You’re probably by now used to maps in which the US is one of just a handful of countries colour-coded for “countries that do X”, where X is something that countries shouldn’t be doing. Let me add another: the above map is how countries determine who needs to file and pay taxes. Dark blue — almost all of the world — is residence based. If you live in a country, that’s where you file and pay taxes. Which makes sense, because that’s the country that’s paying for your benefits. Light blue is similar, territorial-based — you pay taxes based on where your income is. Green is no income tax.
Then there’s the US, one of the only countries in the world which has “Citizenship-based taxation”. Live in another country, work for a foreign company, receive no US benefits and have no meaningful connection with the US whatsoever, with all social obligations for you falling on your country of residence? Tough, you still need to file taxes in the US.
Now, depending on your situation, you may be able to deduct all of your foreign income from your US taxes. The workload is of course higher — you don’t get W2s, you have to look up the exchange rates for each paycheck, there’s other forms you have to file, all sorts of regulations on your bank accounts and assets, etc. The year of me moving to Iceland was the most complicated; I had to file a veritable book with the IRS. I first tried to get a tax professional to do it, but half of the ones I contacted wouldn’t even touch the complexities of dealing with overseas taxes, and the ones who were wanted to charge crazy amounts to do so.
So I do my own taxes. The IRS harassed me back and forth for a year over my 2011 return, before finally agreeing that they owed me money, and sending me a letter confirming that they owed me money. Yet despite this they continued harassing me for another two years. Each time I called up they agreed that they owed me money, and insisted that they would make a note to get the situation resolved; it never got resolved. The letters and threats kept coming. The two sides of the IRS for some reason could not manage to communicate with each other. It was 2014 when I got my refund and finally could stop making expensive overseas calls with long hold times.
Some expats don’t bother to file taxes, counting on the notion that the IRS won’t go after them because it’s not worth their time. Which it might not be. But if you want to permanently get rid of them , you need to get rid of US citizenship. Simple, right? Well, according to US law, it’s supposed to be.
Oh, but of course it’s not.
There are a series of simple steps a person can take to relinquish or renounce their citizenship. The IRS didn’t like losing people that easily, so they created a concept called “tax citizenship”, which means that you can cease being a US citizen and lose all citizenship benefits, but still be considered a citizen by the IRS.
How do you stop being treated as a US citizen by the IRS? Well, you apply for a Certificate of Loss of Nationality (CLN). You need your taxes current for five years, you need to pay any exit taxes (aka if you have over a certain amount of assets or more than $160k salary, they charge you a tax on everything you own). Regardless of whether you have to pay an exit tax, you have to pay $2350 (not counting any attorneys’ costs for navigating the complicated rules they’ve laid out). Just to get a certificate confirming that you don’t have the citizenship that the US government already considers you as not having.
Obviously, charging people such huge filing fees is another thing that the US is alone in - 20 times the average level in other developed countries.
Don’t have much money and can’t afford to spend thousands of dollars? Then tough luck, you’re stuck being considered a US citizen, even if you’re not actually one. Have enough money that the thousands of dollars to file isn’t too big of a problem for you? Then tough luck again, because then you probably have enough money (either assets or salary) that they’ll hit you hard with the exit tax.
Well, so what if the IRS calls you a “tax citizen” if you don’t have connections with the US. I mean, what can they do, right? Unfortunately, they can do a lot.
The FATCA Letter
(If you are a U.S. “Citizen” who has received a FATCA letter you might find this “FATCA Letter” post to be a good starting point.)
Since July 1, 2014, FATCA compliant countries, have been identifying people who are known to have been (as Bruce Springsteen sings) “Born In The USA”. Those people began life as U.S. “Citizens”. If they are still “Citizens” they are subject to U.S. tax, form and penalty obligations. If they are NOT U.S. “Citizens” then they may or may not (depending on their “Relinquishment Date”) be “Tax Citizens”. Those “Born In The USA” must clarify their status as “Citizens”.
What are they trying to find out? They’re trying to A) find out how much money you have, and B) seize whatever they deem that you owe.
...One result of U.S. citizens abroad being subject to the same tax rules as U.S. residents is that U.S. citizens abroad are required to live their lives the way that U.S. residents would. This means that the financial lives of U.S. citizens abroad are deemed “foreign”. The result is that the lives of U.S. citizens abroad are subjected to “heightened scrutiny” and “penalties”.
The retirement planning options of U.S. citizens abroad, using the retirement planning vehicles in their country of residence, are very limited.
4 – What “Information Returns” are required to be reported to the IRS?
I once heard a tax lawyer claim that he had identified as many as 45 “information returns” that Americans abroad may be subject to. But, in the interests of keeping this simple the most common information returns include BUT ARE NOT LIMITED TO:
FBAR (Now called FinCen 114) which is filed with “Financial Crimes”. (Yes, you read right! Financial Crimes). The rules governing FBAR are complicated. What you must know is that:
– the FBAR must be filed no later than June 30 for the previous year
– You are required to file an FBAR if the aggregate value of all your non-U.S. financial accounts (anywhere in the world) exceeds 10,000 U.S. dollars at any time during the year. This means that you may or may not be required to file the FBAR (although in practice must U.S. citizens abroad will be required to file FBARs).
The IRS regards unfiled FBARs as “Delinquent FBARs”. As you might expect there are significant penalties for the failure to file FBARs. Before having a “heart attack” please note that FBAR penalties may be abated if the taxpayer can show “reasonable cause”.
It should be noted that the FBAR requirement is NOT found in Title 26 (Internal Revenue Code) but in Title 31 (Financial Crimes).
FATCA 8938 – Report of Specified Foreign Assets
This requirement has been in effect since 2011. There are thresholds and the threshold depends on:
– whether you live inside or outside the United States; and
– your IRS filing status (as always “married filing separately”) is dealt with most harshly.
FBAR and FATCA Form 8938 are different but they do have significant points of overlap. You will find the following information from the IRS to be helpful:
Do I need to file Form 8938, “Statement of Specified Foreign Financial Assets”?
Comparison of Form 8938 and FBAR Requirements
Although the FBAR and FATCA 8938 forms are the most common “information returns” for Americans abroad, other common information returns INCLUDE:
5471 – Information return for Foreign Corporation (this includes corporations created in your country of residence)
3520 – Information return for a “Foreign Trust” (this may include various pension and retirement plans in your country of residence)
3520A – related to the 3520
If these returns have not been filed, the IRS will regard these as “Delinquent Information Returns”. As you might expect there are significant penalties for the failure to file these returns. Penalties for the failure to file “Information Returns” may be abated if the taxpayer can show “reasonable cause”.
The U.S. Government requires that almost all details of the financial lives of Americans abroad be reported to the IRS.
By having money overseas, the IRS automatically treats you as if you’re trying to launder it. When they send a letter to your bank — because:
1. Requirements For Non-U.S. Banks – “Non-U.S. AKA Foreign Financial Institutions” are required to search for customers that are “U.S. Persons”. Any Foreign Financial Institution that does NOT search for and locate U.S. persons will have 30% of all U.S. dollar transfers (regardless of reason) to that bank confiscated
In short, they threaten your bank to get your bank to threaten you. The only way to get the IRS off your back is to… wait for it…. get that expensive CLN. Now, if you can manage to convince your bank that you’re not a “US person”, and get them to stand up for you, then you can avoid the CLN. But you’re taking a risk by doing so, which is what the IRS counts on factoring into the calculus, in order to make you get the CLN.
Thanks, America, for making your expats feel like hostages.
But anyway… happy tax day, everyone :Þ
In case you’re wondering what taxes are like in Iceland…. it takes about three minutes… the first minute spent googling the URL of the tax site, the second minute logging in, and the third minute just browsing through the information and clicking “confirm”. The government automatically collects all information that it needs for your taxes (wages, ownership of taxable property, etc) and fills everything out. You’re only responsible for filling out anything they missed or correcting any mistakes.
But as for the US side...