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Tuesday, March 27, 2012

The Diaspora Tax War of 2012: Stakeholder Analysis Part II

Yesterday we looked at a few of the people/entities that stand to gain from citizenship-based taxation/FATCA laws.  Today let's talk about the people who stand to lose and how they are reacting to increased worldwide taxation enforcement efforts by the IRS/FATCA laws.

U.S. Immigrants:  Most immigrants who came to the U.S. came to follow the "American Dream."  These days the dream is not so much about "Freedom" (there are a lot of countries in the world where arguably you can be just as free, if not freer then in the U.S.)  These days it's mostly about opportunity.  The U.S. has a huge internal market and up until recently did a good job of generating jobs for natives and immigrants alike.  Contrary to what most Americans think, the U.S. has a relatively low naturalization rate (37%) which means that well over half the immigrants to the U.S. never become U.S. citizens.  They come, make their money, and they go home with their U.S. born children.

With that in mind, citizenship-based taxation is absolutely contrary to their interests.  It is not so much immigrants who come from poor countries who have few or no assets prior to coming to the U.S. or the young who are just starting their careers.  It's mostly about that much sought after Highly-Qualified immigrant population who have existing assets at home and who have high income potential.  From what I have read, Indians seem to be a particular target as are Europeans and Chinese.

When these immigrants came to the U.S. most had the assumption that the only taxes they had to pay were on U.S. income (money earned in the U.S.)  Why did they assume this?  Well, because the vast majority of countries in the world don't tax their citizens abroad and certainly do not tax immigrants in that manner.  France doesn't.  Canada doesn't.  Singapore doesn't.  Singapore even advertises this fact in their marketing literature for highly-qualified immigrants by highlighting the fact that their tax system is purely territorial.  In fact, I can't think of a single choice destination in the world that has this kind of taxation system.

The other reason they assumed the U.S. had a territorial tax system is the fact that when these people were given their U.S. Visas or Green Cards no one informed them that the U.S. does it differently.  Many had bank accounts or property in their home countries prior to coming to the U.S. or they inherited money while living in the U.S. and it just never occurred to them that once they became "U.S. persons" that they would be required to report these things to the IRS.

That, in a nutshell, is what happened but today they are paying dearly for their ignorance.  Just to remind everyone, the penalty for not filing an FBAR on those non-US accounts is 10,000 USD per year and I think the IRS can go back 5 or 6 years which means, at minimum, a 50,000 USD fine if they are caught.  This story was recently posted on Phil Hodgen's blog and it is quite a tale.  Another story is here at Isaac Brock.

Public reaction by U.S. immigrants has been nonexistent.  Some are still in a state of disbelief.  Others are simply too scared to say anything publicly lest they come to the attention of the IRS - you see a lot of anonymous posts from these people on various sites.  Their position is really an awful one.  Since they are not citizens, they can't vote or call up their Congressman to ask for help.   I personally think that the anti-immigrant rhetoric in the U.S. is also a factor.  Just how safe would you feel if you were an immigrant in the U.S. and you just found out that according to the IRS, you are "non-compliant" with U.S. tax and reporting requirements - in other words, you broke the law.  Coming forward can actually mean that these immigrants can be wiped of their entire life savings - every dime they made pursuing the "American Dream."  Some are quietly leaving the U.S.  Some are waiting to see if relief will be offered.   Some are desperately trying to get compliant.  And some are passing the word to friends and family in the home countries.  It will be interesting to see what the impact will be on U.S. immigration.  There are reports (unconfirmed) that some potential immigrants have started turning down Green Cards.

Americans/Green Card Holders Abroad:  A very diverse group.  This includes Americans citizens married to foreign nationals, "Accidental Americans" (people who acquired U.S. citizenship by jus soli or jus sanguinis but who don't reside there), businessmen and women,  dual nationals (people with U.S. and some other citizenship), retirees and so on. The U.S. emigrants were about as ignorant as the U.S. immigrants.  Even today I am encountering Americans in Paris who have no clue about citizenship-based taxation or FATCA.  Unlike U.S. immigrants or Green Card holders, these citizens can vote but their vote/voice is ineffective for two reasons:  they are required to vote in their last U.S. state of residence and most U.S. politicians fear supporting them lest they be accused of "coddling tax evaders."

It has come as a terrible surprise to Americans abroad that people in the homeland have about as much contempt for them they do for immigrants.  Homeland Americans do not love their "Domestic Abroad" and routinely characterize them as "traitorous Benedict Arnold's."  Now these citizens abroad are in a complete panic now that they are aware of the U.S. tax and reporting requirements.  They are facing the same compliance issues as U.S. immigrants and they are now encountering discrimination in their host countries (loss of local banking services, for example, or limited retirement investment opportunities or even being cut out of business deal by non-US partners) as a result of FATCA.

Many of them cannot easily return to the U.S. - if they did they would have to close their businesses or leave their jobs, get divorces from their foreign spouses and, in some cases, leave their minor children behind in the host country.  Contrary to popular belief in the homeland, the vast majority of these people are not millionaires and run a real risk of arriving back home in the U.S. with limited assets, if not in a state of outright penury. On the other hand, they can no longer continue to reside in their host countries as U.S. citizens where they risk paying double taxes (U.S. taxes in addition to host country taxes) and must pay the increasing cost of compliance (international tax specialists to file the 1040 and a whole host of other forms demanded of overseas citizens who have built lives abroad and are permanent residents of their host countries).  Even Nina Olsen, the IRS Taxpayer Advocate in the U.S., said in her 2011 report:
The complexity of international tax law, combined with the administrative burden placed
on these taxpayers, creates an environment where taxpayers who are trying their best to
comply simply cannot. For some, this means paying more U.S. tax than is legally required,
while others may be subject to steep civil and criminal penalties. For some U.S taxpayers
abroad, the tax requirements are so confusing and the compliance burden so great that they give up their U.S. citizenship.
And that sums up quite nicely what is, in fact, happening.  Those who are in the know and can afford it are mostly "complaining and complying" while those who cannot are renouncing U.S. citizenship. 2011 was a banner year for renunciations of U.S. citizenship.  2012 will be worse (see this and this excellent analysis over at Overseas Exile.)

Foreign Financial Entities/U.S. Banks:  Foreign banks and financial institutions are going to groan under the weight of compliance.  There are IT systems and bank procedures that will have to change radically.  Some banks will simply decide that the costs of compliance are too high and will shed customers with a U.S. connection.  Others will disinvest from the U.S. entirely.  This is already happening in Germany and Switzerland and probably other countries I don't know about.

As for the U.S. banks they are also in the fight.  The U.S. Treasury Department has proposed new regulations that would force U.S. banks to report the interest income of their foreign depositors to foreign governments.  This would place U.S. banks in a similar situation to that of the FFI's under FATCA.  They would have to know (or inquire about) the citizenship of their depositors and track account information in order to report it to foreign entities.  Some U.S. Senators are fighting this tooth and nail but I think they will lose.  Banks are about as unloved as U.S. immigrants/emigrants and I doubt anyone is going to cry for them. Not to mention that passing a law to stop this new regulation is a kind of admission (at least in my view) that the U.S. is quite happy to welcome other country's tax evaders as long as they are citizens of other countries.  Yes, in the world of tax havens, the U.S. is the tallest midget in the room.  And finally there is too much at stake here. If the Treasury Department cannot make this rule stick, then there will be no reciprocity (information exchange) and foreign governments will be much less willing to cooperate on FATCA since there will be nothing in it for them.

Foreign Governments:  If there is real reciprocity, I think most foreign governments will go along with FATCA and I think that is how they will sell this to their citizens who are, at the moment, blissfully unaware of the debate.  However, they are running a real political risk.  Their banks are already up in arms but the real moment of truth will come when a sufficient number of non-US citizens are caught in the citizenship-based taxation/FATCA trap and it explodes in the media.  Countries will have a very hard time explaining to their constituents that they were willing to compromise their sovereignty and allow the U.S. (of all places) to tax or penalize their citizens.  The worst possible case would be one concerning an "Accidental American" (someone born in the U.S. who didn't know he had U.S. citizenship and is subsequently caught by the U.S. IRS and fined or forced to file U.S. tax returns in order to renounce.)  I believe that this would be a "scandale" of epic proportions in a country like France and the French government would have to make a very hard choice:  protect her citizens and risk the wrath of the U.S. or comply with U.S. tax law/treaties and turn an innocent French citizen over to the tender mercies of the American justice system/Internal Revenue Service.

United States:  While there are some real benefits of citizenship-based taxation/FATCA for the U.S. government, there are also some significant downsides.  For one thing Senator Rubio is absolutely correct that requiring U.S. banks to be "agents for foreign tax collectors" will cause a massive exodus of foreign money from U.S. banks.  That is a no-brainer.  FATCA itself will do the same but to a lesser degree.  Renunciation/relinquishments of U.S. citizenship will continue to rise and will start to get media attention.  I also predict a spike in compliance with U.S. tax laws and reporting requirements as people prepare to renounce (potential renunciants must have filed 5 years of U.S. tax returns before they can exit).  There will probably be a sharp drop in naturalizations - fewer people taking on U.S. citizenship.  Immigrants with high income potential and assets in their home countries will think twice about the U.S. - Canada will probably be the beneficiary here.    These are the tangible consequences of the current situation.  I have regretfully come to the conclusion that none of this will make any difference.  The terrible thirst for revenue, the complete inability of the American political system to manage the debt and the political risk involved in raising taxes on citizens in the homeland add up to a situation where it makes sense for the U.S. government to go after people with little or no political power in homeland politics.  U.S. immigrants/emigrants are the "low-hanging fruit."

The intangible consequences are harder to measure but real.  For years there has been a kind of halo around U.S. citizenship. In all the years I have been abroad, I have never met (until very recently) an American citizen who wanted to give it up.  On the contrary, it was almost universally acknowledged that this was something precious, something to pass on the children along with stories about the Founding Fathers and the Constitution and all those quintessentially American things.  People were proud to be Americans wherever they were in the world.  There was something shameful about renouncing and the few who did it did so very quietly.

All that has changed.  Renunciation of U.S. citizenship has become THE topic and is now discussed openly by the American diaspora.  I do not know how to convey properly to Americans in the homeland just how angry and bitter Americans abroad are becoming as they realize just how little regard Americans in the homeland have for them.  Some of these people have decided not to leave quietly and they are venting their frustration and discontent in public forums.  From cheerful goodwill ambassadors, proud to affirm their connections to the U.S., they are now frightened of their own government, lurking on Internet forums because they are too afraid to go public, going public and writing endless letters to U.S. politicians who won't give them the time of day, or angrily venting after having lost all hope and resigning themselves to renouncing.

I will end this post by giving you my unvarnished take on it.  This is one of the saddest things I've ever seen in 20 years abroad and I believe that the American nation is diminished as a result.  Should Americans in the homeland be concerned?  I think they should.  Every renunciation or relinquishment, every immigrant who decides not to become a citizen, just takes American citizenship one step further toward toppling completely from its pedestal and that devalues everyone's U.S. citizenship whether they live in the U.S. or abroad.  It's a lessening of "soft power" and is a bucket of cold water cast over every American who thinks the U.S. is the "greatest nation on Earth" and "everyone wants to come to the U.S. and become a citizen."  As much as people in the homeland like to vilify the renunciants, the reality is that U.S. citizenship for citizens abroad is becoming a terrible burden. Asking Americans abroad to risk their businesses and their families, to submit to discrimination in their host countries, to reduce themselves to poverty so that the U.S. can catch "tax evaders" is beyond unreasonable.  You cannot ask someone to make a choice between U.S. citizenship and a 20+ year marriage and the custody of minor children.  That "choice" is so horrific as to call into question the basic goodness of the people who have forced that kind of decision on its own citizens.

As a result I see us moving toward a world where renunciation will become more and more common and American citizenship will be nothing particularly special - it will be "right-sized" to be no more or less then the citizenship of any number of other very nice countries except for that one peculiar institution which sets it apart:  citizenship-based taxation and a willingness to hunt down and harm its own citizens.  And I think that day the U.S. will lose something very precious that it will never ever get back.

3 comments:

Anonymous said...

Hi Victoria,
Does this tax system apply only to US citizens or also to highly-skilled workers working in H1/L1 categories? If that is true, US's competitive advantage will erode soon....

.K.

Victoria FERAUGE said...

Hi K,

The answer (I really regret to say) is "yes". This tax systems applies to US citizens, Green Card holders and immigrants who are trapped by something called the "substantial presence test" that the IRS uses to deem someone a "U.S. Person" for tax purposes. Here's what the IRS says:

"You will be considered a U.S. resident for tax purposes if you meet the substantial presence test for the calendar year. To meet this test, you must be physically present in the United States on at least:

31 days during the current year, and
183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:
All the days you were present in the current year, and
1/3 of the days you were present in the first year before the current year, and
1/6 of the days you were present in the second year before the current year."

It appears that the only visas that are exempt are students, teachers and professional athletes. You can read more here:

http://www.irs.gov/businesses/small/international/article/0,,id=96352,00.html

Victoria

Tim said...

Increasingly I think there is also a case to made for not staying in the US any longer than 90 days at any point in time if don't want any tax related problems.