The American abroad. It’s a classic literary genre. We love the idea of traveling to a foreign country and finding ourselves. Ernest Hemingway drew endless inspiration from his years in Europe. More recently, “Paris to the Moon” by Adam Gopnik and “Eat, Pray, Love” by Elizabeth Gilbert were bestsellers.
The books tend to emphasize romance and adventure. As an American who is actually living abroad, though, I’ve found that the reality is quite different. My fellow Americans back home sometimes regard me with suspicion, and I feel like my government considers me a “toxic citizen.”
The US is one of two countries in the world that taxes its citizens on the income they earn while living abroad. The other is Eritrea. Every single other country bases its taxation on residency, i.e., you only pay taxes where you live and work.
Americans are required to file an annual tax return with the IRS when they’re abroad—even if they don’t owe any money. They’re also required to file a form called an FBAR to declare their foreign bank accounts. An undeclared account incurs a $10,000 fine.
As you might expect, international tax accountants get a lot of business from Americans. One tax accountant based in Amsterdam told me his American clients take their filings very seriously. “If they get the IRS going after them, they have a real problem,” he says.
His clients are the savvy ones, though. In my experience, many Americans who move abroad are not aware that they need to file. The US government does precious little to inform its citizens of their obligations in this area. Over several years, I’ve been informally asking Americans I meet abroad if they file their US taxes. Most of them told me they don’t. They only file and pay taxes in their country of residency. They assume that’s enough. But, in fact, they have unwittingly become lawbreakers. If they move back to America, they could find themselves in quite a bit of trouble.
The current tax laws also create an interesting problem with “accidental Americans.” These are people who are citizens because they were born on American soil or have an American parent, but they have never lived in the US. It’s unknown how large this group may be, but there are certainly thousands. Obviously, the vast majority of them don’t file. But, in the eyes of the IRS, they are lawbreakers.
Michael Kirsch, a tax expert at the Notre Dame School of Law, says it is impossible to generalize about accidental Americans. “Some people might genuinely not be aware that they are Americans. Some might be aware of their citizenship and realize it has value. How do you differentiate between these gradations?” he says.
One well-known example of an “accidental American” is Boris Johnson, the current mayor of London. He has dual citizenship of the UK and the US because he was born in New York. He is often tipped as a future Prime Minister of Great Britain. It’s hard to imagine that the IRS would ever prosecute Johnson for failing to file his US taxes, but that just underscores how problematic these laws are.
Right now, an American’s foreign-earned income is tax-exempt up to $97,600 (adjusted annually for inflation). After that, if the income taxes in your country of residence are lower than America’s, you have to pay Uncle Sam the difference. That sounds simple, but there are many exceptions.
An American’s earnings up to $97,600 are only tax-exempt if they are located outside the US for 330 days in any 12-month period. It’s surprisingly easy to cross the limit. For example, say you take a two-week vacation to the United States for a relative’s wedding in the spring. Then later that year, one of your parents falls seriously ill. You’ll have to count the days very carefully when you book your plane ticket.
Contributions to foreign tax-free retirement savings accounts (the equivalents of IRAs) do not provide a tax credit the way they do in America. “The US tax code makes it impossible for Americans abroad to figure out a favorable way to pay for their retirement,” says Peter W. Dunn, who chose to renounce his American citizenship when he became a Canadian.
Many foreign governments charge a significant value-added tax (VAT). This is like a consumption tax on goods and services. Americans abroad can’t claim a US tax credit for the VAT they pay. Here in Great Britain, where I live, the VAT is currently at 20 percent and a major source of government revenue. For me personally, it represents the lion’s share of what I pay to Her Majesty.
How did American taxes become so different?
The principle of taxing on the basis of citizenship rather than residency can be traced back to our first-ever income tax, enacted during the Civil War. This was a five percent income tax to be paid on income earned inside the US by Americans who lived abroad. Most other Americans were only taxed at three percent. A few years later, the tax was expanded to also include income earned abroad. These laws were specifically targeted at those who were exiting the country to escape the war. The concept of citizenship-based taxation has been enshrined in our tax code ever since.
“The US government at the time would have raised very little money from Americans living in London, but it made a statement that these are Americans, too,” says Kirsch. He believes the benefit of citizenship-based taxation is that it communicates that citizenship has substance and entails burdens as well as benefits.
Victoria Ferauge, a US citizen who has been living in France for over 15 years with her French husband, thinks Americans are suspicious of their countrymen who move abroad. The tax laws are an expression of that. She believes this suspicion has increased since 9/11. “There’s very little that’s known about Americans abroad,” she says. “When there’s a large void, people tend to project their fantasies. Right now, the American public has decided that we’re tax evaders. We’re the rich, unpatriotic Benedict Arnolds and we need to be punished. “
The media does its share to promote that stereotype. Consider the disproportionate coverage given to Eduardo Saverin’s renunciation of his US citizenship. He was super rich, and he was out to avoid tax. The reality is that many Americans abroad are like me. My husband and I have a middle-class income. We rent a tiny apartment and don’t own a car. For a lot of Americans abroad, the fees for an international tax accountant can take up a big chunk of their budget. They often pay higher taxes in their country of residence than if they’d stayed in the US. The biggest concentration of Americans abroad (around 1 million people) lives in Canada – nobody’s definition of a tax haven.
Things are about to get worse for Americans abroad.
The IRS is currently implementing a new law called the Foreign Account Tax Compliance Act (FATCA). Basically, FATCA requires every bank in the entire world to report the account information of its American clients. So every bank in the world is becoming an agent of the US government. It’s still unclear how FATCA can be implemented because in some countries it violates national privacy laws. However, FATCA stipulates that any foreign bank that fails to comply will be subject to a 30 percent withholding tax on its US income.
Rand Paul unsuccessfully introduced a bill to repeal. He says FATCA “is a violation of Americans’ constitutional protections, oversteps the limits of Executive power, disregards the mutual respect of sovereignty among nations and drains money from the federal treasury under the guise of replenishing it, and discourages overseas investment in the United States.”
FATCA is so difficult to comply with that some banks have kicked out their US clients to avoid the being subject to it. Ferauge says she lives in fear that in the future she won’t be able to open a basic checking account.
In response to FATCA, the number of Americans who renounced their citizenship surged in 2013. The media has focused most of its attention on renouncers like Eduardo Saverin, Denise Rich and Tina Turner – again, individuals who are super rich and living the good life in tax haven countries.
However, for many of those who renounced, the decision was made as a last resort after they had reached a point of desperation. Ferauge, who still retains her American citizenship, describes renunciation as “the weapon of the weak.” There is no other way to fight the tax regime.
The question of renunciation becomes more urgent when there is a non-American spouse involved. If a couple holds a joint bank account, the details will be reported. Many non-Americans object vehemently to having their financial data handed over to the IRS.
Dunn says his wife was the primary reason he decided to renounce his US citizenship when he gained a Canadian passport. “It was my duty to her,” he says.
To me, my American citizenship is priceless. We live in England because my husband’s career is here for now. I hope we’ll move back to the US in a few years. I don’t mind paying an accountant to sort out my taxes if that’s what it takes. But it’s painful to me to be lumped together with unpatriotic Americans who “deserted” their country.
Taxation and Representation
Americans abroad may pay taxes, but they have very little representation in US government. Americans can still vote from abroad and their Congressmen are determined on the basis of their last U.S. address. However, Congress doesn’t have much interest in its foreign-based constituents. If you visit the website of any member of Congress and click “contact,” you will see that it is not possible to list a non-U.S. Address.
“When I write to my representatives, I use my mother’s address, even though I haven’t lived with her in 30 years. I include my actual address in France in the body of my letter,” says Ferauge. Many Americans abroad report not receiving answers to their letters to their congressmen.
While their elected representatives won’t give them the time of day, Americans abroad have begun helping each other. This is a phenomenon inspired by the arrival of FATCA. Americans all over the world are talking on blogs and message boards. They are sharing their experiences and giving each other advice. Perhaps their cooperation will finally give them a voice.
Regardless, the reporting of foreign bank accounts is unlikely to go away. “FATCA is having broader implications. Other countries are looking at this and getting involved in more robust information sharing,” says Kirsch.
FATCA itself is so unwieldy that it may well fall apart and be replaced by a different reporting scheme. The IRS – which recently had its budget cut – will have a hard time enforcing both FATCA and Obamacare.
And that leads me to one major benefit of being an American abroad: I am exempt from Obamacare. The IRS has stated that any American who resides in another country for 330 days a year is automatically considered to have qualifying health insurance. As far as upsides go, that’s a pretty big one. I’ll take it.
