Part 2 – Americans living outside the USA are subject to a more punitive tax regime than those living inside the USA

Introduction

As these three prominent tax professionals confirm, the title of this post is correct! The rest of the world stops taxing their citizens who move to other countries. The United States taxes them more! The United States imposes more penalties on them! The United States makes it practically impossible for them to integrate into the tax systems of other countries.

But, don’t take my word for it. See the following interview with three very prominent U.S. tax professionals.

(The video in the above tweet is one of eight videos discussing how the United States Of America taxes and regulates the lives of people who live in other countries.)

Part 1 of this series explains the “Mission Of SEAT“.

In part 1, I made the important point that the United States is actually imposing:

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A separate and more punitive tax system applied to individuals living in other countries

It’s far worse than the United States imposing worldwide taxation on (1) people who do not live in the United States and (2) on their income sourced outside the United States.

This is because, the system of worldwide taxation that the United States imposes on individuals living outside of the United States, is a separate and more punitive version than the system imposed on U.S. residents. In earlier posts I have identified a number of specific examples. Of interest is a discussion I had with three very highly regarded U.S. tax professionals who agreed with the proposition that: “The United States is imposing a separate and more punitive tax system on individuals who live outside the United States”. You can view some of the discussion here. Imagine, never having even lived in the United States and being subjected to a U.S. tax system that is more harsh than the system imposed on U.S. residents!

With the exception of the United States and Eritrea, other countries stop imposing worldwide taxation on citizens who move to another country. But, with respect to U.S. citizens who move from the United States to integrate into another country: The United States imposes a more punitive form of taxation. Homeland Americans have never heard of FBAR, FATCA, PFIC, Phantom Gains, Subpart F, Transition Tax or GILTI. For Americans abroad these terms are part of their daily vocabulary.

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Yes, it’s true the U.S. tax system penalizes you for living outside the United States.

Those who like your information is small doses should stop reading now. You have read the general message of this post. But for those who are skeptics or who want to understand this better …

Here are twelve examples from Canada

12 examples (in addition to the “transition tax”) which U.S. residents can “laugh about” and U.S./Canada dual citizens resident in Canada can/should “rage about”:

1. Templeton Mutual Fund bought in the U.S. by a U.S. resident is NOT subject to PFIC confiscation. The same mutual fund (with exactly the same securities) bought in Canada by a Canadian resident is subject to PFIC confiscation. Furthermore, the Canadian resident is required to report his ownership in his Canadian mutual fund on Form 8621.

2. A U.S. resident who invests in a ROTH IRA has automatic “tax deferral” and is not subject to U.S. taxation. A Canadian resident who invests in an equivalent Canadian TFSA (in Canada) does not have “tax deferral” and is subject to U.S taxation on the income on TFSA in the United States even though he is not subject to taxation on the income in Canada.

3. A U.S. resident who invests in an ABLE plan (Achieving a Better Life Experience Act) has automatic tax deferral. A Canadian resident who invests in an RDSP (equivalent “special needs plan”) is subject to U.S. taxation on that income. Furthermore, the Canadian resident is required to report his ownership of his RDSP on Form 3520.

4. A U.S. resident who invests in a S. 529 “education plan” has automatic tax deferral. A Canadian resident who invests in an RESP (equivalent “education plan”) does not have “tax deferral” and is subject to U.S. taxation on that income. Furthermore, the Canadian resident is required to report his ownership in his RESP on Form 3520. (See also this discussion from Virginia La Torre Jeker who describes the difficulties Americans abroad may experience should they try to make use of a Section 529 plan.)

5. A U.S. resident who receives distributions from a 401K plan is not subject to the 3.8% Obamacare surtax. A Canadian resident who takes a distribution from an (equivalent) Canadian RRSP is subject to the 3.8% Obamacare surtax. Furthermore, the Canadian resident is required to report his Obamacare surtax  on Form 8960.

6. A U.S. resident is not required to report his local U.S. bank accounts to U.S. Financial Crimes. A Canadian resident is required to report his Canadian bank accounts to U.S. Financial Crimes. This is a very special category of “form crime” -see information about Mr. FBAR.

7. A U.S. resident is not required to report his U.S. financial assets annually to the IRS on Form 8938. A Canadian resident may be required to report his Canadian financial assets annually to the IRS on Form 8938. Form 8938 is an extremely intrusive, time consuming form.

8. A U.S. resident is NOT required to treat his business activities in the USA as foreign and subject to penalties and reporting. Certain Canadian residents are required to treat their business activities in Canada as foreign and subject to penalties and reporting. Check out Form 5471 and Form 8865.

9. A U.S. resident married to a U.S. citizen spouse is allowed to make unlimited gifts to his spouse. A Canadian resident married to  a Canadian citizen spouse is NOT allowed to make unlimited gifts to his spouse. Furthermore, the Canadian resident is required to report certain gifts to his spouse on Form 709. Furthermore, the Canadian resident is required to report certain gifts from his spouse on Form 3520. The U.S. imposes numerous forms of punitive taxation on U.S. citizens who marry non-citizens.

10.  A U.S. resident who renounces U.S. citizenship will not have his U.S. pension plan subject to confiscation because of the Section 877A Exit Tax. A Canadian resident who renounces U.S. citizenship would have his Canadian pension plan subject to confiscation because of the S. 877A Exit Tax. It’s because it the pension is NOT a “U.S. pension”, but is a “Canadian pension”.

11. The TCJA includes a provision that allows U.S. residents to deduct property taxes on their U.S. principal residences, but specifically does NOT allow a Canadian living in Canadian to deduct property taxes on his Canadian principal residence.

12. As explained by Virginia La Torre Jeker, The TCJA provided allows a deduction of up to 20% of pass through income for specified service business owners with income under $157,500 (twice that for married filing jointly) for certain income effectively connected with the conduct of the trade or business within the US. A U.S. resident operating a U.S. business is entitled to the deduction. A Canadian resident carrying on a small unincorporated business in Canada is NOT entitled to the 20% reduction.

Conclusion – from one of my previous posts …

One answer to the question includes

I know the answer to this question. I filed one year using TurboTax (and a host of paper filings since TurboTax falls way short of being sophisticated enough for a foreign return) and it had a helpful function at the end where you could compare your US tax liability against others in a similar income band. My US tax liability was 2.5x the average bill in the same income band. That’s not 2.5% but 2.5x. My “fair share” was more than twice as much for the same level of income as the homelander “fair share”.

Thankfully, the out of pocket cost was limited by the taxes I had already paid in the UK. But, it shows the cost of not living a life optimised for the rules of the US tax system can be enormous. If you live in the US, there are tax no brainers. If you live in the UK, there are tax no brainers. But if you’re subject to both systems at the same time, you can’t benefit from the tax no brainers since, by and large, the other country takes what the other giveth.

As I’ve said before, the US tax system includes on the basis of citizenship but excludes on the basis of physical location since participation in the tax no brainers is limited by things like US source earned income which you can, generally, only get when you live in the US.

Yes, it’s true.

John Richardson – Follow me on Twitter @Expatriationlaw

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