By Andreas Kluth Nov 26, 2019 Bloomberg Opinion
The U.S. is (almost) unique in the way it taxes citizens working abroad. Its system stinks.
An estimated 9 million American citizens living outside the U.S. face a tax nightmare those at home can’t imagine and none should ever suffer. The reason: The U.S. is one of only two countries in the world (the other is Eritrea) that taxes its citizens regardless of where they live.
American expats don’t necessarily owe the U.S. any tax: They can deduct taxes paid to host countries, which are often higher, or take an exemption. But they have to file returns and disclosures regardless, at a significant cost in accounting fees, nuisance and needless anxiety. The rules are often unclear, and foreign employers and financial institutions don’t report the numbers in the way the Internal Revenue Service prefers. The penalties for even innocent mistakes can be draconian. The U.S. proceeds as though any citizen with a foreign bank account were a likely tax evader or money launderer. Citizens with foreign assets must disclose them not only to the IRS but also to the Financial Crimes Enforcement Network.
Surprisingly enough, people who live and work abroad tend to acquire other overseas assets along the way. The IRS sees a plain-vanilla European mutual fund, for example, as a “passive foreign investment company,” and requires disclosures that are Kafkaesque. The Obama-era Foreign Account Tax Compliance Act made things worse. It threatens foreign banks with drastic penalties if they fail to provide information on customers who are “U.S. persons” (citizens or green-card holders). As a result, many financial institutions simply refuse to serve Americans at all.
Owing to the original sin of citizen-based taxation, moreover, every tweak to American tax law seems to exacerbate the problem. President Donald Trump’s reform of 2017 added rules aimed at the overseas profits of U.S. companies. Inadvertently, the IRS now treats the American owner of a lemonade stand in Belgium like Google, forcing them to declare a new kind of income known — say it out loud to feel it — as GILTI.
The original targets of this harsh regime were rich Americans living in the U.S. and stashing money in hidden offshore accounts. But hardened tax cheats developed new evasion strategies long ago. The victims today are Americans abroad with ordinary incomes and no special tax expertise. They include “accidental Americans” who aren’t even aware of the rules — children born in the U.S. while their foreign parents happened to be visiting, for instance, or people born and living abroad whose fathers were U.S. soldiers.
Some U.S. expats renounce their citizenship, but few want to cut ties to their country, and for most the cost is prohibitive in any case. They should never be made to feel that it’s necessary. At a minimum, the U.S. should simplify the rules for its expats and raise the balance thresholds so middle-income filers are exempt. But the best solution would be even simpler: Follow the example set by almost every other economy (did I mention Eritrea?) and base the personal income tax on residency, not citizenship.
This post does not necessarily reflect the opinion of the US Tax Consultants and its owners.