Dear Congress... I'm Not Sure You've Thought This Through...
Talk about potentially eliminating the worldwide taxation of U.S. citizens is getting some expats excited.
In theory… if the proposed change were approved… that would put U.S. citizens on par with citizens of every other country in the world except Eritrea, the only other country that also taxes citizens on worldwide income no matter where in the world they live.
Of course, you’d still pay taxes on any income generated in the United States, including dividend and interest income. However, knowing that Congress sometimes pulls the trigger first before thinking through the consequences or the details, I thought I’d try to help the congressmen out by thinking this through a little for them…
What would the tax rules for Americans overseas look like should the U.S. Congress change the basis of the U.S. tax system from citizenship to residency, I wonder.
Would Americans abroad and not resident in the United States need to file a tax return at all?
Unless Congress also repeals FATCA or at least the part that allowed the IRS to create Form 8938, requiring anyone with foreign financial assets over the thresholds to report all their offshore financial assets and accounts, U.S. expats with more than US$200,000 in foreign financial assets (US$400,000 for a couple) will still be required to file that form at least.
What about Americans living abroad with their own businesses? Again, I’d guess that we’ll still have to file forms 5471 and 8858 for our offshore entities.
Then there is income from an offshore trust. Will only U.S. residents be taxed on that? If so, I see a boom in the making for offshore trust attorneys. You might want to book your time with one now… as well as with the residency consultants they work with. Those guys will get busy.
Most U.S. expats living and earning income overseas are paying taxes on that income in the countries where they are working. However, in reality, between the Foreign Earned Income Exclusion and foreign tax credits, relatively few Americans overseas pay taxes on their income in the United States.
In today’s world, it’s not the tax owed that’s the problem for most Americans living and earning income overseas. It’s the cost of compliance with U.S. IRS regulations.
Paying a tax accountant thousands of dollars a year to send a stack of forms to the IRS just to tell them you owe nothing is an unnecessary expense that I don’t see going away.
While there’s no doubt that changing from the current extraordinary and ridiculous citizenship-based approach to taxation to a residency-based approach would benefit some Americans working outside the United States, the U.S. tax code and the current situation are too complicated to expect that expats won’t continue to suffer at the hands of the very long-armed IRS.
Lief Simon