What two countries make their expatriate citizens fill out income tax returns, even if they don’t live in their countries? One of those countries is the tiny African nation of Eritrea, which broke off from Ethiopia in 1993.
Can you guess what the other country is? If you said the United States of America, you’re right! If you had said the Philippines, you would have been right until the late 1990s. When they became independent in 1946, the Philippines had our tax code replete with worldwide citizenship-based taxation. But they got rid of it.
According to Andrew Henderson in an article published in The Global Citizen titled “Citizen-Based Taxation: Who’s Tried It and Why the U.S. Can’t Quit,” several other countries had citizen-based taxation and gave it up. These countries are: Mexico (which gave it up in 1981, still has temporarily limited reach for Mexicans who move to tax havens), Romania (which gave it up some time between 1933 and 1954; Romanians who move to a country without a tax treaty can remain liable for Romanian taxes for three years after they move out of the country), Bulgaria (which gave it up in 1996), Vietnam (which gave it up in 2009), and Myanmar (which gave it up in 2012).
Here is the link to Henderson’s article: nomadcapitalist.com/global-citizen
Except for Eritrea, citizens of all other countries who move away are beyond the reach of their home country’s taxing authority. The only exception is for people who live in another country, but who derive income explicitly from their homeland.
But the American citizen (or the non-citizen who has permanent U.S.-resident status) who moves to Germany, as I did in 1977, has to grapple with two competing tax collectors: the German “Finanzamt,” and the American IRS. U.S. citizens living in Germany can take a credit for taxes paid to Germany – as long as the German tax rate is the same or lower than the U.S. tax rate. U.S. citizens in Germany can also exempt up to $108,700 of German "earned income" from their U.S. tax base. "Earned income" does not include investment income.
So, if U.S. citizens can take a foreign tax credit and exempt "earned income," why is the system still unfair? Consider this example. If I had won a million German marks (now it’s Euros) in the South German Lottery, the winnings would have been tax-free in Germany but reportable as income to our IRS. Conversely, if I had invested in municipal bonds in the United States, the income from those bonds would have been tax-free in the United States but reportable as income to Germany. Either way, the American ex-pat loses.
But why should U.S. citizens worry about the U.S. tax code if they live abroad? Indeed, the United States cannot enforce its tax code against a citizen who is in another country. But, if that citizen ever returns, even for a brief visit, they can be pulled aside at the airport. Also, a US citizen with delinquent taxes could be denied a passport renewal. I know from personal experience that many American expatriates are unaware of the requirement to report their worldwide income to the IRS. In that case, they had better either stay where they are, or file and pay up.
How does the United States ever find out? After I left Germany and returned to the United States, the Obama Administration persuaded Congress to enact FATCA (the Foreign Account Tax Compliance Act). This legislation imposes reporting requirements on banks anywhere in the world that open accounts for U.S. citizens. As a result of this legislation, many foreign banks refuse to open accounts for Americans. These banks prefer not to bother with the myriad of U.S. regulations they could face if they were to open such an account.
US citizens living abroad can always get the IRS to stop harassing them by renouncing their US citizenship. But that extreme measure comes at a cost. It requires an interview at a US Consulate, and someone renouncing their citizenship must pay a fee of over $2,000. Under some circumstances, the renouncer also must also pay an Exit Tax. There was once a presumption that the renouncer was taking this step to avoid U.S. taxation, making the person subject to U.S. taxation for a number of years. This so-called “Elizabeth Taylor Amendment” apparently is no longer in effect.
Is enforcing US citizenship-based taxation cost-effective? The U.S. State Department estimates that only about 10 million out of 330 million U.S. citizens (about 3%) live outside the United States. Some of those citizens never lived in the United States at all. In 2019, there were 170 million income tax returns filed. Only 1.7 million (about 1%) came from abroad. Those 1.7 million returns yielded a total of $12.6 billion to the US Treasury. That’s about one half of one percent of the total intake of around $3.1 trillion.
Why should U.S. residents care about their ex-pat colleagues? For one reason, U.S. citizens abroad contribute to U.S. exports and foreign investment in the United States, as I did while living in Germany. Putting U.S. citizens at a tax disadvantage encourages hiring foreign nationals in their place.
U.S. expatriates today enjoy a privilege that I did not have when I lived in Germany – although I was still filing U.S. tax returns. They now can vote for federal offices, i.e., U.S. Senate, U.S. House of Representatives, and President. They vote in the last U.S. Congressional District to which they had a nexus. Other countries give their ex-pats the same privilege without the same tax obligation. For example, German citizens living in the United States can vote in a German election without tangling with the “Finanzamt.”
Recently I had two interviews with podcast hosts representing Americans overseas. The first one was with John Richardson, and is over an hour long. John is an American lawyer living in Toronto who bills himself as a “Lawyer for U.S. Persons Abroad.” Here it is: prep.podbean.com
There was a shorter one with Carter Clews who bills himself as “Carib Carter”. Here’s a link to that interview: https://youtu.be/Uk_I-QUsJCo. Clews is President of The Offshore Club, which Clews says has over two thousand members. It helps Americans find second homes out of the United States in the Caribbean area. Second homes are enjoyable and provide a refuge if the political climate here becomes unfriendly.
We finish by stating the obvious. The issues with taxing Americans overseas end with the FAIRtax. The FAIRtax taxes consumption of services and new tangible goods within the United States. If Americans choose to do anything outside the country, their choices are no longer anyone else’s business. And with the FAIRtax, when foreign tourists pay for a stay in a New York hotel, they help support your Social Security.
Please let us know what you think of extraterritorial taxation.
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