Residency-based taxes on the table for U.S. expats

Our editorial opinion

The U.S. income tax deadline for overseas Americans is just 18 days away, and next year the tax code may be very different.

American Citizens Abroad, an expat advocacy organization, says its 18 months of work has paid off in getting U.S. lawmakers to consider changes in the current system to residency-based taxation.

The organization said that residency-based taxation has been cited in two key reports, one by the Joint Committee of Taxation and the second in a white paper by the Senate Finance Committee.

Another advocacy organization, the Association of Americans Resident Overseas, points out that Americans living abroad must pay taxes twice: once to the country in which they reside and work and again to the U.S. on all their foreign income.

“The U.S. is the only developed country that taxes its citizens living overseas on foreign-earned income,” said the association. “This has made it too expensive for U.S. companies to send their employees abroad to grow their business.”

In fact, the association says that an estimated one million overseas U.S. tax filers pay an average of $2,000 each to have professionals prepare their submissions because the law is too complex for individuals. That’s a drain of $2 billion, the association said.

The current citizenship-based tax system has spawned a number of complex rules. For example, expats who own Costa Rican corporations, even if only to hold a home or a car, face complex reporting responsibilities. In addition, expats with Costa Rican bank accounts also must make a separate filing with the U.S. Treasury Department if the account contains $10,000 or more at any time during the year. This is the hated FBAR, the report of foreign bank and financial accounts.

American Citizens Abroad said its representatives met continually with legislators and key offices in Washington, D.C., including the Senate Finance Committee, The House Ways & Means Committee, and the Joint Committee on Taxation.

Dave Camp, chairman of the House Ways & Means Committee, and Sen. Max Baucus, chairman of the Senate Finance Committee, are both pushing for a major restructuring of the U.S. Tax Code, notes American Citizens Abroad.

However, the outcome may not be beneficial to Americans overseas. There have been some suggestions that the foreign earned income exclusion be eliminated. This is the section of the tax code that allows U.S. citizens working overseas to exclude $95,100 this year from their 2012 U.S. taxes. American Citizens Abroad noted that the exclusion would be meaningless if U.S. lawmakers opt for a citizenship-based tax system. But some lawmakers just want to eliminate the income exclusion to generate more money for the federal government.

The white paper prepared for the Senate Finance Committee addresses U.S. competitivity overseas.

“Tax reform is an opportunity to strengthen the competitiveness of the U.S. in the global economy. It is also an opportunity to improve the tax system by making it more fair, efficient, clear and simple,” says the white paper. It also says:

“U.S. corporations generally pay tax at a federal statutory rate of 35 percent on their foreign earnings (reduced by foreign tax credits), either immediately or when such earnings are repatriated. Their competitors in foreign countries typically pay tax on their foreign earnings at a lower statutory rate (and, some believe, a lower effective rate). Their competitors also are not taxed significantly, if at all, on repatriated foreign earnings. Some are concerned that these features of our tax system put U.S. multinationals at a competitive disadvantage by reducing the after-tax return they can offer investors, which in turn increases their cost of capital compared to a typical foreign competitor.”

For individuals, the Association of Americans Resident Overseas points out that “penalties for human errors on tax forms are also much higher on Americans abroad than they are on those residing in the U.S. For example, the penalty for failure to disclose assets is $10,000 with a maximum penalty of $50,000 for one taxable year.”

The association has a long list of discriminatory rules that face overseas U.S. tax files and not U.S. residents.

Expats also face discrimination locally when they try to open or maintain a local bank account. The Foreign Account Tax Compliance Act, the hated FATCA, requires foreign financial institutions to report directly to the U.S. Internal Revenue Service information about financial accounts held by U.S. taxpayers or held by foreign entities in which U.S. taxpayers hold a substantial ownership interest. The act also requires some U.S. citizens to report their assets to the federal government.

It is this measure that has caused banks to deny accounts to U.S. citizens, In Costa Rica expats sometimes have to visit banks with reams of paperwork to show from where their money originates even if they have an account with a very modest amount of money. In one case the amount leading to the interrogation was $85.

The complexities of the U.S. Tax Code made news earlier this month when Apple CEO Tom Cook appeared before the U.S. Senate’s Permanent Subcommittee on Investigations to defend his firm’s practice of not paying taxes to any government on $74 billion in overseas income. The tax avoidance efforts are fully legal. But even Cook said the tax code needs an overhaul.

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