“Since 2013, upwards of 1,800 U.S. citizens residing overseas have chosen to renounce their U.S. citizenship in the face of new tax laws and disclosure requirements such as FATCA.”
-Giancarlo Serrato
The United States shares an interesting commonality with Eritrea and North Korea – it levies taxes on a citizenship basis. A citizen of the United States residing outside the United States is taxed on his “worldwide income,” income generated in the United States and income generated abroad, resulting in a system of taxation based strictly on citizenship, regardless of the taxpayer’s residency.
U.S. citizens living and working outside of the United States are required to file an income tax return first in the jurisdiction in which they are a resident and then another in the United States. Although foreign taxes paid to foreign jurisdictions are creditable against U.S. taxes owed, the United States does not recognize all types of foreign taxes. For example, “wealth taxes” and “value added taxes,” which are commonly used in Europe in lieu of income tax, are not considered qualified foreign tax credits.
Unfortunately, Congress has not attempted to harmonize these inconsistencies. Instead, Congress has made reporting and filing obligations for U.S. citizens living overseas more strenuous, expensive, and increasingly confusing.
In 2010, President Obama signed into law the Hiring Incentives to Restore Employment Act (“HIRE”) that contained the Foreign Account Tax Compliance Act (“FATCA”). FATCA is sending shivers down the backs of U.S. citizens living overseas and frightening foreign financial institutions (“FFIs”) and foreign banks away from investing in the United States and maintaining accounts for U.S. citizens.
In a nutshell, FATCA requires all FFIs, with accounts and other specified financial vehicles, such as trusts or hedge funds, held in the name of U.S. citizens, U.S. green card holders, and U.S. persons to report information on these accounts either directly or via Intergovernmental Agreements (“IGAs”) to the IRS. If they fail to do so, they must pay a 30 percent withholding tax on the proceeds from these financial vehicles. Starting in July of 2014, such reporting will become an annual obligation for these FFIs who, in addition to reporting the account holder’s personal information, will need to report the highest balances on the accounts in question and a list of the account activity. Account holders, or U.S. citizens, U.S. green card holders, and U.S. persons, will also be required to report their accounts or financial vehicles held outside the United States on IRS Form 8938. In summary, FATCA has been designed as a “matching program” for the U.S. Treasury to crack down on tax evasion. In practice, however, FATCA severely reduces U.S. economic competitiveness and increases the burden of tax administrability.
In some jurisdictions, the ability of FFIs to separate out “U.S. citizens/persons” from group financial products is nearly impossible, therefore locking U.S. citizens out from certain financial vehicles. Given the recent case by the Department of Justice against Wegelin & Co, UBS and Credit Suisse, many FFIs have become wary of being able to clean their client base of non-compliant U.S. citizens/persons, as the risk of having these individuals on record with the bank could result in penalizing fines. Without the ability to have lines of credit and basic bank accounts, like checking, saving, and investment accounts, U.S. citizens working overseas simply will not be able to survive and do business. This problem will have a direct effect on U.S. exports and international business opportunities.
FATCA also presents a risk to the U.S. securities markets, as FATCA requires that not only U.S. citizens and green card holders report on accounts held outside of the U.S. but also that foreign nationals who have invested in the United States (e.g. IBM and/or Apple stock) will be required to report on their accounts and FFIs will be required to report their information to the IRS. This added reporting requirement, which many foreign nationals interpret as an intrusion into their banking privacy, could have damaging effects on investment in the U.S. securities market by reducing the attractiveness of these investments.
In addition, for non-participating FFIs, the 30 percent withholding tax on these investments will make them even less attractive for potential foreign investment. Individuals holding U.S. securities in non-participating FFIs will be hit with the 30 percent withholding tax and thus may look to alternative investments that may return less but be less burdensome vis-a-vis compliance requirements.
Furthermore, FATCA will generate new filing forms and increase paperwork for the IRS through the administration of FATCA Form 8938 and the management of financial information being sent from the participating FFI’s. If the IRS cannot efficiently mine that information, then its principal goal, uncovering U.S. tax evasion, will be completely undermined.
Since 2013, upwards of 1,800 U.S. citizens residing overseas have chosen to renounce their U.S. citizenship in the face of new tax laws and disclosure requirements such as FATCA. Only time will tell what future consequences the U.S. tax policy will present domestically and internationally. I, for one, urge Congress to revise its tax policy for U.S. citizens living overseas in an effort to strengthen American economic competitiveness during these financially volatile times.
Posted Feb. 7, 2014