It’s worse and even more outrageous than you might think …
Q. Does it makes sense that a US citizen living in Switzerland should be taxable on his income earned in Switzerland while a US citizen living in Puerto Rico should not be taxable on his income earned in Puerto Rico? This anomaly is NOT the result of tax treaties. It’s written right into the Internal Revenue Code.
Part 1 of this series introduced you to the idea that the United States taxes the non-US income of people who do NOT live in the United States and are tax residents of other countries. (Well this is the penalty for having been “Born In The USA”.)
Part 2 of this series explained that the rules used to impose taxation on those nonresidents were far more punitive than the rules imposed on Homeland Americans. It’s true. All other countries stop imposing taxation on their citizens who sever residence from and/or domicile from a country. But, the United States takes the opposite approach. The United States imposes worse taxation on those citizens (whether expats, emigrants or accidentals) who live outside the USA than on those who live in the USA. (Proving that the US taxation does not even pretend to be a “benefits based” tax system.)
Part 3 of this series explained how the way that Americans abroad are taxed by the United States depends – because of treaties – on the country where the individual lives. A US citizen living in France will be taxed differently (by the IRS) from a US citizen living in Canada. But, in both cases, the U.S. citizen is taxable on his income earned in France or Canada. That said, when it comes to the taxation of income earned in foreign countries, the US tax rules are clear! US citizens residing in foreign countries are required to treat the income earned in those countries as taxable by the United States. (Note that even income excluded under the 911 Foreign Earned Income Exclusion is first included on a US tax return and then excluded.)
The rule of US citizenship-based taxation generally make it impossible for a US citizen, unless they renounce US citizenship, to avoid US taxation on foreign source income. But, there are exceptions and Puerto Rico is one exception.
The Tax Havens for U.S. citizens are part of the United States – Yes US Possessions/Territories …
It’s true, US citizens may be able to avoid taxation on income earned in certain US territories!
Let the impact of that sink in. So, if a US citizen resides in Switzerland he will taxable by the United States on income earned in Switzerland. But, if a US citizen resides in the US territories of Puerto Rico or American Samoa, that US citizen may not be taxable on income earned in those territories. Let me explain.
Puerto Rico – Internal Revenue Code – 933
The following items shall not be included in gross income and shall be exempt from taxation under this subtitle:
(1)Resident of Puerto Rico for entire taxable year
In the case of an individual who is a bona fide resident of Puerto Rico during the entire taxable year, income derived from sources within Puerto Rico (except amounts received for services performed as an employee of the United States or any agency thereof); but such individual shall not be allowed as a deduction from his gross income any deductions (other than the deduction under section 151, relating to personal exemptions), or any credit, properly allocable to or chargeable against amounts excluded from gross income under this paragraph.
So, a US citizen can move to Puerto Rico – a US Territory – and avoid taxation on income earned in Puerto Rico.
See this …
See IRC S. 931 – One of few places US citizens can live and NOT be taxable on income earned where they reside – Puerto Rico resident US citizens NOT taxable on Puerto Rico source income: "Puerto Rico Tax Haven: Is Puerto Rico an Offshore Jurisdiction?" https://t.co/o3IHjdNu3G
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) January 25, 2021
and this …
How Puerto Rico Became the Newest Tax Haven for the Super Rich https://t.co/Ncea4ehlf3 via @gqmagazine pic.twitter.com/hGYfoCr7YO
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) January 25, 2021
American Samoa- Internal Revenue Code – Section 931
Q. What about a US citizen who resides in American Samoa?
A. The US citizen will NOT be taxable in income sourced in American Samoa
(a)General rule
In the case of an individual who is a bona fide resident of a specified possession during the entire taxable year, gross income shall not include—
(1)income derived from sources within any specified possession, and
(2)income effectively connected with the conduct of a trade or business by such individual within any specified possession.
Incidentally individuals born in American Samoa are considered to be US Nationals (entitled to a US Passport) but NOT a US citizen (subject to US worldwide taxation. This means that entitlement to a US passport is NOT the price that one pays for taxation.)
If you are getting excited and want to understand more, See IRS Publication 970.
Q. Does it makes sense that a US citizen living in Switzerland should be taxable on his income earned in Switzerland while a US citizen living in Puerto Rico should not be taxable on his income earned in Puerto Rico? This anomaly is NOT the result of tax treaties. It’s written right into the Internal Revenue Code.
#YouCantMakeThisUp!
John Richardson – Follow me on Twitter @Expatriationlaw
