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Individuals implement International Trusts and offshore planning for a wide variety of legal purposes. For some, it's about protecting assets at home. For others, it's about international diversification. Or retirement and estate planning. Or about moving self, family or assets to safer shores. The reasons - and the individuals - vary widely. But one underlying concern has been the U.S. tax treatment of assets and income.
But now, there is a new glimmer of hope for U.S. taxpayers going offshore. Currently, without proper planning, a complex web of U.S. tax compliance measures and forms awaits all U.S. taxpayers with assets or income offshore. But that may soon become a thing of the past for some, and U.S. citizens may only be taxed on where they reside.
Our newsletter today updates recent steps occurring in Washington to reduce offshore tax burdens for some U.S. individuals. To understand the progress being made, you need to first fully grasp…..
The Unfair Treatment of U.S. Taxpayers Offshore
If you are a U.S. taxpayer (citizen or resident alien), the rules for filing tax returns are generally the same, regardless of where you live across the globe. All of your worldwide income is subject to U.S. income tax, regardless of where you reside. The U.S. is the only country in the world with citizen-based taxation, with the exception of tiny Eritrea, a poor East African country along the Red Sea. All 195 other countries in the world have residence based taxation, meaning you only pay taxes where you physically reside.
One notable exemption to the above harsh treatment of U.S. taxpayers applies when you live and earn income outside of the U.S. These lucky overseas expats are allowed by the IRS a foreign earned income exclusion, plus a foreign housing deduction. This can add up to $200,000, or more, for a husband and wife living abroad, even when drawing an income from their own business. However, this exclusion does not include passive income sources. The rules can be complex, but we attempt to sort it out in Chapter Eight of Offshore Living & Investing, 2nd edition. Follow this link to the table of contents.
The current problem with citizen-based taxation is that the U.S. is the only country (except impoverished Eritrea) that taxes its citizens on their world-wide income, no matter where they live. All other countries across the world treat their citizens fairly, with only tax based upon residency, not citizenship. The tax model around the world for 96% of the world population simply considers where you live at the moment. The global residency based tax system is a much fairer treatment than what currently applies to U.S. taxpayers.
To understand the unfairness, consider if you moved across U.S. state borders – for example, from New York to Florida, or California to Colorado - and your former state wanted to continue taxing you after you moved. It certainly doesn’t seem reasonable that you should continue to pay taxes in your former state, particularly when you will also have tax obligations in the new state.
But that’s exactly what California attempted to do when a proposal was considered to continue taxing Californians that moved to another state, even if they were paying state taxes in their new state of residence. If California’s proposal followed the U.S. government tax system, then all individuals born in California - or five years after becoming a California tax resident - would continue to pay taxes for the rest of their life regardless of what other state, or country, in which they legally resided, in the future.
These poor West Coast souls would be taxed on wages, pensions, 401(k) withdrawals, Social Security benefits, capital gains, on the sale of real estate, stocks, bonds and everything else, received anywhere in the world….forever.
As crazy as California’s proposal sounds, this is exactly what currently occurs to all U.S. citizens living abroad. The U.S. Government taxes all U.S. citizens (and long-time foreign citizen residents), who, for whatever reason, have relocated to live, work or retire in a foreign country. They are subject to both the tax system of where they live abroad, and then taxed again on that same income by the IRS.
Worse yet, the U.S. Federal income tax applies to individuals born outside of the U.S. even when only one parent is a U.S. citizen, and even though they are a citizen by birth of a foreign country where they have always resided. And they are taxed even if they have never obtained a U.S. Social Security number, or never obtained a U.S. passport, or don’t speak English, or have never even visited, worked, or lived in the U.S. during their entire lifetime.
And this same individual born and residing abroad who has never visited the U.S., is still required to file an annual U.S. tax return, and also comply with foreign asset transfers and other compliance forms such as the FBAR FinCEN Form 114 and Form 8938 under FATCA. They are required to provide the U.S. government all details of their local bank accounts, brokerage accounts, foreign social security taxes, foreign retirement accounts, and much more. Outrageous!
The U.S. is the only country in the world that subjects its citizens residing abroad to such harsh treatment and double taxation.
Forbes Magazine, and other major publications, have repeatedly reported how American citizens living abroad have been hit especially hard, as have dual U.S. and Canadian citizens. The burdensome U.S. taxation policy has gotten many into hot water with the IRS.
As a result, there has been significant refusal by some to report worldwide income. And an even bigger failure to disclose the existence and details of foreign banks and other financial accounts.
Not only is this unfair treatment of U.S. taxpayers, but it makes U.S. citizens uncompetitive when taking jobs abroad. And this includes employment from U.S. companies with foreign offices requiring U.S. expertise and experience. These extra burdens further decrease U.S. employment opportunities and U.S. companies competitiveness in the international market place.
Even more draconian is the treatment of U.S. citizens having to pay an “Exit Tax” if renouncing U.S. citizenship to avoid the U.S. compliance headaches.
An article in the Florida Tax Review by William Thomas Worster of The Hague University, maintains that the Exit Tax imposed on persons choosing to renounce their U.S. citizenship is unconstitutional. He argues that former citizens should be treated as any other nonresident foreign individual, and not be discriminated against on the basis of their national origin. “(W)hen a citizen elects to leave the community and no longer receive the rights of the community, then the individual should not have lingering obligations upon leaving the state.”
There must be a fairer way for the U.S. government to treat its citizens. And maybe now is the time for U.S. individuals to be taxed based upon where they reside, like the rest of the world.
A Glimmer of Hope for U.S. Taxpayers Abroad?
As Americans living abroad have been renouncing their citizenship in record numbers in recent years, the question of whether the U.S. should switch to the residency based model has continued to generate debate in Washington. Giving up U.S. citizenship has increased noticeably in recent years after the U.S. government increased red-tape informational compliance, and stepping up tax enforcement on U.S. individuals offshore.
As a result, a resident based tax (RBT) system was proposed to the U.S. Congress by the American Citizens Abroad (ACA), which represents U.S. citizens living, working and retiring outside the U.S. The RBT proposal advocates a residence-based tax instead of one based on citizenship, along with other various tax reforms.
ACA believes that the upcoming Congress will consider amending the tax code from a citizenship-based approach to a residency based approach. What exactly the end result might entail in the way of changes to the existing tax code has not been spelled out.
In order to continue to promote a constructive consideration of the subject, the ACA has provided a written description of the elements of its RBT proposal, in addition to responses to questions raised by Congressional members and supporters.
ACA, in conjunction with other groups, are creating a coalition of organizations interested in the subject of RBT to support the work of developing a fairer tax system for those opting offshore.
Is there a light at the end of the tunnel?
ACA representatives continue to meet with and educate both House and Senate tax staffs and, perhaps even more important, with staff from the Joint Committee on Taxation. And some in Congress acknowledge that residence-based taxation would be better than the current system.
Long term, a residence-based tax system would encourage U.S. companies to send more American staff overseas to represent U.S. interests and promote American-made products. This should help the U.S. global competitiveness, and the U.S. economy. And the proposal would certainly make life significantly easier for those U.S. taxpayers living, working or retiring offshore.
As another step in the right direction, the IRS posted on its website FAQs for streamlining compliance procedures for taxpayers living abroad. And the IRS states that individuals who have entered the overseas voluntary disclosure program (OVDI) can opt out to enter the streamlined program.
Progress continues, albeit slowly.
Yes, there appears to be glimmers of light at the end of the tunnel. At least we hope that we aren't being blinded by a fast approaching train coming down the tunnel.
Where to Learn More
In the meantime, international planning for asset protection, global investment diversification, offshore living and investing, pre-migration planning, and more, is essential. And it's perfectly legal. The world is a great place, filled with wonderful opportunities, regardless of what you see or hear on Fox News and CNN.
In previous newsletters, we covered a wide range of topics on domestic and international planning, including integrated asset protection, and offshore living and investing. Many of these Past Articles can be found at DavidTanzer.com, if you wish to learn more about international planning tips.
And How to Legally Protect Your Assets, 2nd edition, is an excellent primer on the above topics, and more, if you are just getting started. Offshore Living & Investing, 2nd edition, is another good option. Both are available directly from our site in hard copy, Kindle, or .pdf versions.
If you want to review your own international planning options, get started with an initial review of your personal situation right here.
Until next time......
David
David A Tanzer, Esq.
JD, BSc, Ph.D (Hon)
For more information visit www.DavidTanzer.com or email to Datlegal@aol.com. David is the author of “How to Legally Protect Your Assets” and “Offshore Living and Investing.”
David A Tanzer & Assoc., PC.
Datlegal@aol.com
DAT@DavidTanzer.com
www.DavidTanzer.com
Vail, CO USA:
Tel. (970) 476-6100
Fax (720) 293-2272
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Tel. (64) 9 353-1328
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(Licensed to Practice Law in U.S. States & Federal Courts; Assoc. Member Auckland, N.Z. District Law Society - Foreign Lawyer; & Assoc. Member Queensland Law Society, AU - Foreign Lawyer)
The comments herein are not intended to constitute a legal or tax opinion regarding any specific legal or tax issue as additional issues may exist; does not reach a conclusion with respect to any specific legal or tax issue addressed herein or any additional issues not included; and cannot be used for the purpose of avoiding legal or tax obligations or penalties with respect to issues in or outside the scope of matters discussed herein.
(c) Copyright by David A. Tanzer & Associates, P.C. All rights reserved. Except as permitted under the United States Copyright Act of 1976, as amended, and pursuant to the laws of all countries, no part hereof may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, electronic or otherwise, without the prior written permission of David A. Tanzer & Associates, P.C. Reprint in whole or part strictly prohibited unless prior written permission is granted. International Copyright protected under the Berne Convention, Universal Copyright Convention and laws of all other Copyright protected countries, and consistent with the World Trade Organization TRIPS.
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