacted a little negatively and probably unfairly to the letter as McDermott used more words, or seemed to give equal weight, on making the “confusing labyrinth” of tax compliance less confusing— than on fixing the real problem. If I am successful in meeting with his people in Seattle only RBT will be on my agenda.
Next month I pass through Michigan and wonder whether I should stop by at one of Carl Levin’s district sites and express my opinion…
I decided to contact my own senator, Ben Cardin (D-MD), who is the Finance Committee. His assistant didn’t want to meet with me, but asked me to send him my suggestions by email.
I think it’s been mentioned that one’s own Senator can help with such things as Freedom of Information requests.
I just understood something about the expatriation tax that I hadn’t noticed before. The expatriation tax is composed of two taxes at the time of expatriation, one on tax-deferred accounts and one on unrealized capital gains, and a transfer tax on the expatriate’s heirs later. I understand the reasoning behind the tax on unrealized capital gains, because the US doesn’t tax capital gains of nonresident aliens in general (I still think it’s unnecessary, it’s unjustified in many cases, and it may lead to double taxation, but at least the general concept is logical). I thought that the reason for the tax on tax-deferred accounts at the time of expatriation was also that the US didn’t tax these accounts from nonresident aliens either, but that’s not true. The US does tax distributions of US tax-deferred accounts of nonresident aliens, with a withholding tax of 30%, which they must ajust (pay more or receive a refund) later by filing a nonresident tax return (1040NR). The tax may be reduced or eliminated by a tax treaty, but in that case the person would pay tax to the country of residence. Foreign income can only be tax-deferred in the US for retirement plans under a tax treaty, in which case the distributions are not even taxed by the US if the person is not residing there (this is one of the few exceptions of the saving clause, allowed for US citizens abroad).
Therefore, there is no way that a person can avoid taxes on a tax-deferred account, in the US or abroad, by expatriating. The expatriation tax on tax-deferred accounts thus can only be explained as some kind of deterrent of expatriation, which is totally inconsistent with the justification for the bill given by the committees when they proposed it.
@Shadow Raider, Canada has an exit tax on emigrants leaving Canada. I am not aware of widespread complaints against this tax or concerns raised about its constitutionality.
Exit taxes have been much discussed before on IBS, but do you also (still?) oppose the Canada exit tax?
The argument that is continually made to me is that the Canada departure tax at emigration (unrealized capital gains?) is equivalent to the tax paid when departing by death in Canada—and that even though the departure by emigration tax must impact on mobility rights, it is a “reasonable” tax that would not contradict constitution since it (apparently) is identical to the departure by death tax. People who stay and die in Canada would not escape the tax—and similarly, emigrants should not be able to escape the equivalent tax on the gains.
Do you accept the argument?
@ShadowRaider, the tax on deferred accounts that is unavoidable on expatriation only applies if the person is ‘covered’, right?
@ShadowRaider, your conclusion matches mine. I have always maintained that while some of the exit tax may be defensible, the parts of it that relate to retirement accounts are entirely indefensible. Several commentators have noted that it leads not only to much higher tax on retirement savings because of vastly earlier payment but also to real double taxation. I don’t think there was ever any doubt that HEART was intended to punish expatriation, regardless of the hot air expelled in the JCT.
@IRSCompliantForever, Canada’s exit tax does not ‘pre-tax’ retirement savings decades before withdrawal and at higher rates than during withdrawal. If it did, I suspect you would see many more complaints about it.
@WhiteKat, yes. Confiscation of large chunks of one’s retirement savings is an extra disincentive put in place to catch people who are close to retirement and have worked hard and saved.
@IRSCompliantForever, In the case of Canada, I accept the argument because the exit tax is consistent: it doesn’t include items that would be taxed anyway like Canadian real estate and retirement accounts, unrealized capital gains are taxed at inheritance anyway, and the basis is adjusted when a person becomes a resident. However, in the case of the US the exit tax is not consistent. It includes items that would be taxed anyway like US real estate and retirement accounts. Unrealized capital gains, if kept until inheritance as a citizen or resident, are not taxed at all, and there is no estate tax for assets under $5 million (the exit tax exemption was set at $600,000 because that was the estate tax exemption in 1995, when the law was first proposed, and apparently the committees “forgot” to update the number in 2008). The basis is not adjusted for immigrants. There is also a huge potential for double taxation if the new country of residence also taxes the same gains when realized. Ignoring these details, I accept the tax on unrealized gains, but as Watcher also concluded, the part about tax-deferred accounts doesn’t make any sense. The transfer tax doesn’t either. If the exit tax compensates tax avoidance, fine, but that’s not what they are doing here. The US exit tax increases tax liability compared to if the person remained a citizen or resident.
@WhiteKat, Yes, this whole thing only applies to covered expatriates.
In these days of revenue-started governments the idea that something is double taxed is becoming a back-burner issue which, I fear, means that they no longer care much about it. What they all want is revenue for themselves. The mere fact that some other taxing authority has already collected tax revenue is something that they care less and less about with each passing day.
Foreign tax credits, for example, generate zero tax revenue for the taxing authority that allows you to utilize them to offset what you owe to that particular tax authority. The fact that you may also have paid tax on that income to some other country is just your tough luck. It is punishment for your bad behavior.
Ninety-two percent of the US tax returns filed with the IRS by US persons abroad, with the FEIE and the use of foreign tax credits, end up owing zero in taxes to the US. But they sure cost the people who ore obligated by law to file them a pile of money to be able to submit correct tax returns. Tax returns like this, instead of generating tax revenue for the IRS are tax revenue destroyers because it costs the IRS a lot of money to just to process and handle them. They create make-work jobs that produce nothing of value to the nation or its economy. It is akin to digging holes and then digging more holes just to fill the holes you have already dug. A total waste of time and resources.
@ShadowRaider: The basis is not adjusted for immigrants.
Under ‘normal’ capital gains rules there is no step up, so immigrants get to pay US taxes on gains that occurred perhaps many years before they ever set foot in the US. But under ‘exit tax’ rules there is a step up for the valuation on the date you become a US resident.
http://hodgen.com/property-you-acquired-before-coming-to-the-usa/
Right on the rest though: potential for double tax on assets with a gain, once by the US on departing and again by the country of residence when you actually sell; potential for double-tax on retirement savings; potential for large increase in tax liability due to section 2801 transfer tax, and so on.
Like FATCA, the ‘exit tax’ is a prime example of a reasonable premise with an extremely poor implementation. I am pretty sure it destroys the revenue stream it intends to capture, but… hey-ho!, I don’t really care. The US is not my country and therefore its self-destructive tax policy is not my problem. If anything, the US ‘exit tax’ makes my country more attractive to well educated immigrants who might otherwise choose the US as their preferred destination, so on that basis HEART could well be a net win for me and for my country’s economy.
@Shadow Raider, my question only related to the Canada exit tax, a tax not designed as a “punishment” for leaving.
The US expatriate tax is as you say a special case, and with its intent in part being to “…express official disapproval of..[and] punish tax-motivated expatriation.”
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1628568
@Watcher, Thanks for the clarification. I was already aware that of the adjustment for immigrants under the exit tax, I was referring to the general capital gains tax.
@IRSCompliantForever, Sorry if I diverged. Regarding the Canadian exit tax, I don’t think it’s necessary, and it can still cause double taxation if the new country of residence taxes the same gains when realized. However, it’s consistent with the rest of the Canadian tax system, so I agree that it’s not designed to punish.
@Shadow Raider, now I diverge:
Have you interacted with Congressman Sandy Levin or his office? He is on the House W&M Committee,
@IRSCompliantForever, I haven’t contacted Sandy Levin’s office.
In the “For what it is worth” column, the other day he started following me on Twitter. Don’t know why. So, I sent him this. Maybe a staffer saw it. Probably not.
https://twitter.com/FATCA_Fallout/status/378384927336566785
@Just Me,
Interesting—a positive sign? I asked because I am going to try to visit his office in a few weeks.