Tax Reform Proposed For US Expats

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James Spader

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In a new tax reform proposal issued in November 2012, American Citizens Abroad (ACA) has proposed a ‘win-win solution’ that streamlines United States tax law and raises additional tax revenue, by recommending that Americans residing abroad have the option to elect to be taxed on the same basis as non-resident foreign nationals.

ACA calls this option Americans Abroad Taxation (AAT), which would, it says, resolve the current incompatibilities between citizenship-based taxation and the Foreign Account Tax Compliance Act (FATCA) that is intended to ensure that the Internal Revenue Service (IRS) obtains information on financial accounts held by US taxpayers.

ACA believes that current IRS practices are “creating more problems than they are solving”. As a general rule, Americans abroad pay taxes to their local country of residence, and they are also subject to US taxation. It points out that the combination of US taxes and the onerous filing requirements under the Report of Foreign Bank and Financial Accounts (FBAR), as well as the “extremely complex and burdensome” FATCA legislation “is a lethal model, making life for Americans residing overseas extremely difficult”.

It adds that tax reform is necessary as recent US tax policies now prevent an increasing number of Americans abroad from opening and maintaining a local bank account, signing mortgages or insurance

contracts, obtaining employment, and entering joint-ventures and partnerships with foreigners. "These policies are forcing increasing numbers of Americans to renounce their US nationality in order to function in a global society,” the ACA warns.

AAT would allow Americans abroad, if they so elect, to be taxed by the IRS on the same basis as the US currently taxes non-resident aliens.

Under the ACA’s proposal, US source income would thereby be taxed through withholding taxes determined by US tax law and US income tax treaties. This would include withholding taxes on all US source unearned income (including dividends, interest, royalties, pensions and passive rents from US properties).

On the other hand, income earned in the US by Americans abroad, income from participations in US partnerships and compensation for self-employment services performed in the US would be taxed, as the case may be, either by a withholding tax at source or by reporting income under the same rules that apply to non-resident aliens who have 'effectively connected' income.

“This recommendation,” the ACA confirms, “is totally consistent with the tax policy practiced throughout the world; it levels the competitive playing field which is currently tipped against Americans abroad.”

ACA has calculated that AAT would produce USD35bn in additional revenue for the IRS over ten years, compared with the current system, largely because the US would collect withholding taxes on US source income, thereby pre-empting tax revenue which presently goes to foreign governments under the current citizenship-based taxation (as higher tax rates in OECD countries presently generate foreign tax credits that cancel most US tax liability).

According to the ACA, the new system would also: provide anti-abuse measures; define the taxation of Americans abroad (as proposed by the House of Representatives Ways and Means Committee) on a territorial basis; enhance the competitiveness of the US; stimulate job creation for Americans at home and abroad; and rationalize and reduce the administrative burden of the IRS in a cost-effective way.

AAT would be made available as an option to Americans, including green card holders, who have established residence overseas and are not residents in a country determined by the IRS to be a tax haven, and who provide proof of being subject to taxation in the country of residence. To qualify, they would have to pay a one-time administrative fee of USD500, and have paid US taxes due up to the date of AAT election.

For most Americans abroad, a form electing to be subject to AAT would be the last IRS or Treasury form to be filed during their lifetime. Contributions to US Social Security and Medicare by self-employed Americans abroad would become voluntary, unless required by a Social Security agreement, and AAT taxpayers who return to the US, or who establish residence in the US for the first time, would be automatically subject to ordinary tax rules for US residents.