The US tax system is unique in that it assesses tax liability on citizenship as well as residency. However, the recent Residence-Based Taxation for Americans Abroad Act first introduced by Rep Darin LaHood aimed to provide a means of no longer participating in the US tax system but maintaining US citizenship while living outside the US. The bill did not pass, but there is a lot of work being done to hit revenue neutrality with the hopes of reintroducing the bill and passage at a later date. This is a summary of a discussion with Mark Warren and the Tax Fairness for Americans Abroad.
Residence- vs. Citizenship-Based Taxation
Most countries in the world impose taxes based on residency and location. Basically, countries tax business, property and individuals who live within their borders. This is both logical and practical: the people living in the country are the people most benefiting from their taxes and are the easiest group to collect taxes from.
The US, however, also imposes taxes and reporting requirements for Americans living outside its borders. As Americans abroad, we know we must do FBAR reporting and possibly pay taxes to the US purely because of our nationality, even if our assets and earnings are located entirely outside the US. The current citizenship-based system allows Americans abroad to reduce their US taxes on foreign-source income with foreign tax credits and exclusions, but US citizens with income in low-tax rate jurisdictions often have a net tax due to the US that they would not have if they were not American. These taxes as well as the annual costs and risks of filing compliance have led many Americans to simplify their lives by renouncing their US citizenship.
The LaHood and Young Act – Elective Residence-Based Taxation
The Residence-Based Taxation for Americans Abroad Act and expected future versions of the bill propose that Americans abroad be allowed to essentially renounce for tax purposes without losing their citizenship. This allows Americans, who may prefer to stay within the US tax system for various reasons while living abroad, to continue to enjoy the benefits of their nationality and possibly favorable tax treaties. Further, the proposed act includes a “departure tax,” which is similar to the Exit Tax currently calculated on Americans who renounce their citizenship.
What’s the hold-up?
The short answer is, money. The proposed act is not revenue neutral; the expectation is that it would result in a loss in US tax revenues of a few billion dollars per year and maybe much more in the first few years. This would happen when those living in low -tax rate countries would no longer be paying income tax to the US, and the first few years would have large groups of people taking advantage of the opportunity to eliminate their US tax bill through the departure tax. Additionally, there is a risk that high-net-worth individuals would relocate outside the US to lower tax jurisdictions, while also still spending a significant number of days in the US annually, and thus this would become a tax shelter. This is very much not the intention of the Act’s writers and the US citizens abroad who support it!
LaHood, Young and their staff are working to get the revenue impact down and gain bipartisan support to introduce and debate and potentially pass the bill in the coming years. There’s a belief that after the election, if Congress is divided, there would be more support to pass bipartisan and popular legislation.
