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Why Is the US About the Only Country on Earth That Taxes Its Citizens Abroad?

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November 18, 2017

By SUSAN CALLAHAN, Associate Editor and Featured Columnist


I grew up in America and, like most Americans, I am proud of my country. Politics aside, we Americans love our country. So it was with a great deal of surprise that I learned, after traveling abroad, that the United States shares a distinction of being almost the only country on Earth that taxes its citizens abroad. It shares this distinction with the tiny African nation of Eritrea. What? Why is the US taxing its citizens even after they leave it? What's the basis for this tax anyway?

You to the IRS: You Don't Own Me

Back in the 1960's Leslie Gore wrote and sang the iconic song "You Don't Own Me", a freedom anthem for all women to their possessive boyfriends and husbands.  The song describes exactly how many Americans living abroad feel about the IRS.  There are 9 million Americans living abroad, according to the 2016 estimate from the State Department. Some of these people don't even know they are Americans, such as children born abroad to American parents in Canada and other countries or children of foreign parents born in America. Boris Johnson, the current Foreign Secretary of the United Kingdom was one such person. He had not lived in the US since he was 5 years old and recently gave up his US citizenship.

Though we no longer benefit from municipal, state or Federal services (more on that later), we are still taxed as though we still live down the street.  To be more precise, we don't have to pay city taxes unless we actually live in a city. We don't have to pay state taxes unless we live in a State or own property or earn income there. But we do still have to pay Federal taxes.

Every year, no matter where you are on Earth, you still have to file your US tax returns and pay US tax. Lost on a desert island? Yep, you still owe taxes. When you get "unlost", you'll have to explain to the IRS why you missed those deadline to file.

Taxes Are Based on Citizenship Not Residency

The US taxes its citizens based on the fact of citizenship , not on the actual residency. Logically enough, the Us type of tax is called "citizenship based taxation" and the system followed by the rest of the world is "residency based taxation".

What would justify citizenship based taxation? The legal argument appears weak. If we look, by analogy, at the power of a state to tax people who are not residents of their state, we see that courts have consistently said that a state's power to tax ends at its borders. Minnesota can't reach across state lines and tax residents of Michigan. Oklahoma can't reach across state lines and tax residents of Texas.

But when it comes to the Federal government, no court has ruled --- yet --- against the US applying its power to enforce its obligations to tax individuals even though they no longer live in the US.

Why Are US Individuals Treated Worse Than US Corporations











Interestingly, individuals can be taxed even when they live outside the US but corporations cannot. A US corporation operating through a subsidiary or affiliate outside the US, is not taxed in the US. Instead, the foreign country taxes it.  This is the way that corporations have legally avoided paying trillions of taxes through the years. Witness the hoards of tech companies whose subsidiaries in Ireland actually hold most of their profits.

The Unintended Consequences of Citizenship Taxation

Citizenship taxation has long been the law. You have to file with the IRS no matter where you live. But many citizens have not been filing. We know this because even though the number of Americans living abroad is in the millions, the IRS only receives about 800,000 tax returns from citizens abroad each year.

Many Americans simply resolve to live out their lives and leave the IRS behind. And while it may not be the Boy Scout/Girl Scout choice, no one was hurt much by it anyway. The reason that the IRS didn't care much about pursuing Americans abroad is that there is a generous tax exemption for foreign-based income, amounting to over $100,000.

This kind of  tacit agreement to "live and let live" ended with the Obama administrations signing of the FATCA law. This law was designed to catch the fat cats who might have bene hiding millions in Switzerland or other tax havens. It required banks to report to the IRS if they had Americans with accounts.

Now, if you live abroad and you're not filing with the IRS, you're probably looking over your shoulder, because any bank you have accounts with is telling the IRS exactly where to find you.

The New Tax Reform Bill Might Unwind FATCA

A new tax reform bill (The Tax Cuts and Jobs Act° has been passed by the House and is on its way to the Senate. The Financial Times quotes House Ways and Means Committee Chairman Kevin Brady of Texas as saying that they are considering repealing Territorial Tax For Individuals (TTFI) but no mention was made of FATCA. We don't know yet if even TTFI made it into the final markup of the bill that the House passed.

When we know, we'll let you know.




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