1. Citizenship-based taxation and related reporting requirements:
Problems and proposed solution
October 18, 2012

2. Outline Taxation systems for individuals US taxation of foreign income
Citizenship-based taxation
US taxation of foreign income
Requirements to report foreign assets
Recent IRS enforcement programs
Foreign Account Tax Compliance Act (FATCA)
Effects
Proposal

3. Taxation systems for individuals
No income tax (23)
Territorial (34)
Residential (185)
Citizenship-based (2)

4. Citizenship-based taxation
Presently, only two countries tax the foreign income of nonresident citizens: Eritrea and the United States
Mexico, the Soviet Union, the Philippines, Vietnam and Myanmar previously used citizenship-based taxation but all eventually abolished it
Eritrea:
Highly authoritarian government, accused of various violations of human rights, most militarized country in the world
Levies a 2% tax on net income of nonresident citizens
Diaspora tax condemned by United Nations Security Council Resolution 2023, and successfully prohibited in Canada
United States:
Taxes citizens, regardless of where they reside, in the same manner as residents

5. US taxation of foreign income
Arguably the most complex part of the Internal Revenue Code for individuals
IRS forms 1116, 2555, 3520, 5471, 6251, 8621, 8891, 8938
Rarely supported by tax professionals or software
The IRS has admitted that Americans abroad are the group that needs the most assistance with tax return preparation, and the one that has the least access to it
Due to the credit for the usually higher taxes already paid to their countries of residence, 91% of Americans living abroad do not owe tax to the US, but still must file all forms
Taxes collected from Americans abroad amount to less than 0.2% of federal tax revenue

6. Requirements to report foreign assets
Regardless of tax due, all US citizens and residents must file reports of foreign assets, but most do not
Report of Foreign Bank Accounts (FBAR)
IRS form 3520 (foreign trusts, gifts and inheritance)
IRS form 8938 (foreign financial accounts)
Enormous penalties for noncompliance, disproportional to any tax due
FBAR: 50% of the value of the bank account
IRS form 3520: 35% of the value of the trust, 25% of the value of the gift or inheritance
Account balances, trusts, foreign gifts and foreign inheritances are not taxable
Americans abroad need local bank accounts for mundane activities like earning salaries and paying bills
Immigrants often retain the bank accounts they already had before immigrating to the US

7. Recent IRS enforcement programs
Offshore Voluntary Disclosure Program (OVDP) of 2009
Offshore Voluntary Disclosure Initiative (OVDI) of 2011
2011 program extended indefinitely
Misleading information about possible penalties outside the program
Misleading promises of reduced penalties for voluntary disclosure
Severely criticized by the National Taxpayer Advocate of the IRS, Nina Olson, in her periodic reports to Congress

8. Foreign Account Tax Compliance Act (FATCA)
FATCA is an extraterritorial US law that asks every financial institution in the world to report to the IRS on accounts of US citizens or residents, or face withholding of payments from the US
Included as an amendment to the unrelated Hiring Incentives to Restore Employment (HIRE) Act of 2010
Congress passed FATCA amendment without deliberation
The international financial community has been severely complaining about FATCA
Implementation will cost much more than any possible additional tax revenue to the US
Many foreign banks have decided to avoid FATCA altogether by closing accounts of Americans abroad
Americans are now pariahs in the financial world

9. Effects On Americans abroad On immigrants On the US economy
Negative sentiment toward the US
Loss of availability of financial services
Divorce from foreign spouse
Renunciation of US citizenship: increased by a factor of 7.8 from 2008 to 2011
Emotional stress and despair
On immigrants
Abandonment of green cards and return to country of origin
More emotional stress and despair
Reduced immigration and naturalization by wealthy individuals
On the US economy
Lack of representatives of American companies in other countries to promote US exports
Lower exports and fewer job opportunities

10. Proposal
Replace citizenship-based taxation with residential taxation, in line with the rest of the world
Residential taxation is still worldwide taxation, but only for residents of the country, regardless of citizenship
Simplify reporting of foreign income and assets
Eliminate overburdening or repetitive filing requirements: IRS forms 3520, 5471, 8621, FBAR and FATCA
Eliminate penalties unrelated to tax due