The Reality of U.S. Citizenship Abroad
Nobody denied that the unintended targets of Congressional legislation aimed at those who supposedly “owe allegiance” to the USA, now assisted by craven foreign governments anxious lest their financial services entities lose access to the US market, are mostly unlikely to do anything at all. But the whole idea of universal self-assessment of taxation is to keep the taxpayer in an anxious condition, to make him overpay if possible, but at least not to underpay. Those now faced with an unprecedented, even retroactive, enforcement campaign and who must, if they wish to become compliant and avoid penalty or even prosecution (should they be identified in the future), sacrifice much of their wealth, even become insolvent.
Comment at the Isaac Brock Society blog – July 29, 2013
— US Taxation Abroad (@TaxationAbroad) August 1, 2013
It’s a tough time to be a U.S. citizen abroad. The world is awash in FATCA anxiety. The U.S. has discovered FBAR as a way to raise penalty revenue and have embarked on an “FBAR Fundraiser”. Incredibly all bank accounts outside the U.S. are considered to be “offshore accounts“. U.S. law requires U.S. citizens to enter the U.S. with a U.S. passport. Those renewing their passports are now required to provide information relevant to tax compliance. Many are inclined to simply renounce their U.S. citizenship. Even renouncing citizenship has tax implications. Yet, all indications are, that the vast majority of U.S. citizens abroad are NOT tax compliant.
U.S. citizenship abroad is a problem that needs to be solved.
When it comes to solving problems:
“The formulation of the problem is often more essential than its solution, which may be merely a matter of … skill” – Albert Einstein
— US Taxation Abroad (@TaxationAbroad) August 2, 2013
11 considerations to help you formulate the problem – What to consider before consulting a tax or compliance professional …
1. Investigate the “State” (no pun intended) of your U.S. citizenship
U.S. Citizens born or naturalized in the U.S.
You may have committed a “relinquishing act”. If so, you may have lost your citizenship. Many who became dual citizens prior to 1986 may have a strong claim that they are longer a U.S. citizens. Some who became dual citizens after 1986 (depending on the facts may have relinquished their U.S. citizenship.)
Those who relinquished their U.S. citizenship by becoming a citizen of another country may be entitled to a “backdated CLN” – ( backdated Certificate of Loss of Nationality).
Those born outside the U.S. to one or more U.S. parents
Those born abroad to U.S. citizen parent(s) should seek a professional opinion on your citizenship. Under no circumstances should you simply presume/accept that you are a U.S. citizen.
Sounds ridiculous, but remember it is only “U.S persons” (at least so far) who are under assault. Take the appropriate steps to determine whether you are a U.S. person.
2. Emotional considerations are as important as tax considerations
If you are reading this post the chances are that you are worried. People find themselves at different points on the “anxiety spectrum”. This spectrum ranges from “annoyed curiosity” at the one extreme to “incapacitating trauma” (possibly requiring psychotherapy) at the other extreme. You need to choose the route that best allows you to live your life as a U.S. citizen abroad. You need to be able to sleep at night and move on …
You are dealing with a life planning problem that has arisen because of tax and citizenship issues.
3. It is important that you respond and NOT react!
As the above quote says, tax compliance is designed to make you anxious. The IRS, the lawyers, EAs and accountants are happy to exploit your anxiety. Do NOT react! You must respond. A response requires a calm, deliberate state of mind. Therefore, a “response” requires you to:
Take your time in coming to a decision.
4. A “response” requires that you investigate your possible U.S. tax liability
You should NOT involve a lawyer or accountant until you reach the point where one is required. There is a difference between consulting a lawyer and consulting an accountant. A consultation with a lawyer will give you the benefit of “lawyer client privilege”. This means that, for the most part, conservations with your lawyer will stay with your lawyer. This is NOT the case with conversations with accountants.
You should first take steps to determine whether there may be any tax liability. (This is NOT the same as determining how much the tax liability may be.) This involves recognizing areas where the U.S. and Canada have different tax rules. Remember that the existence of PFICs, Foreign Trusts or Controlled Foreign Corporations (including a Canadian Controlled Private Corporation) are things to consider. The sale of your principal residence is NOT tax free under U.S. tax law. Having you been reporting your RRSP properly? Did you know that TFSAs are not tax exempt under U.S. law? What about your non U.S. pension plan? Remember, at this stage you are in “fact finding” mode.
Those with simple situations might consider using a tax preparation program (Geithner used TurboTax).
Remember that all transactions and valuations must be converted to U.S. dollars.
To reiterate: You must do as much homework as you can prior to a professional consultation.
5. A response requires that you understand your U.S. tax compliance options
What are the vehicles for coming into compliance? What options are available to you?
There are three general categories of options for coming into compliance.
(i) Using OVDP or Streamlined Compliance. This implies direct IRS involvement. These options will necessitate higher professional fees. (OVDP is designed for criminals and not for honest U.S. citizens abroad.) If anybody tells you to enter OVDP please contact me to discuss this.
(ii) Simply file or refile (amend) your past returns. There is no requirement of IRS involvement. But, they may “audit you” later. (In this regard see the December 2011 IRS FS for U.S. citizens abroad.)
(iii) Simply file properly on a “going forward” basis. If the IRS wants to reopen the past, let them.
Note: The real decision is whether or not to involve the IRS into your coming into compliance.
6. A response requires that you consider how your response may affect your Canadian (or other local) tax situation
Remember that a course of action that might make sense from a U.S. perspective, could be harmful from a Canadian perspective. Remember that the sale of assets will generally trigger a tax liability somewhere.
To put it simply: Every U.S. action will have a Canadian reaction and vice-versa.
7. Compliance decisions are rarely susceptible to “black and white answers” – That’s why a decision is required
Although you must come to a decision, you must also understand that there is NO “black and white answer” to the compliance question. Don’t think in terms of right and wrong decisions. Think in terms of “better vs. worse” decisions. Consider your personal circumstances. How complicated is your situation? What is your tolerance for risk?
By its very nature, anything that requires a decision is NOT clear.
8. Chances are you will NOT be happy with any course of action.
There is NO option that you will be happy about. That said, some options are worse than others.
If you do nothing you are running the risk of being discovered and may worry about the risk of discovery.
If you attempt to clean up past problems, it may be financially crippling.
If you comply on a “going forward basis” you may worry about the past.
9. Choosing among compliance options is largely about choosing among emotional outcomes. Do you prefer to live with anger or anxiety?
Because of the injustice of the application of U.S. tax laws to Americans Abroad you may be left with a healthy dose of residual anger. You thought you were investing in mutual funds to save for retirement. The accountants and lawyers tell you that the IRS regards mutual funds as investments to confiscate. The injustice is extreme! Anger is inevitable. Anger is difficult to live with. If you comply on a “going forward” basis you will have greater anxiety. Therefore, compliance options must be viewed in terms of both “objective” and “subjective” considerations.
A. Objective – What is the perceived compliance result of your choice and what are the financial costs?
B. Subjective – What is the emotional state you are left with. For many this is a choice between extreme anger and extreme anxiety. What is the emotional cost?
10. Understand the reality of lawyers and accountants
They are working for the IRS but are being paid by you. They may be friendly, but they are not your friend. Some of them must interact with the IRS in their professional lives. Those lawyers, accountants and EAs (“Enrolled Agents”) who appear before the IRS are subject to IRS rules of practice. These rules are found in Circular 230. This is an important and is developed in the video referenced in the following tweet:
— US Taxation Abroad (@TaxationAbroad) August 2, 2013
Lawyers and accountants cannot tell you to NOT come into compliance!
Therefore, don’t ask them that question. Their job is to explain to you the consequences of all available options, actions and possible reactions. You and only you are responsible for making the decision that is appropriate to your situation. I urge you to take responsibility for that decision.
11. Coming into compliance will solve one problem but will create another (possibly bigger) problem
There are two kinds of U.S. citizens abroad who have problems:
A. U.S. citizens abroad who are NOT compliant with U.S. “tax laws”.
They are forced to endure the continual threats of penalties from the IRS, the media and the compliance industry. Note that there are two kinds of “non-compliant” Americans abroad.
First: Those who have NOT been filing and are NOT in the system.
Second: Those who have been filing, thought they were compliant, but learn that they have been filing incorrectly (very common).
B. U.S. citizens abroad who ARE compliant with U.S. “tax laws”.
U.S. citizens abroad who are tax compliant also have massive problems. Taxpayer-advocate reports that for U.S. Citizens Abroad, tax compliance is somewhere between difficult and impossible.
U.S. Tax compliance:
– is impossibly financially expensive for the average person;
– will consume an unjustifiable amount of time and stress;
– means that you will be unable to engage in normal retirement planning.
To put it another way: coming into U.S. tax compliance will solve one set of problems. But, it will create a new set of problems. Once you are compliant, you must stay compliant! The problem of “staying in compliance” is enough to make people seriously consider renunciation of U.S. citizenship.
Two final pieces of advice:
1. Educate yourself and consider this list before involving a “cross-border” professional!
2. You should neither sell nor acquire any investments without determining the U.S. tax consequences! You do NOT want to make the situation worse!
If after having read this, you would like to discuss your situation contact me and I will help you formulate a plan of attack. Sometimes the hardest part of life is NOT making a decision, but learning HOW to make a decision.