American citizens living in Canada (and around the world) could face an easier time come tax season if a new U.S. bill comes into law. The Tax Fairness for Americans Abroad Act of 2018, introduced on Dec. 20 by Rep. George Holding of North Carolina, a Republican and member of the House Ways & Means Committee, would be a first step towards ending the country’s citizenship-based taxation by taxing only those individuals who are resident in the U.S. or who have income that is connected to the U.S.
The U.S. is effectively the only country in the world that currently imposes citizenship-based taxation in that it taxes all its citizens regardless of where their income is earned or where they live. Eritrea also has citizenship-based taxation, but the African country imposes a flat tax rate of only two per cent on non-resident Eritreans, whereas the U.S. taxes its non-resident citizens at regular, progressive tax rates, with a top 2019 rate of 37 per cent. Nearly every other country has either a residence-based or territorial tax system that only imposes taxation on its residents.
In recent years, academics and various lobby groups, such as American Citizens Abroad, have argued that the U.S. should abandon its citizenship-based taxation policy. In 2015, University of Virginia School of Law professor Ruth Mason, whose research focuses on international, comparative, and state taxation, wrote a paper that took a critical look at the traditional arguments for taxing non-resident citizens. In it, the Harvard-educated professor raised new arguments against the policy, including that it puts the U.S. at a disadvantage when competing with other countries for skilled employees.
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Although citizenship-based taxation was originally designed to punish “economic Benedict Arnolds … Concerns about a few high-profile, rich tax defectors who can be sanctioned with targeted anti-abuse regimes should not drive tax policy governing nearly nine million Americans who reside abroad,” she wrote.
Currently, U.S. citizens living in Canada (like all Canadians) must file a Canadian tax return reporting and paying tax on their worldwide income. In addition, however, they must also file a U.S. tax return reporting that same worldwide income, which is then subject to U.S. tax. Most U.S. citizens who are resident in Canada find that no U.S. income tax is actually owed due to offsetting foreign tax credits, but the investment restrictions, compliance burden and costs of filing U.S. tax and information returns can be severe.
For example, tax professionals often discourage U.S. citizens from investing via tax-preferred vehicles such as a Tax-Free Savings Account, Registered Education Savings Plan or Registered Disability Savings Plan, as the U.S. does not recognize them as tax-preferred accounts. As a result, income from these accounts must be annually reported on a U.S. tax return. Many U.S. tax professionals also consider these plans to be foreign grantor trusts from a U.S. tax perspective, and therefore subject to onerous and costly information return filings.
In addition, U.S. citizens are required to annually disclose to the U.S. Department of Treasury all foreign (i.e., non-U.S.) financial accounts, including bank, brokerage, mutual fund, trust or other types of foreign financial accounts where the total, in aggregate, exceeds US$10,000.
These tax troubles have motivated many U.S. citizens living abroad to explore the process of renouncing their U.S. citizenship, which involves appearing before an officer at a U.S. Consulate or Embassy, signing an oath of renunciation and paying the renunciation fee, currently US$2,350. Wealthy U.S. citizens or those who are not compliant with their U.S. tax filing obligations may also be subject to an “exit tax.”
Congressman Holding’s bill should ease the compliance burden of U.S. citizens living abroad and minimize double taxation. “The (new) Act would create a tax regime that is simpler, fairer, and more competitive for Americans around the world. This bill takes a meaningful step to address the discriminatory double taxation of Americans abroad as well as ease the burden of dual tax filing requirements. Further, this bill will ensure that Americans around the world are able to accurately plan and save for their future without the fear of punishing tax liabilities,” Holding said in an explanatory statement accompanying the release of the draft bill.
Under the proposal, U.S. citizens who have a tax home in a foreign country, are in full compliance with U.S. income tax laws for the previous three years, and establish that they have been a “bona fide resident of a foreign country” for at least a full tax year would be able to file an election to be a “qualified non-resident citizen” and thus be exempt from tax on their foreign source (i.e., non-U.S.) income. They would still remain subject to U.S. tax on their U.S. source income.
In addition, individuals will not be taxed on the gain from the sale of foreign personal property attributable to their time as a qualified non-resident citizen, but they will still be taxed on any gain attributable to their time as a resident of the U.S. For example, if an individual holds a Canadian asset prior to electing to have qualified non-resident citizen status and then sells the asset as a qualified non-resident citizen, that individual will only owe U.S. tax on the portion of gain attributable to the period before their change in status.
Of course, there are still many legislative hurdles that the bill must overcome, including the upcoming shift of power following last month’s U.S. mid-term elections in which the Republican Party increased its majority in the Senate while the Democratic Party won the majority in the House of Representatives, resulting in a split Congress beginning Jan. 3, 2019.
“(T)he community of Americans living and working overseas must get behind and vigorously support the bill and efforts to advance the bill through the passage process,” American Citizens Abroad wrote on its website.