Several weeks ago, I spoke at an American Citizens Abroad (ACA) Town Hall in Geneva, Switzerland. Since KLR prepares a large number of tax returns for U.S. citizens residing abroad this seemed like an excellent opportunity. So when ACA board member Jonathan Lachowitz of White Lighthouse Investment Management extended the speaking invitation I was quick to accept and off I went to Switzerland, the home of many Americans who work or have retired abroad.

Tax reductions not always positive for expats

My presentation focused on the Trump administrations recent tax reform proposals and more specifically what impact they would have on American expats residing abroad. Given the lack of specificity of the proposals my remarks were not particularly comforting to the group.

While any reduction in tax is generally regarded positive in nature, expats subject to tax in their home jurisdictions may not benefit from such reductions. This is due to the mechanics of the primary tax provision that prevents double taxation, the foreign tax credit. The complex mechanism of the foreign tax credit is designed to prevent someone from claiming a credit for more than he/she would’ve paid in the U.S. on related income.

Therefore, when the U.S. tax liability goes down so does the related foreign tax credit thus resulting in no net decrease in total foreign and U.S. tax. Much different results of course for those Americans residing in a foreign jurisdiction that imposes low or no tax in which case a drop in U.S. rates is a welcome relief.

Elimination of citizenship based taxation for Expats

The most sweeping change and one strongly advocated by ACA is the elimination of citizenship based taxation for U.S. citizens working and residing abroad. The U.S. is one of only two countries in the world that bases its individual taxes on citizenship rather than residency (Eritrea being the other.) In the recent Trump tax proposals there are proposals on the business side that would establish a territorial tax system in order to enhance competiveness, however, no parallel provision for individuals.

While there are mechanisms in the U.S. tax laws such as the foreign earned income exclusion and the foreign tax credit that minimize the likelihood of double taxation for expats, another issue is the substantial degree of added complexity in tax compliance. While ostensibly the expat is being treated equally to someone residing domestically, on a practical level the results are quite different.

Let’s take for example the foreign bank reporting requirements that are designed to prevent U.S. taxpayers from hiding money abroad.

If one lives in the U.S. and opens a bank account at their local bank there is no special reporting required. If on the other hand that same person opens their account in a Swiss bank there is a reasonable assumption that some possible tax evasion may be involved. If an expat living in Zurich takes the routine step of opening up a local bank account it would naturally be in a Swiss bank with no particular intent to evade U.S. taxes. Nevertheless the expat has an added compliance burden as well as potentially onerous penalties for not reporting such accounts.

For this reason the ACA has supported a “same country” reporting exception when one opens an account in their country of residence.

Other potential burdens for expats

The financial account reporting is just one of many provisions that unduly burden Americans residing abroad. Items such as pension plans, mutual funds, business entity ownership and trusts have all substantially increased reporting requirements and resulted in significantly less favorable tax consequences when they are deemed to be foreign.

Therefore, a repeal or modification of these various provisions would be highly beneficial for Americans abroad. It is interesting to note that the most frequent complaint of the expat community is not paying U.S. taxes, but rather the time and cost associated with complying with the complex rules involved.

My time in Geneva allowed me to reflect on the complexities involved in living and working abroad. Stay tuned for part two of my series , “Tax Notes on Abroad” where I give some insight on how FATCA is impacting expats.

Questions? Contact me or any member of our International Tax Practice.