04 Dec Will the US tax system ever be reformed to benefit expats?
Around nine million US citizens living around the world face an immensely complex and far-reaching tax system. It’s unlike (almost) any other tax system around the globe, in that it’s one of just two that continue to demand income tax from its citizens no matter where they live and work.
For those unaffected, it’s not commonly understood just how complicated and distressing taxes can be for US expats. Only citizens from Eritrea are subject to the same laws regarding income tax.
Why is the US tax system so complex for expats?
US expats don’t all owe the US Government any tax. There are agreements in place with most countries so that US citizens not living in American can deduct the amount they pay their host country. As these are often higher than the US tax they would owe, it’s cancelled out. There are also various paths to exemption.
However, none of this is automatic. All US expats must file tax returns and disclosures every year, even if they know they won’t end up paying anything to the US. This results in costs for accountancy fees, a lot of paperwork and significant anxiety for many.
For those new to filing US expat taxes, the rules are often opaque, and many employers and financial institutions don’t file in accordance with the Inland Revenue Services (IRS) stipulations, which causes issues. Even innocent errors from US expats can sometimes be subject to rigorous penalties from the US Government as they continue to crack down on potential fraud.
Cracking down on tax evasion is a priority for the IRS
The US Government assumes that any expat holding a foreign bank account could be a money launderer or tax evader. This results in a feeling of anxiety for US expats living and working overseas, as they try to ensure they are compliant with all of the rules.
US citizens living overseas must disclose any foreign assets they hold to the IRS. But they are also legally obliged to disclose them to the Financial Crimes Enforcement Network. This is a separate filing, and it’s up to the citizen to ensure they are filing everything necessary.
The Foreign Account Tax Compliance Act (FATCA) was first introduced in 2010. It obliges foreign banks to automatically report information on US persons and their accounts to the IRS. This means all US citizens or greencard holders. A number of foreign financial institutions prefer not to work with US citizens at all in order to avoid this.
Tax reforms introduced in 2017
New rules were added in 2017 under the current administration to target profits made overseas by US companies. This was originally aimed at rich American citizens living in the US and moving money to offshore accounts. However, tax evaders are generally one step ahead and altered their strategies, leaving the actual targets as US citizens living and working abroad with an average income and no tax expertise.
These include what’s known as ‘accidental American’. This refers to those who didn’t realise they were subject to these tax rules. For example, children who were born in the US while their foreign parents were living their temporarily. Or it could be people born abroad whose fathers were in the US military.
Some US expats may choose to renounce their citizenship entirely, which does remove the tax burden. However, many more simply don’t wish to cut ties with their country, and for others the process is too expensive.
Are there any moves for reform?
So should the US tax system undergo significant reform for US expats? Some US politicians think so. Congressman George Holding introduced the Tax Fairness for Americans Abroad Act of 2018. Also called HR 7358, the bill would make foreign income earned by US expats exempt from tax.
Originated by the Republicans Overseas group, the bill was sent to the 115th Congress for consideration. However, as Congress changed and it’s now 116th Congress, the bill needs to be reintroduced with a Democratic cosignee. The group is still trying to get a bipartisan bill considered by the current administration.
The bill would leave the main tax code the same, rather than proposing a total rewrite. It’s seen a first step to an overall goal of working out the challenges facing US expats overseas. Its main thrust aims to allow non-resident US citizens to elect to be considered ‘qualified non-resident citizens’. This would allow them to only have their US income taxed and all of their foreign income exempt from US tax rules.
How many expats would the bill benefit?
While the bill is yet to be reintroduced, it’s worth considering how much it would benefit US expats. If it did get through Congress, it would be a positive first step to reforming US taxes for expats.
However, the bill still only really benefits a small percentage of US expats living overseas. It doesn’t address a number of concerns for US expats, including FATCA or FBAR reporting. All information reporting would stay the same, and the bill doesn’t address PFICs, foreign trusts reporting or foreign currency conversion transactions.
It would also mean that US expats wouldn’t be able to qualify for the Foreign Earned Income Exclusion if they elect to be considered a non-qualified resident citizen. This would mean all US sourced income would be taxed as if they were a non-resident. Finally, it doesn’t address accidental Americans and their specific tax challenges.
For now, the US tax system remains complex and wide-reaching for US expats. Engaging a US and UK tax specialist is always a good idea for expats. No matter what state your taxes are in, Ingleton Partners can help to ensure you are fully compliant. Our team is highly experienced in both US and UK tax law and will ensure you get up to date with minimal fuss and expense.