Taxing Sanity

“The difference between death and taxes is death doesn’t get worse every time Congress meets.”
 —Will Rogers

In December 2011 Susan Rice, the United States’ UN representative, took to the floor of that organization in support of a resolution condemning the Eritrea for destabilizing its region of Africa and, specifically, for funding that destabilization by taxing the income of its expatriate citizens (variously called citizenship-based taxation or a diaspora tax) in violation of universal human rights. Eritrea is one of only two countries in the world that impose citizenship-based taxation. Ironically, the other one is the United States.

All governments—excepting those two—collect income tax from residents living within their borders but not from their citizens who have established residency in other countries. If a European citizen lives and works in the U.S. for an extended period of time, she files a tax return with the U.S. government but not with her government back home. On the other hand, an American living and working in Europe must file tax returns with both the government of the country where he is living as well as with the U.S. government. While this is an extra burden, in most cases it does not actually result in having to pay full taxes to both governments. A series of taxation treaties generally allow tax paid in one place to be applied as a credit against tax owed in another place.

What has changed since 2010, however, is a law that was passed by Congress called the Foreign Account Tax Compliance Act (FATCA). Aimed at sniffing out bad guys who are into things like money laundering (including terrorists) or tax evasion, it has made lives of ordinary citizens living abroad much less convenient and, in some cases, nightmarish. As a result, the numbers of American renouncing their citizenship has skyrocketed. In 2014 there were 3,417 such renunciations—well over double the number of just two years earlier.

FATCA is mainly a problem for two categories of Americans. One is the so-called “accidental Americans,” people who do not really consider themselves American but who have U.S citizenship because they happened to be born on U.S. soil while their parents were working or holidaying abroad. A surprising number of people fall into this category including (to name just one random example) London mayor Boris Johnson. These people may have little or no attachment to America, but they have the convenience of being able to travel, live and work in the States without the bother of acquiring a visa. The other category is Americans who, for whatever reason, have elected to live in another country.

The problem is that FATCA requires foreign financial institutions that want to have any dealings with the U.S. (in other words, most or all of them) to collect and pass on a whole bunch of information on any of their account holders who have U.S. citizenship. A lot of banks have decided that they don’t want the hassle and so have chosen to simply not to accept Americans as customers. A report on this topic this week on the BBC World Servce included an interview with a Frenchman who had lived his entire life in France and knew no English but, because he happened to have been born in California, was being required by his bank to either close his account or go through the trouble and expense of formally renouncing his U.S. citizenship. An American woman, who had lived thirty years in France, was being given the same choice of options, and she tearfully told of how she had arrived at the painful decision to give up her U.S. citizenship—despite still identifying as American, as she had all her life—in order to be able to stay in France.

Renouncing American citizenship is not just a simple matter of signing a piece of paper. As a solicitor friend once explained to me, the IRS essentially treats an American renouncing his citizenship more or less the same as if he had died, requiring a big tax settlement before letting him go peacefully into the next life.

This is a classic example of the U.S. government taking aim at a legitimate problem and then punishing multitudes of people, few if any of whom are the actual targets. The fat cats trying to avoid tax by hiding money abroad will always have the resources to locate and exploit a loophole. Criminal money launderers will always find another way to move their money around. Instead it is many of the estimated 8.7 million Americans living abroad who are left to deal with (at best) the annoyances, inconveniences and extra costs of the law or (at worst) are left with no practical choice but to cut ties to their home country. After all, it is pretty hard to function in the modern world when banks do not want to deal with you.

Happily for me personally, FATCA has so far not caused my bank to issue such an ultimatum. There are so many Irish people with U.S. ties, I am not sure Irish banks could afford to bar them from holding accounts. But not all banks operating in Ireland are Irish-based. We have come across at least one Dutch-based bank operating here that would not take customers with U.S. citizenship.

Some clear thinking on this problem was articulated by Pepperdine law professor (and former Deputy Assistant Secretary of State) Colleen Graffy, writing last month in The Wall Street Journal: “The best solution is for the U.S. to join the rest of the world in taxing based on residency rather than citizenship. Congress could address both the need for global banking transparency and the negative effects of FATCA by including this in the comprehensive tax reforms likely to take place under the next administration. Doing so would advance American fairness, mobility and economic competitiveness, in addition to protecting the country’s most valuable global asset: its people.”