At least that’s my best guess of what they’re trying to do, based on the rather strange contents of (and omissions from) their latest guidance to U.S. Persons abroad. Patrick Martin of Procopio, Cory, Hargreaves & Savitch LLP reports on recent State Department efforts to communicate with the diaspora about their IRS obligations. State sent out an e-mail blast, and posted the same message on the websites of various U.S. consulates and embassies, for example Tokyo, Bern, and Athens. The guidance was prepared by the IRS rather than State; State is merely the messenger.
Here’s the IRS’ complete answer to the question “What Forms May I Need” (I eliminated references to instructions and Spanish or “EZ” versions of forms):
1040, U.S Individual Income Tax Return
1116, Foreign Tax Credit
2350, Application for Extension of Time to File U.S. Income Tax Return (for U.S. citizens and residents abroad)
2555, Foreign Earned Income Exclusion
4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return
8802, Application for United States Residency Certificate
8938, Statement of Specified Foreign Financial Assets
14653, Certification by U.S. Person Residing Outside of the United States for Streamlined Foreign Offshore Procedures
Form 8802 is only useful to you as an individual if you have a credible case for tax non-residence in the country where you are present, and a claim that such non-residence should exempt you from local taxation on some of your income which the U.S. also does not tax under its own system.
The mention of Form 8938 notwithstanding, this e-mail doesn’t appear to be aimed at accidental Americans or long-term emigrants who conduct all their finances locally — the largest category of non-resident non-filers who have assets which could be subject to fines and actually might owe U.S. taxes in unusual years (e.g. on the sale of a house). None of us have any claim to U.S. residency under a tax treaty. If the IRS were aiming at us, it would have been far more relevant to mention Forms 3520 and 8621 than Form 8802.
Nor is this e-mail likely to be aimed at short-term corporate assignees — who might be able to benefit from Form 8802, but in general have Big 4 assistance as part of their overseas assignment package and so are far likelier than average to be compliant with their U.S. tax obligations (thus artificially driving up the average income of FEIE users). Rather, the IRS seems to be trying to contact people to whom Form 8802 is relevant and who currently have a low rate of compliance. My guess is that means students, teachers, and researchers, in particular young graduates teaching ESL classes.
So who is the audience of this new guidance?
The IRS reminds the recipients of its message:
All U.S. citizens and resident aliens must file a U.S. individual income tax return, even if they permanently live outside the United States and may not owe any tax because of income exclusion or tax credit.
The message was sent out to people whose e-mail addresses the State Department already knew, i.e. people who are aware of their U.S. citizenship and made themselves known to the consulate, but may be unaware of their tax filing obligations. It was also posted in the American Citizens Services section of websites. The people who read it likely consider themselves “Americans”, and probably think of their present location as “abroad” rather than home. The State Department message almost certainly did not reach any “undocumented relinquishers” or people born in the U.S. who aren’t aware they were ever U.S. citizens. Probably the only way State Department or the IRS can get in touch with the latter group is through media coverage.
Also, assuming the IRS is not perverse or malicious, they should have tried their best to compile a list of forms which is genuinely relevant to their target audience, while excluding those forms which are likely to be irrelevant and confusing to that audience
American ESL teachers abroad are the only large group who fits all of the above criteria:
(a) They are residing in countries which are not common American destinations for permanent settlement abroad and whose languages are often difficult for Anglophones to learn; most will continue to regard themselves as “Americans abroad” rather than “immigrants to Xyzland”
(b) They are likely to benefit from filing Form 8802, as I will discuss below
(c) They are not likely to have a Form 3520 filing obligation, because their jobs do not typically offer retirement savings plans
(d) They are not likely to have a Form 8621 filing obligation, because they are spending most of their money paying off student debt rather than investing, and certainly not investing in local mutual funds
This theory doesn’t fit perfectly: the IRS mentions Form 8938, which is only applicable to people who had $200,000 in “foreign” financial assets at year end, or $300,000 at some point — possible if you’re selling a house or saving for retirement where you live, extremely unlikely for a teacher or student who could take Form 8802 benefits (even a hypothetical graduate student who had five years of tuition and expenses in a local bank account all at the same time.) Many ESL teachers probably don’t even have $10,000 in their local bank accounts for FinCEN to steal with FBAR fines.
However, it fits far better than the alternative theory that the IRS is seriously trying to target emigrants with that email, given the omission of Forms 3520 and 8621, and the inclusion of 8802 which is confusing and irrelevant to most emigrants. Alternatively, a third theory is that someone at the IRS is quietly implying that Form 3520 and 8621 are not relevant to U.S. Persons abroad, perhaps because they have an unspoken policy of not pursuing U.S. Persons abroad for those forms in relation to ordinary financial instruments which weren’t purpose-created for tax avoidance or evasion. In that case, instead of leaving the law unenforced and murky, they should use their clear statutory authority to exempt U.S. Persons abroad from filing those forms.
What’s Form 8802?
Form 8802, Application for United States Residency Certification (PDF) is used to request a certificate of residency, Form 6166, that residents of the United States may need to claim income tax treaty benefits and certain other tax benefits in foreign countries.
This means you are using your status as a tax resident of the United States to reduce your tax burden in a country outside of the U.S by treaty — the reverse scenario, using your status as a tax resident of a non-U.S. country to reduce your U.S. tax burden by treaty, simply is not possible for U.S. citizens, and could cause various problems for green card holders.
According to Paperwork Reduction Act filings, the IRS receives roughly 100,000 Form 8802s per year. In 2006, the IRS began charging a user fee for you to file this form and exercise your “treaty rights”. A quick look at the form itself confirms that it is filed not just by individuals, but businesses, trusts, and other entities as well — in fact I’d guess that they’re the primary users of this form, since they are far more likely than individuals to understand how to take advantage of U.S. tax treaties and to have the kinds of income to which treaties apply.
Not aimed at permanent emigrants
Individuals With Residency Outside the United States
If you are in any of the following categories for the current or prior tax year for which certification is requested, you must submit a statement and documentation, as described below, with Form 8802.
1. You are a resident under the internal law of both the United States and the treaty country for which you are requesting certification (you are a dual resident).
2. You are a green card holder or U.S. citizen who filed Form 2555, Foreign Earned Income.
If you are a dual resident described in category 1, above, your request may be denied unless you submit evidence to establish that you are a resident of the United States under the tie breaker provision in the residence article of the treaty with the country for which you are requesting certification.
If you are described in category 2 or 3, attach a statement and documentation to establish why you believe you should be entitled to certification as a resident of the U.S. for purposes of the relevant treaty. Under many U.S. treaties, U.S. citizens or green card holders who do not have a substantial presence, permanent home, or habitual abode in the United States during the tax year are not entitled to treaty benefits. U.S. citizens or green card holders who reside outside the United States must examine the specific treaty to determine if they are eligible for treaty benefits and U.S. residency certification. See Exceptions, below.
Among Isaac Brock Society participants there are both emigrants from the U.S. and immigrants to the U.S.; the immigrants might have used Form 8802 to get treaty benefits for investments in their countries of origin, but the emigrants (the majority among us) live outside of the U.S. on a permanent basis, have done so for many years, and visit only occasionally, meaning we have no claim to U.S. residence under any tax treaty. Some retirees might have a claim to U.S. tax residence, but the overwhelming majority of popular international retirement destinations for U.S. citizens — the countries of Latin America — do not have tax treaties with the U.S. in the first place, so Form 8802 doesn’t benefit them either.
The exceptions mentioned in the Form 8802 instructions relate only to U.S. Persons resident in a second country and trying to claim treaty benefits in a third country — this probably means treaty benefits on investment income, rather than employment income, since tax treaties generally state that the country where a non-resident person exercised employment for more than half the year has the right to tax that employment income.
Who could use Form 8802?
There is one big category of U.S. persons abroad — expats, rather than emigrants — who can benefit from Form 8802. As the instructions state:
If you are described in category 2 and are claiming treaty benefits under a provision applicable to payments received in consideration of teaching or research activities, see Table 2 for the penalties of perjury statement you must either enter on line 10 of Form 8802 or attach to the form.
These benefits are generally time-limited to two or three years. Blogs, forums and other laypersons’ websites aimed at ESL teachers (e.g. in Japan, mainland China, and South Korea) feature extensive discussions of how to use Form 8802 to get out of local taxes while still using the physical presence test (though possibly not the bona fide residence test) of Form 2555 to escape U.S. taxes. This results in double non-taxation, though on a very low income base — sometimes barely high enough to result in a U.S. tax filing obligation in the first place. Professors and researchers can also take advantage of these treaty provisions, though ESL teachers probably form the vast majority of the population which benefits.
The rest of us, of course, tend to ignore tax treaties entirely because the “saving clause” says the U.S. will ignore the treaty when calculating our U.S. taxes and determining our paperwork obligations (making it pointless to try to claim benefits as a foreign resident), while it’s patently obvious even without reading the treaty that we’d be residents of the countries where we actually live — the locations of our permanent homes, centres of economic interests, and the like — making it impossible to claim benefits as a U.S. resident.
What forms are more relevant to emigrants than Form 8802?
By “relevant”, I mean: are there more emigrants who should file that form than should file Form 8802?
As mentioned above, we don’t know the exact number of individual filers of Form 8802 — somewhere in the low-to-mid tens of thousands, likely. Nor do we know the peak number of filers that the IRS might get if they achieved 100% compliance from all U.S. Persons in other countries. (Form 8802 isn’t mandatory anyway, but if you are going to the trouble of filing, you might as well take your benefits from that.) A recent CBS MarketWatch article states that there are about a quarter of a million recent university graduates working abroad as ESL teachers, though that figure includes non-U.S. citizens. Americans form more than half of the global population of native Anglophones, so the number of American ESL teachers abroad is probably in the low six figures. However, as mentioned above, the ones who can qualify for Form 8802 are overwhelmingly not “emigrants” — most treaties limit tax benefits for teachers and students to a few years at most.
Form 3520: The IRS estimates that 20,000 people used to have to file Form 8891 for Canadian RRSPs each year. I have previously stated that I consider this to be implausibly low. But anyway, assuming that half of those filers are U.S. Persons in Canada (rather than Canadians in the U.S.), that Canadians are 1/6 of all U.S. persons abroad, and that other U.S. persons are contributing to local retirement plans which the U.S. considers foreign trusts in the same proportion as Canadians are contributing to RRSPs, then at least fifty thousand people per year should be filing Form 3520.
Similarly, in a previous post, I used a different method to guess the number of U.S. Persons abroad who should be filing Form 3520: I made every possible nonsense assumption to reduce my numbers as far as possible — starting with a lowball estimate of two million Americans abroad, estimating one million of those lived in Canada and only owned RRSPs not RESPs or RDSPs, asserting that the rest have about 1/3 the labour force participation rate of Homelanders, etc. — and I couldn’t get the number of should-be filers below thirty thousand. The true number is probably in the hundreds of thousands.
Form 8621: The Toronto Star reported last January that more than a third of Canadians own mutual funds, while the Financial Post states that Canadians have CA$1 trillion in mutual funds. That’s an average of nearly CA$100,000 per person — well above the de minimis threshold that would require annual Form 8621 filing under the HIRE Act’s new rules for the U.S. Persons among them. In other words, there could be 300,000 people in Canada alone who need to file Form 8621 (if they made a QEF election, which is probably less painful than not making one), and that doesn’t even count the estimated five-sixths of the American diaspora which doesn’t live in Canada.
Form 8854: Even the “Expatriation Statement” might be more relevant to emigrants than Form 8802. I say that not merely to be snarky but due to the IRS’ own estimate of eleven thousand Form 8854 filers per year. That estimate, not updated since 1998, was apparently based on the idea that all ex-citizens and somewhat more than half of ex-green card holders would have an 8854 filing obligation. There are certainly more people with a Form 8854 filing obligation in 2015 than in 1998. How many more is a matter of debate.
What does the U.S. government get out of this?
If I am correct about the target audience, these efforts will decrease foreign countries’ tax revenues while not increasing U.S. tax revenue. American ESL teachers abroad who aren’t aware of their U.S. tax filing obligations are probably paying taxes in the countries where they actually live, since they wouldn’t be able to qualify to escape local taxes via Form 8802 U.S. residency certification unless they actually filed U.S. taxes. Once they become aware of their U.S. tax filing obligations, their countries of residence (which actually provide services to them) will lose out on tax revenues, while due to the FEIE Washington gains nothing besides the US$85 residence certification fee, and that fee probably only covers the amount paid out in wages & benefits to the IRS employee who processes the Form 8802 in the first place.
Instead, it seems that the IRS is trying to inform people of the benefits of being an American abroad. That does not mean “the benefits of U.S. citizenship”. That means the benefits of spending a stint working in a country which you self-consciously think of as “abroad” in order to pay off your student loans, before you return to the Homeland as all true Americans must eventually do.
Though the U.S. government does not benefit in monetary terms from this little exercise, they do in reputational terms. Note the explicit mention of Form 14653, the Streamlined Compliance form. ESL teachers abroad are a population who face little danger from any of Streamlined’s factors for classifying “high risk” filers. They have a high incentive to participate so that they can re-enter the U.S. in the near future. And they are probably neither able nor willing to try to avoid the IRS by demanding the protection of their local governments.
If the IRS succeeds, they will get a large population of filers who can move smoothly through Streamlined without any horror stories. Then we will no doubt see Statistics of Income and GAO analyses (not to mention Reuters and Associated Press articles) trumpeting the success of Streamlined and praising the U.S. government for proactively helping U.S. citizens abroad. Advocates of citizenship-based taxation will then seize on these reports in a dishonest attempt to muddle the issues surrounding long-term emigrants who have much more complicated filing situations.
Though I was surprised to learn that some American expats can go abroad to high-tax countries and not pay any taxes to support the public services that they use, I do not begrudge them their treaty benefits. These provisions have long appeared in many countries’ tax treaties and have the praiseworthy aim of promoting cultural understanding and scientific exchange (much unlike some other uniquely bizarre features of U.S. tax treaties).
It’s good to see that the IRS and State are interested in helping ESL teachers and graduate students abroad. However, it would have been nice if the U.S. government were more explicit about their apparently-intended audience, to avoid confusing the rest of the diaspora who also have IRS filing obligations but will not benefit from any time they waste learning about Form 8802 and treaty benefits. It would be even better if that government did more to help out other U.S. Persons who are at higher risk of serious harm from the U.S. tax system and have a far lower probability of ever moving back to the U.S. and imposing costs on it. Instead they’re charging us ridiculous fees to exit the system, and proposing half-baked “relief” schemes which barely help any of us.