by Karen Alpert
www.fixthetaxtreaty.org
Overview
This feedback addresses the Residence Based Taxation (RBT) proposal from American Citizens Abroad that can be found at these links:
- Residency-Based_Taxation_ACA_Proposal_Side-By-Side_Comparison_161201_Final (1)
- Residency-Based_Taxation_Baseline_Approach_Feb._7_2017
- https://www.americansabroad.org/news/aca-publishes-detailed-descr-of-its-rbt-proposal-and-announces-coalition-to-score-rbt-proposal/
- https://www.americansabroad.org/news/aca-advances-on-residency-based-taxation-rbt/
This proposal starts from the premise that citizenship is an acceptable basis for taxation. Shouldn’t that premise be questioned? Allison Christians, tax law professor at McGill University, argues that citizenship alone is not a sufficient basis for taxation ( https://ssrn.com/abstract=2924925). Every other country on the planet (bar Eritrea) starts from the premise that countries have the right to tax residents to support the services used by residents.
Qualification for RBT
For Accidental Americans – both those born in the US to foreign parents who have not lived in the US as an adult, and those born outside the US who qualify for US citizenship from birth but have never lived in the US – the justification for citizenship based taxation is non-existent. Do these individuals need to apply for a “Departure Certificate”? If so, at what age?
When a person makes a long-term move out of the US, why should they have to wait for 5 years to qualify for RBT? If I move from California to Texas, once I’ve established a residence in Texas, California no longer taxes me as a resident, effective immediately. Why should an international move be any different?
While waiting those 5 years, US tax will cost low income earners much more than it does under the current system. The proposal repeals the Foreign Earned Income Exemption (FEIE). While the level of FEIE is quite high, it is most valuable for middle class and lower socio-economic groups. Other countries have much more generous tax free thresholds and lower tax rates at low income levels. In Australia, for example, an individual could earn up to A$20,000 (US$15,000) before any Australian tax is due. Loss of FEIE will mean tax is due to the US for individuals earning US$10-15k. At the other end of the income spectrum, however, FTC is always a better answer than FEIE. Australia’s tax rates rise to 45% for incomes above A$180,000 (US$135,000). So, repeal of Section 911 FEIE will impact those least able to pay additional taxes and exacerbate income inequality.
The proposal does not address other information returns. Current IRS rules require that forms 8621 (PFICs) and 5471 (controlled foreign corporation) are required even when a tax return is not. For many Americans abroad, the reporting (and associated punitive penalties) is more of a problem than actually paying taxes (most owe no tax to the US anyway). If the reporting continues as long as one is a citizen, then renunciations will continue as well.
Departure Certificate
When applying for a Departure Certificate it appears that the IRS has control over the timing of the issuance of the Certificate and thus the effective date. With the current renunciation process, the potential renunciant has the date of the appointment in advance and can decide on the day whether to complete the process or not. With volatile exchange rates, the timing can affect the US dollar net worth of the individual, potentially subjecting them to the Departure Tax should the value of the US dollar fall relative to their home currency in the time between submission and approval of the application for Departure Certificate. Additionally, lack of control over the timing could cause hardship for those who must be free of US reporting to take up a job, or otherwise have a time-critical need to be free of US taxation.
Annual re-certification is a bureaucratic nightmare. One possible alternative is to collect this information as US citizens enter and leave the country. For those who return to employment in the US, the chance of avoiding taxation is minimal. Similarly, Social Security checks or investment income sent to a US address could be used as a rebuttable presumption that the US citizen is once again residing in the US.
In the Departure Tax section of the proposal it is not clear whether the intention is to use the net worth threshold in section 877(a)(2) and raise that to $5million for both renunciants and citizens opting in to RBT. Given the justification used by legislators for both the exit tax and the Departure Tax, the net worth threshold for both should be linked to the estate tax threshold and similarly indexed for inflation.
At what point does an individual determine that they have been tax compliant. Is it similar to the current Exit Tax procedures where delinquent returns filed before filing form 8854 allow one to certify compliance?
The IRS “User Fee” of $2,350 per person is a lot of money for those on modest incomes – precisely the people who will be hurt most by the repeal of section 911. The renunciation fee, which the IRS User fee is based on, is already the highest such fee in the world, and a financial hardship for many. Forcing citizens to buy their way out of Citizenship based taxation at this high price means that only those who are already relatively well-off will be able to buy their freedom. Like the current system, the proposal exacerbates income inequality by making it prohibitively expensive for those with incomes below the median to exit the double taxation forced on them by the unfair system of citizenship based taxation. As under current rules, the proposed User Fee also makes it harder and more expensive for US citizens residing outside of the US to leave the US tax system than it is for permanent residents (green card holders) – in this area citizens are treated worse than non-citizens!
Furthermore, setting the IRS User Fee to the same price as renunciation makes renunciation preferable to RBT for many citizens abroad. Those who will not be covered expatriates, who are having trouble maintaining banking relationships, are shut out of jobs due to either FATCA/FBAR reporting or the requirement to report controlled corporations to the IRS, or have no intention of returning to the US will find renunciation preferable.
Anti‐Abuse Rules
Under the Anti-Abuse rules – gain from sale of securities taxable in the US for two years after receiving the Departure Certificate: but individuals must have a foreign residence for five years before they are even eligible for a Departure Certificate, and if their net worth is above $5 million they must pay a Departure Tax. What abuse is it if securities are sold within 2 years of receiving the Departure Certificate?
On page 6: “Individuals eligible for the special rule for individuals residing abroad (RBT rules, above) would be subject to the Departure Tax, whether or not they are tax-compliant. The date of departure for such individuals would be the subsequent date of issuance of a valid Certificate.” This appears to contradict the special rule on page 5 which states that these individuals are not subject to the Departure Tax if they are tax-compliant.
On page 6: “If an individual who was a non-resident American for any of the prior 5 years and was a resident American for any year prior to that period, and again becomes a resident American, then he or she shall be treated as a resident American for each of the prior five years.” (emphasis added) This appears to be saying that anyone returning to the US who has ever been subject to US tax will have to amend their prior 5 years of non-resident returns and file as a resident. The proposal requires individuals to wait for 5 years before they are eligible for RBT, then if their life circumstances change and they move back to the US, they will lose the benefit of up to 5 years of non-resident treatment under RBT?
FATCA and FBAR reporting
There are several reasons FATCA should be repealed beyond the problem of access to banking by US Persons. FATCA costs much more than it will ever generate in revenue. The OECD’s Common Reporting Standard (CRS) has been implemented by financial institutions in many of the countries with FATCA IGAs. Under CRS, institutions collect the tax residence of their clients. If the US were to abandon FATCA and implement CRS (not likely, I know), then financial institutions would not be required to use a separate system for American clients, and they would no longer be subject to the 30% FATCA withholding. Under those circumstances, FFIs would be much more welcoming to American clients. Furthermore, those Americans who qualify for RBT, would be tax-resident only in one country, and only reported to that country. Those who do not yet qualify would be tax-resident in two countries (one being the US) and their data would be reported to the US.
Same Country Exception (SCE): There are many legitimate reasons to hold bank accounts in countries other than where one is resident. In Europe, in particular, it is quite common to bank in another country. SCE does not make compliance any easier for FFIs – they must still keep track of their American account holders and treat them differently should they move across a border or back to the US. Under FATCA, the threat of 30% withholding is so draconian that many banks, especially European banks burned by the DOJ, are not willing to take any risks with US citizen account holders. What concrete evidence does ACA have that banks, especially in Europe, will be any more willing to deal with Americans under SCE?
For taxpayers who qualify for RBT and have received a Departure Certificate, why does the US need to know about their non-US bank accounts and investments? In this circumstance, non-US accounts do not generate income taxable in the US. Requiring FBAR reporting (and form 8938 for any accounts not required to be reported on FBAR) will be seen as a disadvantage to retaining US citizenship. Many NRA spouses and business partners object to joint accounts being reported to the IRS and/or FINCEN.
@ JapanT
“But deferred compensation items such as pensions are included in the net wealth calculation when expatriating and if total wealth is over 2,000,000 they are taxed at source at 4O%,(and again by your resident country,)”
@JapanT
“Then, those covered by this have already paid this, correct? How does this change with a move to RBT?”
RBT would not change this, they would have already paid , unless they extracted money from the fund to bring them below the 2,000,000 while still a US citizen, paid the current rate of tax to the US and gave away the money eg to family to lower their net worth.
This was just an aside, to state when the tax treaties would NOT come into affect, ie for covered expats.
Karen – I don’t know, maybe.
So, am I correct that no one would be hurt by a switch to RBT or am I missing something?
The effect of RBT on US retirement savings / SS depends on the treaty – and there are many permutations.
The Australia/US treaty says that SS is taxable ONLY by the country paying it. The US has the sole right to tax US social security, and Australia has the sole right to tax the Australian Age Pension (and a small minority would argue that superannuation falls under this provision as well). So, a NRA living in Australia who qualifies for US Social Security benefits will pay 25.5% of those benefits in US tax, withheld at source, but will not include any of this on their Australian tax return.
As for retirement savings, there is a clause in the treaty that says that “…pensions and other similar remuneration paid to an individual who is a resident of one of the Contracting States in consideration of past employment shall be taxable only in that State.” So, if a distribution from a US retirement plan to an Australian resident is considered a “pension or similar remuneration”, then it is taxable only by Australia and US withholding should be zero. Whether this applies appears to depend on facts and circumstances. There is a US private letter ruling on point (Private Letter Ruling 200416008), but the facts described are very specific.
When comparing RBT to CBT, it is important to remember that under RBT any US tax withholding will probably be at a higher rate than would have been due under CBT. This is because under CBT a non-resident US citizen still gets the standard deduction, personal exemption, and benefit of lower tax brackets. So, where the US withholding is greater than the tax paid in the resident country, RBT will leave someone worse off than CBT. For Australians, that is clearly the case with US Social Security.
@Karen et al
Here is an IRS chart listing the relevant treaty tables.
Table 1 has relevance to discussion.
All would need renegotiation under RO proposal.
https://www.irs.gov/pub/irs-utl/Tax_Treaty_Table_1.pdf
More info
https://www.irs.gov/individuals/international-taxpayers/tax-treaty-tables
“So, where the US withholding is greater than the tax paid in the resident country, RBT will leave someone worse off than CBT. For Australians, that is clearly the case with US Social Security.”
Still, isn’t that preferable to yearly paper work and or fear of fines for mistakes or omissions.
“…am I missing something?”
Under CBT, US citizens are entitled to US citizen tax breaks/benefits but are denied treaty benefits. Under RBT, US citizens would be entitled to treaty benefits but denied US citizen tax breaks/benefits. Some would be better off under CBT, some would be better off under RBT. If the US proposed to switch to RBT as a matter of policy, those who would be worse off under the change would try to prevent it, but if there was a clear and convincing policy objective, the change might go through. If there was no policy reason for the change, those who would be worse off under the change would have a much better chance of preventing it from happening.
But if the change was optional, each US citizen would be able to choose CBT or RBT so it would be less difficult to get that to happen.
What value would US tax breaks be if we need not file nor pay anything, on a yearly basis, to the States?
I think JapanT has it right, just the freedom from US forms, threats and penalties would be worth the small losses.
Japan T says:
Depends on the dollar amounts involved. For someone expecting US Social Security to be their main source of income in retirement, the cost of CBT compliance may be minimal, but the cost of RBT could be 20-25% of the income they need to live on.
I don’t think there are too many people in this situation (other than, perhaps, in lower tax / lower cost of living countries with large retired US expat populations) – but the point is that the dollars stack up differently for everyone. Not everyone will benefit from RBT.
“I think JapanT has it right, just the freedom from US forms, threats and penalties would be worth the small losses.”
If it turned out that all US citizens agreed in preferring RBT, that would certainly increase the chances of success.
“Depends on the dollar amounts involved. For someone expecting US Social Security to be their main source of income in retirement, the cost of CBT compliance may be minimal, but the cost of RBT could be 20-25% of the income they need to live on.”
Even that, I think is relatively small compared to the trouble of FBAR and risk of fines added to the risk of having one’s personal data leaked, the possibility of getting hit with fines for not complying with some future requirement that one would have no way to learn about.
To me, it seems like getting caught in a bear trap and not wanting to cut off the leg and free yourself because you don’t want to give up tennis.
“If it turned out that all US citizens agreed in preferring RBT, that would certainly increase the chances of success.”
What US citizens prefer seems to be irrelevant in the decision making.
“What US citizens prefer seems to be irrelevant in the decision making.”
Boy, ain’t that the truth.
What US citizens with deep pockets prefer is far from irrelevant.
“What US citizens with deep pockets prefer is far from irrelevant.”
While generally true, FATCA is sold as going after those with deep pockets. Deep pocket people are for CBT?
Am I correctly interpreting the most recent (Sept 27) ACA RBT proposal?
Does it say that a “departure certificate” would be waived only to those who first become IRS compliant?
This would include all those with a U.S. taint who do not have any meaningful relationship with the United States?
Non-meaningfuls would first have to become IRS compliant to get a get out of jail free card?
“Individuals meeting the residency test for RBT for at least 3 years prior to date of enactment of these rules and who certify under penalty of perjury that they have been tax compliant, would not be subject to the Departure Tax.”
From: https://www.americansabroad.org/media/files/files/d6a1660a/Residency-Based_Taxation_Vanilla_Approach_Sept_27_2017.pdf
That’s a nonstarter for me.
The ACA RBT plan is elective: the person has to actively choose RBT, and follow the rules, which no doubt include being compliant.
An elective proposal might (or might not) have a better chance of becoming law, but for many would not be any help at all and might be worse.
While a plan that involved a complete switch from CBT would be worse for a different subset, and might also have less chance of becoming law.
From what I gleen from here, seems no different than renouncing, gotta spend time and money I do not have to get compliant and file a bunch or paper work. I’d rather knaw my arm off and then never have to deal with any of this again.
Worse than renouncing, in requiring more paperwork; renunciation does not require complyiance.
@Stephen Kish
“Does it say that a “departure certificate” would be waived only to those who first become IRS compliant?”
I’ve read and re-read the 27 Sept. release several times, and I can confidently say it’s not clear. But, nonetheless, this is my interpretation.
IMHO, there is no “waiver” of the Departure Certificate. Don’t confuse Departure Certificate with Departure Tax (which might be waived if residency requirements and tax compliance are met).
To qualify for RBT, one must qualify under existing 911 rules for residency, AND, one must apply for a Departure Certificate. This is true for all wishing to be under RBT treatment (no exceptions). Therein lies the rub (actually, 3 rubs).
In order to validate a Departure Certificate, in the year of obtaining the Certificate, one must file a “split year” tax return (1040NR with 1040 attached). For each and every year thereafter that one wishes to retain RBT status, a statement confirming 911 residency requirements are still met must be filed with the IRS, AND, FBAR rules and requirements remain in effect.
The Departure Tax requirements are met by filing a “form” similar to 8854 (contents undefined) which maintain basic (but not exact) 877 rules. Thresholds for tax due are raised from $2million to $5million. What is unclear – it appears this “form” would also need be filed in the year of obtaining the Certificate, but the document also says:
“Special Rule for Americans Abroad. Individuals meeting the residency test for RBT for at least 3 years prior to date of enactment of these rules and who certify under penalty of perjury that they have been tax compliant, would not be subject to the Departure Tax.”
So yes, if one seeks to avoid the Departure Tax element, tax compliance needs to be confirmed. What is unclear – if you go forward by completing the Departure Tax “form”, do you need to be tax compliant – BUT, what questions about compliance will the form ask (as of yet unknown)? Still, it’s a moot point since in order to obtain the Certificate, the split year return must be filed anyway. So, 1 year, 3 years, or 5 years, you still have to file a US tax return.
Odd:
“Individuals could “opt out” of the new residency-based taxation rules simply by not applying for a Departure Certificate.”
Do they just not understand the difference between opting out and opting in? Under this plan, those hoping to escape US tax-filing would have to opt in to these new rules. And opting in would be no simple matter.
Is there any sensible policy justification for putting the departure certificate “user fee” on par with the renunciation fee? I can’t seem to find one in the proposal.