Advocacy to change the U.S. rules of “citizenship-based taxation” is going strong. For example, last week there was a delegation in Washington, DC. Americans Citizens abroad is active and working hard. Republicans Overseas through the efforts of Solomon Yue has been a leader. Democrats Abroad is starting to rise to the occasion.
Legislative change will require a “conversation” with the “powers to be” in DC. It is difficult for those who have not experienced the difficulties of complying with the U.S. tax code (as a “taxpayer abroad”), to understand the problem.
One of the responses frequently heard is:
“What’s the problem”. You can exempt about $100,000 USD per year under the Foreign Earned Income Exclusion.
Although true, as you know, the exclusion applies to “earned income” only. There are many sources of income that are (1) not earned income and (2) are not taxable in your country of residence and (3) are taxable in the USA.
In order to assist those who will be part of “the conversation” in DC, I would like to ask that you provide examples of how/why a U.S. citizen living in another country with income well below the $100,000 Foreign Earned Income Exclusion can end of paying tax to the United States.
I think that a number of focused examples could be very important. These examples could include things like phantom capital gains and U.S. taxation “kicking in” at a lower level of income than in your country of residence. Of course it would be great to be able to document and wide and diverse range of examples.
When if you comment, if you could provide reasonable detail and specify where you live. Also, if you have any knowledge of how a tax treaty might affect U.S. tax (recognising that tax treaties mostly do not assist individuals) it would be helpful.
Thanks in advance!
I live in the UK. My salary is £26,000 before tax, so I’m well under the FEIE.
Around 13 years ago I started up a Unit Trust ISA. Under UK law, there is no tax on the capital growth or dividends. However, US tax law declares that this is a PFIC, and would tax me heavily on the capital gains plus charge interest on the unpaid tax from previous years. There would be no UK tax to offset, and this is not considered to be ‘earned income’.
Capital gains. I have just the one house, my primary residence. Under UK law, I would pay no capital gains upon the sale of this house. Under US tax law, I would be subject to capital gains. Again, there would be no UK tax to offset this, and this is not considered to be ‘earned income.’
Finally, when I retire, I can draw down part of my pension as a lump sum. This would be tax free here in the UK. Under US tax laws, I would be taxed on the lump sum. No UK tax to offset this, and it would not be regarded as ‘earned income’.
It’s not exactly a tax but Israel and the us don’t have a social security agreement so freelancers have to pay social security to both countries which in the short term is very expensive and in the long term putting the money in the stock market or saving up to buy a home would be much better investments.
Unemployment benefits from a foreign government – not taxable in that country so no FTCs. Not earned so no FEIE.
Retrenchment payments when made redundant (eg 1 week for every year worked) – often tax free or limited tax in foreign country (eg £30K exempt in the UK), not considered earned as relates to prior years.
Phantom FX gains every time you make a repayement on your homeloan.
PFIC rules clashing with EU KID rules. Us Persons should not invest in funds which are PFICs (ie should onkybinvest in US based funds). But EU citizens cannot be offered (by advisors or brokers) any funds that have not issued a Key Information Document in a prescribed format. No US funds issue these documents. So EU resident US Persons are unable to by US based funds/ETFs due to EU rules and are not able to buy EU based funds/ETFs due to US tax PFIC rules. Check mate.
Pension contributions in one country when you live in a third country. If you live in the UK you can claim treaty benefits to exempt your employer’s contributions to your UK pension. If they second you to another country (eg France) for 3 years and another and another, you cannot claim treaty benefits because although you are still employed under a UK contract to a UK employer you don’t qualify for the treaty. And when you take out your pension in your retirement the UK will tax you (no matter where in the world you live) and there will not be anything to claim the credit against in the US so you’ve paid to the US when contributing and paid to the UK when withdrawing. Maybe up to 80% tax!?
In Canada we have Registered education plans (RESP) where you can contribute post tax for your child’s education and children withdrawal tax free. Everyone can get a $500 match each year from the government for a $2500 contribution and lower income persons will get additional grants whether or not they contribute $. The US views this account as a foreign trust and taxes it accordingly. The same is true of the Tax Free Savings Account (TFSA) which is like a Roth without any age restrictions for withdrawal. I’m no accountant but I believe you would pay tax as a lower income person on a foreign trust?
TCJA’s Transition Tax.
In Switzerland, women on maternity leave or young adults performing (compulsory) military or civil service are financially “compensated” under a mechanism called Allocation Perte de Gain (or Erwerbersatzordnung in German).
This income stream is taxable in the US because it is technically unearned income, penalising women on maternity leave and nineteen-year olds on national service.
The 2nd example I have from Canada is we don’t get a child tax deduction, instead you get up to $6496 per child under 6 and up to $5481 per child 6-17. It is come based and phases out over $100k. There are also some other benefits offered by the provinces that can boost this further for very low income and kids with disabilities. This $ is not taxable in Canada since it’s funded by Canadian tax payers but is taxable in the US since it’s unearned income.
@All
These are fantastic responses! Please keep them coming and please to ask others who you know to contribute to this!
Lottery and gambling gains – even when won in Canada!
https://blog.turbotax.intuit.com/income-and-investments/how-are-gambling-winnings-taxed-8891/
UK – not only do we pay US capital gains on over $250,000 gain on main home (gain not at all taxable in U.K.) Phantom Currency gains on sale of main home when the money has never been in dollars also has to be paid (whilst shockingly, any phantom currency loss is not allowed to be taken).
Help to Buy or Lifetime ISAs where UK government gives a significant bonus for savings towards first home or retirement (unearned income by US standards but tax free here) is considered non earned income so is taxed by the US government.
Child benefit – what is used in the U.K. instead of a tax deduction, is unearned income and so is taxed.
It is impossible to save in private pensions or the stock market here in any form of mutual funds as considered PFIC, etc etc…..
If you have a mortgage in the foreign country where you live and then a few years later you refinance your mortgage, but in that time the foreign currency denomination of your mortgage has weakened against the dollar, so now the USD value of your mortgage has decreased from the original amount minus your payments. Then according to the IRS you have a foreign currency exchange gain and owe taxes on your “gain” that isn’t really a gain.
https://www.ingletonpartners.com/the-us-taxation-of-a-mortgage-foreign-exchange-gain/
Similar to US IRS punitive (and discriminatory) treatment of our RESPs and TFSAs (mentioned above), Canada’s ‘tax free’ registered savings plans for those with disabilities (RDSP) STILL not recognized by the US as ‘tax free’ or ‘tax exempt’ (see ex. ). Considered taxable ‘foreign trust’ by US (though no formal ruling to that effect has been made by IRS, same as for TFSA and RESP as far as I know to date?) .
Our Canadian federal government remains complicit and negligent in not demanding that RESPs, TFSAs and RDSPs be exempted from US tax under the existing tax treaty with the US – similar to the treatment of our RRSPs ( historically originally taxed by the US, subjected to onerous, punitive and complex reporting and then finally – during the outcry over the OVDI, FATCA campaign of fear and spotlight on IRS treatment of RRSPs – finally the IRS simplified a process for obtaining IRS recognition of RRSP tax free status – under certain conditions) .
US maltreatment of the most vulnerable continues to be glaring – by extraterritorially taxing education savings, disability savings and the ordinary savings of Canadian households – despite the IRS celebrating and advocating that US residents use parallel taxfree US savings mechanisms – available only for those living and saving INSIDE the US. And to add insult to that injury, the US provides for NO extraterritorial assistance for the vulnerable – minors and families needing help with post-secondary education, those with disabilities, etc. outside the US.
US tax academics and apologists for US extraterritorial taxation inside the US are apparently not bothered at all since they never (with few exceptions) mention these issues. Compare the zero authors writing about these well known and now longstanding inequities to the numbers of those writing to justify the extraterritorial taxation of those living and paying taxes outside of the US – including justifying the taxation of those who merely inherited UStaxableperson status via a parent. A few singular US tax law practitioners have helped us bring this to IRS attention ( ex. https://hodgen.com/irs-meetings-today-about-rrsps/ https://hodgen.com/mentally-incompetent-people-and-renunciation-some-bad-solutions/ ), as well as some tax accounting organizations like the ex. AICPA https://www.aicpa.org/press/pressreleases/2016/aicpa-presses-us-treasury-department.html https://www.aicpa.org/content/dam/aicpa/advocacy/tax/downloadabledocuments/2016-03-04-comments-on-proposed-tax-relief-us-can-equivalent-purpose-def-tax-savings-plans.pdf )so US tax advocates as well as the IRS and Finance Canada cannot say they don’t know about the problem).
One prominent US tax academic was asked in person during an event here in Canada about the plight of those whose RDSPs were considered taxable but who were denied even the partial ‘relief’ of renunciation due to being considered legally incompetent. The response was that perhaps some kind of ‘fix’ could be contemplated. Most of those US tax academics continue to egregiously sin against the most vulnerable ‘taxablepersons’ outside the US by never mentioning the US punitive extraterritorial tax of education, disability and other types of savings generated and held outside the US by those ‘abroad’.
There is also the US extraterritorial maltreatment of our local / non-US disability benefits and grants as they are not considered ‘earned’ income. Same for our Canadian EI, maternity benefits, etc.
What could be more egregious than the US extraterritorially taxing those outside the US in conditions innately designed to help individuals in need – ex. during school, maternity leave, unemployment, retirement, disability, etc.?
The UK does not have tax deductions for dependent children. Instead there is child benefit which the government pays directly into the claimants bank account. This is usually paid to the mother. If the mother is American then the benefit would be liable to US tax. If the mother elects that the non US father claim the benefit instead, the mother’s future state UK pension would be affected if she was not earning or earning enough to pay National Insurance contributions.
I am in Canada (BC). When I worked I could use the earned income credit and never had to pay any US tax.. Now that I’m retired and no more earned income, just Canada pension and a RIF, I have had to pay tax even though my income is only about $34,000 US. I pay my taxes in both countries. It really sucks. I have lived in Canada over 40 years, hold dual citizenship but have resisted renouncing because all my family lives in the US. I go to an accountant in the US to get my taxes done as no one in my area will prepare US taxes so it gets expensive to comply.
Yearly expensive compliance costs over and above for accounts deemed by the US ‘trusts’ — 3520 and 3520A and penalties for not filing (for those with lower income, disabilities, those least able to understand complexity, pay expensive fees …
https://www.irs.gov/pub/int_practice_units/FEN9434_02_05R.pdf
To say nothing, of those who are deemed not allowed to expatriate due to lack of mental capacity.
With reference to:
This is an interesting way to think about the issue. The only way to avoid U.S. taxation if living outside the USA is to get all your income from working. Once you stop working your income will become taxable in the USA.
Notice how “Digital Nomads” are able to meet the Section 911 test by staying outside the USA for 330 days a year. If they both avoid any U.S. income and ensure that their only foreign income is earned income they will not be subject to U.S. income tax. But, the moment they have any investment or other unearned income they will be subject to U.S. income tax.
Perhaps the motto of Americans abroad should be:
This is so perverse.
Carbon taxes in Canada (the politicians here have falsely accused the essential to all life CO2 molecule of climate malfeasance) are an added cost to all Canadian residents. QUESTION: Would a US tainted Canadian resident who receives carbon tax rebates from provincial and/or federal governments have to report this as unearned income on their US tax forms? There are also GST/HST rebates and possibly others I’m not aware of which could fall into the same category. These are relatively small amounts but everything adds up. If these rebates are reportable I wonder what IRS paperwork is involved.
Win tax-free lottery ( or pre-paid tax lottery)
San Marino does not have a tax treaty nor a totalization agreement with the USA. Unemployment income is generally not taxed by San Marino but is taxed by the USA, Also, San Marino taxation can be very low or not existent in certain cases. Self-employed persons in San Marino pay a local equivalent of the self-employment tax for which they cannot claim a credit. Generally, there is no double taxation, but tax is due to the higher tax jurisdiction, which may be the USA. In the case of self-employment, the taxpayer is subject to double contribution: Italy and San Marino. In Italy, the sale of real property generally is not subject to capital gains taxes but may be subject to US taxes. These statements are based on actual cases. Sometimes a workaround can be found, but more often paying some US taxes becomes unavoidable.
Easy. Maternity Leave.
In Canada when you get maternity leave, you pay Canadian/provincial taxes on it, but since it’s not “earned income” you also have to pay tax on it to the US. There are no tax credits to offset this
As to who would bother reporting this to the IRS, that is another question.
I own a two-unit rental in the USA. It has a mortgage, which I pay. It’s in an econocmically depressed real estate market, although growing. My rental income is about twice my mortgage payments. The remaining half represents almost all of my income. I work in my country, but my income is negligible compared to my US income. If I reach the minimum US income, I’ll have to pay income tax. So far, I haven’t earned that much in the USA:
MJ. Seems to me that there is something wrong. With just CPP and a RIF you should not have to pay any US tax. CPP is taxable only in Canada. You don’t even have to mention it on US return.
““What’s the problem”. You can exempt about $100,000 USD per year under the Foreign Earned Income Exclusion.”
Perfect! This highlights the OVERSIMPLIFICATION response from many Republicans in US Government, no empathy or concern for people, only corporate profits and their dividends / pensions.
Rental income. The US requires depreciation be taken on a rental property, so when it is sold, there will almost always be recapture income for any gains. Very few low income people claim CCA in Canada on rental properties specifically to avoid the recapture tax later.
Excellent project.
May I suggest that the direction would have more impact with greater focus.
* Focus on Canada, U.K., Australia. Not the entire world, although examples from the world may be provided.
* Focus on total tax paid for a certain income level in: USA, Canada, U.K. Australia.
* Focus on (as is the request of this project): where the FEIE will not save you.
* Focus on taxes in the countries where the U.S. will not provide tax credit, and these may include SALT, mortgage, VAT Or any other taxes higher in the U.S.
*Focus on compliance costs: USA, Canada, U.K. Australia.
*Focus on the restrictions imposed on investing etc.
* Focus on U.S. resident services received USA vs Canada, U.K. Australia.
It will show the raw deal from the US.
Potential remedy here is hinted at what is proposed by Treasury for GILTI exemption, and that is if the company income is taxed above a certain level by the country of actual residence then EXEMPTION.
This feeds into the MYTH Homelanders have that US Persons are out to move abroad to evade taxes by moving to where they perceive as tax haven countries.