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!
The layers of mutiple potential penalty structures designed to punish all things ‘foreign’ are in themselves a US extraterritorial tax on individuals outside the US.
And, the cost of US tax ‘expert’ assistance in preparing 3520 / 3520A for non-US sited estates functions as a US extraterritorial tax on those living outside the US. The non-US sited estate could have zero US tax owing, but incur outsized professional fees merely for the preparation of required forms.
US persons living abroad with incomes below $100,000 per year need to save for retirement. Foreign pension plans generally do not qualify for special tax treatment like US qualified pension plans, US 401Ks or IRAs do. Pre-tax contributions are not deductible for US income tax purposes and annual growth in plans may be taxed – even if contributions are after-tax and /or income is not distributed. In addition, employer contributions to those plans may also be taxable in the year of contribution.
As one example, a TFSA account in Canada is funded by after-tax dollars as a Roth IRA is in the USA. Growth in the TFSA is taxable by the IRS but not taxable in Canada hence no offsetting Foreign Tax Credit. US taxes plus heavy accounting fees means that a TFSA held by a US person is a loss-making retirement plan. In addition the US person abroad wanting to contribute to an IRA instead of a TFSA is not eligible to so so if their income is covered by the Foreign Earned Income Exclusion. Because of the tax treatment and unavailability issues both of these two retirement savings vehicles are useless to US persons abroad. Those more knowledgeable than I may wish to comment on the way other retirement plans used by US persons abroad are unfairly penalized by the US tax system. I have no personal experience with Australian pensions/superannuation, but do understand that reporting them to the IRS can be financially burdensome or even devastating.
US persons abroad with earned incomes of less than the ~$100,000 FEIE are financially penalized by the US tax treatment of pension plans and retirement savings.
Re: Portland @ 7:05
The CPA I have in the US wants a copy of my CDN tax return and he converts the CPP, OAS & RIF amounts to US dollars and I also receive a small SS amount of $4400 per year which is in US dollars. He has included all of them as pension income when determining any tax owing. I have paid a small amount of US tax for the last three years and my CPA never once advised me to exclude my CDN pension amounts. I would expect a CPA would know what they are doing but perhaps time to find a new accountant. I’m too old for all this grief and definitely not trying to screw the US system. I follow the rules and comply and still pay but I do get a refund on my CDN return due to medical deductions and I get tax taken off my CDN pensions. I think there are a lot of us lower income expats out here and when asked by other expats I tell them to stay under the radar as it’s not worth the aggravation. I don’t have much so when I die someone else can figure it out.
**Where can I look to find out about not reporting CDN government pensions on a US tax return? I would like to see that in writing.
Back to my earlier comment:
This one needs to be divided:
“* 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 taxes in the countries where the U.S. will not provide tax credit, such as VAT (higher than U.S. sales tax) etc.
* Focus on US taxes where the source country will not provide credit for U.S. taxes as the source is not the U.S. NNIT, AMT,
*Focus on tax breaks the U.S. has but not source country and thus can not be taken: mortgage deduction. SALT deductions not allowed as foreign.
http://isaacbrocksociety.ca/2019/06/16/brock-project-could-you-share-examples-where-lower-income-americansabroad-would-be-required-to-pay-u-s-taxes/comment-page-1/#comment-8643335
Where is this leading to.
IMO, it best leads to a few charts to convey the situation.
One chart could be income tax rates of U.S., Canada, U.K., and Australia going across a range of incomes. Then we see that those countries are way higher. Then, as that is the case than persons tax resident there should get EXEMPTION from U.S. taxation (similar to the exemption proposed by Treasury for GILTI).
Two things:
1) Like Arielle Oren stated above, one who is self-employed easily ends up paying double social security tax, which eats up 30% or more of gross income.
2) Charitable donations: my husband and I donate generously to various charitable organizations. Although many are international organizations (WWF, Greenpeace, etc.), we donate to the local offices where we live. Naturally! They are all set up as monthly auto-pays from our local bank account (sorry, I mean “foreign”–boo! hiss!–BANK). However, whereas we can deduct such donations from our local taxes, since they are not US-registered offices, we can’t deduct from US taxes. So America is taxing the money we give to Greenpeace!
A more egregious example in our case: years ago my husband published a book locally, from which he donated 100 percent of his royalties to an Asian-headquartered animal welfare charity. The book sold well and generated respectable money for the charity organization. The publisher sent him a bi-annual cheque, which he then paid over to the charity. He never actually cashed them himself. The one time we consulted an accountant for our US taxes, the accountant threw a fit! Of course we had to declare the full income from the book, and were unable to claim the 100% donation of those funds. Since this was “unearned income”, my husband had to pay around 20 percent (I forget the exact figure) of the royalty that he himself never received to the IRS. He changed the contract with the publisher, who now pays the charity directly. But this experience left him extremely bitter toward the USA; here he was, trying to unselfishly do good in the world, and the IRS punished him for it.
“have paid a small amount of US tax for the last three years and my CPA never once advised me to exclude my CDN pension amounts. … I do get a refund on my CDN return due to medical deductions and I get tax taken off my CDN pensions.”
Perhaps the CDA is simply over-reporting to make sure you get a refund?
I get the impression a lot of US tax advisers believe they need to make sure the client keeps getting a refund so that the client (supposedly impressed by the tax adviser’s expertise) will come back the next year.
Maybe worth doing it yourself, if your affairs are not complex. If your Canadian pensions are exempt by treaty, you don’t need to report them. This is clearly stated in the 1040 instructions.
Nothing will come of this. To win this we would need a crowd funding campaign that would raise 10 of millions of dollars. Then we could afford the best lobbyists. Even then we would need a better strategy. A better strategy would be to present the Americans abroad as an asset.
For most politicians that means as voting assets. Most Americans abroad do not vote. If we could show that a better compliance system would lead to more voting, especially if the voters abroad were packaged into their own electoral college, then the politicians might be better disposed to provide a solution. At the moment we are asking for something for nothing.
Earlier this year I attended a meeting in London where George Holding spoke about his proposed bill to address the tax issues faced by Americans abroad. The bill is not intended as a solution. The intention of the bill is to get congress debating the issue properly with the hope that a workable bill emerges from the debate. However this plan requires a Democrat on the ways and means committee to support it. George is still trying to find one.
Frankly there will be no relief in the short term. I have decided to renounce as soon as I am able to do so. Everyone affected by this issue is going to have to pull the trigger. That means either moving to the USA to live to renouncing.
With respect to the issues of U.S. taxation of CPP and OAS for U.S. citizens resident in Canada:
1. Assuming that the CPP and OAS are exempt from U.S. taxation pursuant to the Canada U.S. Tax Treaty, the IRS says:
https://www.irs.gov/individuals/international-taxpayers/nonresident-aliens-exclusions-from-income
2. On the question of the treaty exemption for CPP and OAS payments for U.S. citizens living in Canada:
https://www.fin.gc.ca/treaties-conventions/unitedstates-etatunis-eng.asp
If you combine 1 and 2 you should get the result you want.
@Salamander
Sorry but this thread is for people who were asked the specific question of how low income tax compliant U.S. citizens abroad might end up owing U.S. tax. Not sure how your comment relates to that.
As Henry Ford said: Whether you think you can do it or you don’t think you can do it, You’re right.
MJ OAS and CPP are not taxable in the US for Canadian Residents.
I have posted a detailed answer on the tax questions thread so as not to take too much room on this one. See the right sidebar under “important Information”
From the comments on here I think the simplest solution that would be most likely to garner support from Congress is to change the FEIE to the FIE (maybe with a stronger domicile/physical presence test to exclude unearned income). Or, if people moving to tax havens to avoid tax is still a concern, institute a “standard foreign tax credit” where based on your country of residence and the average amount of tax (all types) that someone with said income level (irrespective of the source of income as long as it’s non-US) would pay you can take a no-questions-asked credit (similar to the standard deduction). In either case require a tax return be filed only if tax is actually owed.
This situation is similar to others already posted; it’s just another example:
A dual citizen of the US and Canada has a low annual income, say between $20,000 & $30,000. This person has been retired for many years and ALL of her income is generated from the proceeds of her investments that she (with her single-citizenship, 6th generation Canadian husband) has been able to make in the course of her life through a frugal life-style and careful money management. Because investment income is not “earned” income it is fully taxable (minus deductions) by BOTH governments. Problem is, she didn’t know that. While always acknowledging her citizenship in both Canada and the U.S., she was unaware (prior to 2011) that the U.S. regarded people like her (who had lived outside of the U.S. for nearly their entire lives) to be U.S. taxpayers.
By her very identity, she has, unwittingly, jeopardized her family’s financial well-being. If she were to come forward at this late stage in her life, either to enter the U.S. tax system or to renounce her U.S. citizenship “cleanly”, she would stand to lose a significant portion of her income-generating capital in tax and penalties. This would, undoubtedly, result in considerable financial hardship for both her and her husband – all because she made the choice, decades ago in her youth, to retain her historical *identity* as someone with long roots – and profound interest – in her American heritage.
Absolutely no need to come forward.
A retired US citizen living in UK could be hit with significant U.S. taxation if they were relying solely on investment income from a stocks and shares ISA holding mutual funds (investment trusts or unit trusts). Their ISA would be tax-free to HMRC but could be heavily taxes under the PFIC regime,.
They would also face potentially huge tax preparation bills as PFIC form 8621 is costly and complex to prepare. One could face huge taxes from phantom gains under the Mark to market regime.
One accountant quoted me something close to £14,000 PER YEAR as I held at that time over 40 holdings in mutual funds even though the average holding was less than £2000 each. We were talking about a portfolio in the region of $250,000.
I wound up hiring another accountant who was still painfully expensive but who was willing to amend the several years I needed to do a Streamlined disclosure for approx £8000. A lot less 14K times six years, etc.
Was a frightening time and so glad to have it all l well behind me.
I owed over $10,000 to the IRS which I paid because I realised I would need to be able to continue visiting family stateside, etc.
I could imagine that many longterm expats could face similar issues if they’ve done their financial planning the British way.
Another thing is that it would be very hard for someone with a small pension or ISA dividend income to benefit from claiming foreign tax credit Form 1116. Our personal allowance is currently £12,500 which is around $16,000 before any British income tax is due.
We also have an annual interest allowance of £1000 and I believe an annual dividend allowance of £2000. This is in addition to whatever interest or dividend income might be coming from an ISa which is tax-free here.
We can currently invest up to £20,000 per year into an ISA which is far more generous than the annual IRA allowances.
We also can take 25% of any pension drawdown as tax free…so under current rules, I could someday retire with over £20,000 coming in without even having to pay any income taxes to UK, though would be paying to US at that level.
So low income people can be hit at lower thresholds by US…but its true that U.K. taxation is far higher than U.S. tax rates for high income people.
Essentially what MuzzlednoMore explained.
“under current rules, I could someday retire with over £20,000 coming in without even having to pay any income taxes to UK, though would be paying to US at that level.”
That’s the way the treaty works. The aim is to try to prevent double taxation and to try to prevent “double non-taxation.” If the $20,000 wasn’t taxed by either country, the dual citizen would be being taxed more advantageously than US-resident fellow Americans; while at the same time the US/UK dual citizen could also be being taxed more advantageously than UK-resident fellow Brits by filing US tax returns to claim US tax breaks on US investments.
The treaty tries to plug the CBT-created loophole by providing that income not taxed by one country may be taxed by the other, up to the higher of the two tax levels.
If the dual citizen doesn’t file US tax returns, or stops being a dual citizen, the problem goes away.
@Phyllis Henderson, I can actually appreciate that dual citizenship comes with duties as well as privileges. But U. S.expats/dual citizens are being blindsided by the lack of information being given to them about continued compliance obligations.
The condors love it and are minting it.
It is also very difficult to take make use of U.S. tax breaks on U.S. investments because it’s currently very difficult to have a U.S. brokerage account if they find out you’re no longer living in the U.S., plus EU ‘KID’ egulations make it very difficult to have U.S.-based mutual funds or etfs, for example.
@monalisa1776 – exactly. US Taxpayers shoudl not own funds outside of the US (they are going to be PFICs or cost a lot to prove every year that they are not PFICs). EU residents are not allowed to be sold funds or ETFs that do not issue a KID (no US funds issue KIDs). US brokers are now blocking EU residents from buying ETFs. So you cannot benefit from any low cost passive (or active) investment vehicles. Unfortunately Betterment etc have not started offering their direct ownership of indices to non-US customers. And that’s before you get into foreign resident US persons not being able to save for retirement in local pension systems so are at a great disadvantage to any US resident US person who have many tax advantaged savings and investment products. US Persons overseas are mostly just looking to be treated equally to US resident US Persons or their colleagues with whom they live and work in their country of residence (often for their entire lives).
Paying US tax on a UK ISA is purely voluntary. ISAs are not reported under FATCA. So the IRS will only know about it if you tell them. If you then, yes, the costs of both the time to prepare the forms plus the tax can wipe out all of your gains and even eat into the capital.
Best just to stay out of the system if you want to be able to retire.
The inevitability of death and taxes can be particularly and unexpectedly painful.
This nasty little wrinkle may have persuaded many non-US-spouses to encourage enthusiastically their wife/husband’s speedy US renunciation:
For the sake of argument, let’s imagine one non-US-citizen spouse with their dutifully US-tax-form-filing US-citizen. They live in a mortgage-free home which they had bought gradually via their work-sourced earnings, all 100% outside the US, over previous decades. No longer working, they have a modest pension income, but little in the way of serious savings or investments. A very normal scenario.
The US-citizen dies first, and all the correct formalities need to be gone through. The US tax authorities want ‘their’ slice of the death taxes due on the accrued value the home the couple had purchased together. In the couple’s country of residence, these tax would fall due only at the death of the surviving spouse (also be true, if it the non-US spouse dies first).
However, the US tax authorities do not wait for the death of the surviving NON-US-spouse before demanding the prompt payment of ‘their’ slice of the pie. This falls due on the death of the US citizen – irrespective of any difficulties the non-US-spouse might face in raising the money.
With little in the way of savings, and a now reduced income due to the loss of the spouse’s pension, the grieving surviving non-US-citizen could very well find themself forced to sell their own home – to pay foreign taxes (to the US) for paper gains on their only substantial asset. An asset had been purchased with their own lifetime’s earnings, in their own country.
Yes, it stinks.
“U. S.expats/dual citizens are being blindsided by the lack of information being given to them about continued compliance obligations.”
Yes. It’s all explained somewhere or other, but there’s no single, official, concise plain-language explanation.
There’s actually an IRS reform bill waiting to be signed, I believe. It’s supposed to make the IRS more “taxpayer-friendly”, but as far as I know it doesn’t even mention the situation of US citizens living outside the US. Ironically, there has been a tussle between Treasury, which doesn’t want a “free-file” service which would actually be any help (i.e. compete with the commercial services), and various politicians who do want the IRS to be allowed to offer a service that would be good enough to compete with the $$$ services. In the end, I believe, they just left it out.
A good freefile service which could deal with the international situation could save a lot of problems for expats, by for instance popping up warnings about cross-border investments that would cause tax conflicts. The expat would have time to move the money before it caused trouble.
Not likely to happen though. As you say, the tax advice industry stops any real attempt to inform potential clients of the hazards before they get embroiled.
“US Persons overseas are mostly just looking to be treated equally to US resident US Persons or their colleagues with whom they live and work in their country of residence (often for their entire lives).”
Yes – unfortunately, the tax agencies have the job of plugging the loopholes, and the measures taken to plug the loopholes can cause problems not just for the tax-evaders but also for law-abiding US citizens who just want to save for their retirement.
CBT is the root cause; but is not easy to change, unfortunately.
@KingOfTheRoad – On the other hand the US “death tax” IS one that in practice only affects the rich (regardless of where they live); IIRC the current exemption amount is $10 million (was half that before Trump’s tax cuts were enacted). The main way it affects most people is the need to declare certain gifts over a certain amount (but once again those who do not anticipate having an estate large enough can opt to have the excess gift amount come out of their lifetime exemption rather than pay gift tax on it at that time). As you hinted with one’s home there is also the possibility of capital gains tax which might end up affecting those into (at least the upper) middle class, but still the $250,000 (IIRC) exemption for one person (or $500,000 if the spouse is being treated as a US person for tax purposes) for a principal residence applies regardless of where they live (the main way this has disparate impact on expats is that currency fluctuations could result in a phantom gain if their country’s currency goes up vs. the USD).