Someone wrote me that, ‘FATCA is a problem for residents of Canada only because the United States sticks to its outdated policy of citizenship-based taxation.’” Although there has been some political movement to end the worst effects of citizenship-based taxation, a recent article from American Expat Finance by Helen Burggraf, suggests that the politics of changing U.S. tax policy for Americans abroad may – with the possible retirement of Congressman Holding – become more difficult.
Democrats Abroad has been questioning prospective nominees about their positions on each of FATCA and citizenship-based taxation. It has phrased its question in a way that assumes that a move to citizenship-based taxation to residence-based taxation would result in no loss of tax revenue to the United States Treasury. John Richardson, Karen Alpert and Laura Snyder explain why they feel this is an inappropriate and dangerous assumption in the following article, reprinted with permission of TaxConnections.
Democrats Abroad (DA) recently reached out to the Democratic presidential candidates to ask them about issues relevant to Americans living overseas. The questions DA posed and the responses it received can be accessed here.
We strongly applaud DA for this valuable initiative. But we believe that it is important—indeed, vital—to call out the framing of this question:
“Most Americans living abroad think that the time has come for Residency-Based Taxation, the principle guiding all other countries’ tax systems and a fix for numerous unjust burdens on Americans living and working abroad. There are bi-partisan, revenue-neutral proposals to implement RBT that include robust provisions to protect the law from abuse by tax evaders. All we need is a moment of leadership to get this done. Will you be that leader?”
We believe that it is a grave error to condition a move to residency-based taxation (RBT) upon a demonstration of revenue neutrality. Doing so would serve to perpetuate the immoral and unjust system in place today.
These are the reasons why:
1) The current system is immoral and unjust on its face.
As DA noted in its question, today Americans living abroad are subject to “numerous unjust burdens” with respect to US taxation. Put another way, subjecting persons who do not live in the United States to US income taxation and thus forcing them to live under two incompatible tax systems is unjust. That is the very reason so many object to it and the reason this question was included in the questions posed to the presidential candidates.
Regardless of the outcome of any determination of revenue neutrality, the current system will remain unjust.
The United States has many times in the past changed its laws seeking to address situations that were considered to be immoral and unjust.
- Married Women’s Property Act, allowing women to own property and enter into contracts independently of their husbands,
- Civil Rights Act, lifting restrictions on African-Americans’ access to public accommodations such as schools and businesses, and
- Legalization of same-sex marriage, allowing same-sex spouses to file under the status married filing jointly, expanding eligibility for spousal benefits.
Each of these laws had implications with respect to tax revenue but revenue neutrality was never a condition of their adoption. They were adopted in order to right a wrong.
Citizenship taxation dates back to the Civil War. At that time and up until a few decades ago, citizenship was closely tied to domicile. That is, people generally lived in the country where they held citizenship. Those who emigrated from one country to another in most cases lost their original citizenship due to widespread prohibitions on dual citizenship. Today, prohibitions on dual citizenship have mostly fallen away and dual and even triple citizenship is common.1 Citizenship is no longer tied to domicile. For these reasons there are today many US citizens living outside the United States who have had little to no economic ties to the United States for 5, 10, 20, 30, 40 years and more, if indeed they ever had any. They are domiciled in other countries and they are subject to income taxation in the countries where they live.
Subjecting people who do not live in the United States to US income taxation does not fit the new reality of citizenship. As noted above, doing so requires them to live under two incompatible tax regimes. This is the very reason why, as DA has noted in its question above, they suffer “numerous unjust burdens.” This injustice will neither shrink nor grow based upon the outcome of any determination of revenue neutrality.
Indeed, by describing the current system as unjust but at the same time conditioning a move away from it upon revenue neutrality, DA is sending the message that not just the current tax system but any other injustice is acceptable if it is revenue positive for the US Treasury.
2) It is not possible to be sure of just how much revenue the United States actually collects from non-resident citizens and green card holders.
Public IRS data lists returns filed from addresses outside of the US but these include diplomatic and military personnel and temporary expats who would likely be considered US tax residents under RBT. Therefore there is no public information available that would enable a reliable estimation of revenue impact as opposed to pure speculation. Furthermore, the current taxation of US source income for nonresident aliens is at a higher tax rate than applied to most US citizens. Moving to residence based taxation would probably mean that nonresident citizens would actually pay more US tax on their US source income. The exact amount would depend on the relevant tax treaties and cannot be reliably estimated in advance. The revenue that the US would lose by moving to residence based taxation is the tax collected on foreign source income of nonresident citizens—income that their home countries have primary taxing rights to in the first place.
3) A determination of revenue neutrality must examine not just income but also costs incurred in relation to that income. This includes not only costs incurred by the IRS but also by private actors who share responsibility for US tax administration with the IRS.
Costs incurred by the IRS: While the provisions that apply to nonresident citizens are among the most complex in the Internal Revenue Code, the level of support the IRS provides to those taxpayers is much lower than that provided to US residents.
The National Taxpayer Advocate (NTA) has observed on a number of occasions that overseas taxpayers have unique needs: not only are they are confronted with an overwhelming complexity of international tax rules and reporting requirements but also they face potentially devastating penalties for even inadvertent noncompliance.2 It was in this context that in its 2015 report the NTA set forth a litany of service failures by the IRS with respect to overseas taxpayers. These failings included the closure of IRS attaché offices that had been housed in US consulates, the discontinuance of an email system permitting taxpayers to correspond with the IRS, the lack of availability of toll-free phone numbers for persons calling the IRS from overseas, inadequate postal correspondence,3 the lack of training of IRS representatives to be able to adequately respond to the queries of overseas taxpayers. These failures, together with a multitude of others—such as highly limited foreign language capabilities and the inability for overseas taxpayers to create an online account with the IRS—remain true today. As the NTA noted, these service failures constitute serious violations the Taxpayer Bill of Rights4 and more specifically of the right to be informed, the right to quality service and the right to a fair and just tax system.
The current system of taxing nonresidents is untenable without expending the resources required to remedy these failures. And—going beyond the NTA’s report—without expending the resources required to provide overseas taxpayers with the full support that they require as a result of the complexities they face and the multitude of languages they speak. At this time, the IRS has neither the resources nor the expertise to effectively administer tax law for residents of other countries whose entire existence—economically and in many cases linguistically—is “foreign” to the United States. For these reasons, any analysis of the revenue neutrality of RBT is not complete without accounting for these costs on the part of the IRS—costs that it should incur but that to date it has failed to do.
Costs incurred by others: It is not just the IRS that incurs costs with respect to tax administration for overseas taxpayers. Overseas taxpayers themselves as well as foreign financial institutions (FFIs) incur considerable costs in connection with the administration of the United States’ system of worldwide taxation.
This is not an accident; to the contrary it is a deliberate component of IRS strategy. In its April 2019 “IRS Integrated Modernization Business Plan,” the IRS lists its “Strategic Goal 3” as “Collaborate with external partners proactively to improve tax administration.”5
A November, 2019 report by the Internal Revenue Service Advisory Council elaborates on what this means:
“IRS’s strategic goal [is] to collaborate with external partners proactively to improve tax administration by incorporating opportunities to leverage and enable as customer service delivery channels trusted members of the tax community. Tax practitioners, tax software vendors, financial institutions and payroll providers are aligned with the IRS’s mission to provide quality taxpayer service by helping taxpayers understand and meet their tax obligations. Each mission and business partner can serve dozens, hundreds, thousands or millions of taxpayers.“6
At first glance this might sound innocuous. But scratch the surface and you’ll realize that the IRS is announcing in no uncertain terms its intention to rely even more heavily than it already does upon persons like tax practitioners and upon organizations like tax software vendors and financial institutions to carry out tax administration on behalf of the United States. That is, the IRS—a public agency—is planning to rely even more heavily than it already does upon tax practitioners, tax software vendors, and financial institutions—the private sector—to carry out what is in fact a public service.
The IRS is funded by public tax dollars. In contrast, tax practitioners, tax software vendors, and financial institutions are funded by private customer (taxpayer) fees. For example, as reported in the Democrats Abroad survey report published earlier this year, 55% of non-resident tax filers engage the support of a professional tax preparer; of these, 61% incur a tax filing preparation cost of over $500—at least twice what US based Americans spend on average.7 In fact, professional fees of upwards of $2000 and more each year for the preparation of an overseas tax return is common.
Equally if not more significant is this: according to a survey of Americans living overseas published in October, 2019, 41% of the survey’s 602 participants reported paying significant fees to a professional tax preparer even though they end up owing nothing in US taxes.8 This statistic alone shines a bright light not only on the high cost of tax administration placed squarely on the shoulders of overseas taxpayers but also on the fact that this cost is incurred without any corresponding revenue for the US Treasury.
As regards FFIs, it is not just IRS policy but also federal law that requires them to engage in tax administration on behalf of the United States. More specifically, FATCA obliges FFIs to develop and implement complex procedures enabling them to identify among all account holders those who are “suspected US persons.”9 Their failure to do so is subject to very steep penalties: a withholding tax of 30 percent on all payments of the FFI’s US-source income. FFIs have incurred and continue to incur substantial costs in administering FATCA. While no one has performed a comprehensive study there is information available: the Spanish bank Banco Bilbao Vizcaya Argentaria estimated that compliance costs could range from $8.5 million for a local entity to $850 million for a global one. The British government estimated the aggregate initial costs to UK financial institutions at $1.1 billion to $1.9 billion, with a continuing cost of $60 million to $100 million a year. More globally, KPMG and Deloitte have estimated that more than 250,000 FFIs are affected by FATCA, with costs for some of the larger ones reaching more than $200 million.10
Overseas taxpayers and FFIs incur these costs because of IRS policy to “collaborate” with tax practitioners, tax software vendors, and financial institutions for the purpose of tax administration and because of federal law (FATCA). That is, extensive costs for the purpose of US tax administration are incurred not only by the public sector (the IRS) but also by private actors.
A complete and honest examination of the revenue neutrality of RBT must take into account these considerable tax administration costs that the current system places squarely on the shoulders not of the IRS but of FFIs and overseas taxpayers themselves.
A finding that RBT would not be revenue neutral would entail consequences for which the IRS is woefully unprepared.
As noted above, taxation by the United States on the basis of citizenship rather than residence requires that the IRS acquire the resources and expertise needed to effectively administer tax law for US citizens who are residents of other countries and whose entire existence is “foreign” to the United States. If it were determined that RBT could not be adopted because it was not revenue neutral then the Taxpayer Bill of Rights requires that the IRS spend the resources necessary to provide the same level of service to international taxpayers as is provided to domestic taxpayers. It is entirely inconsistent and a complete contradiction of logic, on the one hand, to defend the current system as revenue positive to the United States but yet, on the other hand, to continue to provide insufficient resources for the IRS such that it cannot fully support overseas taxpayers. Either there is a revenue surplus from the taxation of persons outside the United States or there isn’t. And if there is then it is incumbent on the IRS to fully support overseas taxpayers. Otherwise the determination of revenue neutrality was a farce and its outcome will serve to perpetuate continued violations of the Taxpayer Bill of Rights.
Again, we applaud DA’s efforts to reach out to the Democratic presidential candidates to ask them about issues relevant to Americans living overseas. It is a very important initiative. However, for the reasons explained above, we strongly recommend that DA remove from its communications any suggestion that a demonstration of revenue neutrality should be required in order for the United States to adopt a system of residence-based taxation.
1. See, for example, Maarten Vink, Arjan H. Schakel, David Reichely, Ngo Chun Lukz and Gerard-Rene´ de Groot, “The International Diffusion of Expatriate Dual Citizenship,” Migration Studies 7:3 (2019), 362-383,<a href=”https://academic.oup.com/migration/article/7/3/362/5488849” rel=”noopener noreferrer” target=”_blank”> https://academic.oup.com/migration/article/7/3/362/5488849</a>.
2. National Taxpayer Advocate, “Most Serious Problem #7: International Taxpayer Service: The IRS’s Strategy for Service on Demand Fails to Compensate for the Closure of International Tax Attaché Offices and Does Not Sufficiently Address the Unique Needs of International Taxpayers,” 2015, 73, <a href=”https://taxpayeradvocate.irs.gov/Media/Default/Documents/2015ARC/ARC15_Volume1_MSP_07_International-TP-Service.pdf” rel=”noopener noreferrer” target=”_blank”>https://taxpayeradvocate.irs.gov/Media/Default/Documents/2015ARC/ARC15_Volume1_MSP_07_International-TP-Service.pdf</a>.
3. The problems with postal correspondence is also documented in a 2015 report by the Treasury Inspector General for Tax Administration (TIGTA), “Planned Improvements Have Not Been Made to Manage and Track Correspondence with International Taxpayers,” 8 September 2015, <a href=”https://www.treasury.gov/tigta/auditreports/2015reports/201530072fr.html” rel=”noopener noreferrer” target=”_blank”>https://www.treasury.gov/tigta/auditreports/2015reports/201530072fr.html</a>.
4. Taxpayer Bill of Rights:<a href=”https://www.irs.gov/taxpayer-bill-of-rights” rel=”noopener noreferrer” target=”_blank”> https://www.irs.gov/taxpayer-bill-of-rights</a>.
5. “IRS Integrated Modernization Business Plan, April, 2019, 14,<a href=”https://www.irs.gov/pub/irs-utl/irs_2019_integrated_modernization_business_plan.pdf” rel=”noopener noreferrer” target=”_blank”> https://www.irs.gov/pub/irs-utl/irs_2019_integrated_modernization_business_plan.pdf</a>.
6.Internal Revenue Service Advisory Council Public Report,” November 2019, 96-97, <a href=”https://www.irs.gov/pub/irs-pdf/p5316.pdf” rel=”noopener noreferrer” target=”_blank”>https://www.irs.gov/pub/irs-pdf/p5316.pdf</a>
7. Democrats Abroad, “Tax Filing from Abroad: Research On Non-Resident Americans and U.S. Taxation,” March 2019, 4, available at <a href=”https://www.democratsabroad.org/carmelan/democrats_abroad_publishes_2019_expat_tax_research_datapack” rel=”noopener noreferrer” target=”_blank”>https://www.democratsabroad.org/carmelan/democrats_abroad_publishes_2019_expat_tax_research_datapack</a>.
8. “’I Feel Threatened by My Very Identity’ – Report On US Taxation and FATCA Survey Part 1: Data,” October 25, 2019, 11,<a href=”http://www.citizenshipsolutions.ca/wp-content/uploads/2019/10/Part-1-Data.pdf” rel=”noopener noreferrer” target=”_blank”> http://www.citizenshipsolutions.ca/wp-content/uploads/2019/10/Part-1-Data.pdf</a>
9. This is the phrase used by the IRS to refer to United States citizens: Internal Revenue Service, “ Foreign Account Tax Compliance Act International Compliance Management Model (ICMM) FATCA 4.1 Report Notification Technical Support Guide Version 3.0,” June 2, 2016, 4, <a href=”https://www.irs.gov/pub/fatca/fatcaicmmreportnotificationtechnicalsupportguidedraft.pdf” rel=”noopener noreferrer” target=”_blank”>https://www.irs.gov/pub/fatca/fatcaicmmreportnotificationtechnicalsupportguidedraft.pdf</a>.
10. Nigel Green, “A Corporate-Welfare Bonanza for Tax-Compliance Firms: Soon the Foreign Account Tax Compliance Act Will Cost More Money than It Recovers,” Wall Street Journal, April 2, 2017, <a href=”https://www.wsj.com/articles/a-corporate-welfare-bonanza-for-tax-compliance-firms-1491163938#comments_sector” rel=”noopener noreferrer” target=”_blank”>https://www.wsj.com/articles/a-corporate-welfare-bonanza-for-tax-compliance-firms-1491163938#comments_sector.