Why U.S. Pursues Citizens Overseas
By John D. McKinnon
May 18, 2012, 4:39 PM
Associated PressSen. Charles Schumer (D., N.Y.), left, accompanied by Sen. Bob Casey (D., Pa.), gestures during a news conference blasting Facebook co-founder Eduardo Saverin’s remouncing of his U.S. citizenship.The U.S. is the only country that taxes its citizens on their world-wide income, no matter where they live.
OK, there’s also Eritrea. It imposes what is derisively termed a “diaspora tax” on its citizens.
Otherwise, though, the basic rule is that countries impose their taxes on individuals based on their residency, not their citizenship.
The case of Eduardo Saverin, the billionaire Facebook co-founder living in Singapore who recently renounced his U.S. citizenship – and thus his U.S. tax obligation on his future income and gains – has served as a reminder of how different the rules are here.
But why is the U.S. such an outlier? And should it consider abandoning its exceptional approach, or stick to its principles? That’s a debate that is picking up steam this week.
The U.S. rule – not so different from war-torn Eritrea’s – has its roots in desperate national conflict. The first U.S. income tax, enacted in 1861 in the early months of the American Civil War, levied a 3% tax on incomes over $800, but a 5% tax on income earned in the U.S. by “any citizen of the United States residing abroad.”
The aim was to prevent wealthy people ducking their military and civic obligations by fleeing the U.S. in its time of crisis. In 1864, the tax was expanded to include income from all sources, no matter where generated. Scholars say this happened as the proud sense of being a citizen of the U.S. – with all its opportunities and obligations – first flowered out of the battlefields.
That model of citizenship-based taxation has remained in the U.S. law ever since, even as the rest of the world has gravitated to a different model, one that simply considers where the taxpayer is living at the moment.
The concept of citizenship-based taxation never really caught on elsewhere, as early international agreements focused on taxing based on either residence or source of income.
The question of whether the U.S. should now switch to the residency model has been generating more debate in recent years, particularly as the U.S. has stepped up tax enforcement on its non-resident citizens. Americans abroad are renouncing their citizenship in greater numbers over the last couple of years, in part because of the increased red tape. Globally, 1,781 Americans renounced their citizenship last year, compared with 742 in 2009 and 278 in 2006, according to Treasury data.
Many say it’s time to fall in line with other countries, especially in an age of increased globalization. “We’ve come to realize it’s the only solution,” says Jackie Bugnion, a director of American Citizens Abroad, an expat group. She says that recent tightening of U.S. tax rules for foreign accounts is “the straw that broke the camel’s back” for a lot of U.S. nationals abroad.
Other experts, including Michael Kirsch of Notre Dame law school, say increased mobility argues for maintaining the U.S. model, not getting rid of it.
Like it or not, Mr. Saverin’s case probably shows how the U.S. model already is losing its grip. Until a few years ago, the U.S. simply presumed that rich people renouncing their U.S. citizenship and moving overseas were doing so for improper tax reasons, and made them prove otherwise in order to escape from the IRS. But that model proved essentially unworkable – lawyers could always find other reasons for the move – and there was at least an argument to be made that the whole system was unfair.
So a few years ago, the U.S. adopted its own version of the system that many residency-taxation countries use when their wealthy people leave – hit them with an exit tax on the way out. In Mr. Saverin’s case it will amount to hundreds of millions of dollars, as he has recently confirmed.
Some experts think his move could be just the beginning.
“I think Saverin proves the point that it now makes sense for many U.S. citizens living permanently overseas to relinquish their passport and pay the exit tax,” said Reuven Avi-Yonah, a University of Michigan professor. The exit tax has removed the uncertainty of the old rule. Besides, he adds, the trend in U.S. taxation is likely to be upward for years to come.
All in all, “it makes sense to bite the bullet and pay,” he said.http://blogs.wsj.com/washwire/2012/05/1 ... -overseas/