Obama budget: “Dual citizens from birth” who are NOT “US residents” should be taxed as non-residents

 

“It’s unjust, it’s inhumane, I didn’t choose where I was born!”

This accurately describes the sentiments of those who are the target of FATCA Hunt. “Place Of Birth Taxation” is unfair to ALL those it affects. The most visible and egregious example of the unfairness is it’s application to “Accidental Americans“.

The context just imagine …

Imagine having been born in the United States, never having lived in the United States and then being “captured in FATCA Hunt”. It appears that the Obama administration has realized that the most visible unfairness of “place of birth” taxation is the application to Accidental Americans.

As a result, both the 2016 and 2017 Obama budget proposals have contained provisions to allow “Accidental Americans” to relinquish U.S. citizenship without being subject to the S. 877A Exit Tax or without having to certify U.S. tax compliance with respect to worldwide income. Those who qualify would be required to certify U.S. tax compliance on the basis that they were/are subject to the U.S. tax system as “non-resident aliens”. This raises the twin questions of:

1. Who is a “non-resident” alien? – See Internal Revenue Code S. 7701(b); and

2. How is a “non-resident” alien taxed? – See Internal Revenue Code S. 2(d) and S. 871.

I wrote a detailed post, referenced by the following tweet, about this issue in 2015.


Details of the Obama Budget Proposal …

The details of the proposal offered in the 2016 Obama budget were summarized by Virginia La Torre Jeker as follows. Interestingly she references the upcoming lawsuit challenging aspects of U.S. “Place Of Birth Taxation”.

Relief for “Accidental” Americans

In the 2016 Budget Proposal, the Obama Administration formally acknowledged that many Americans who wish to expatriate have valid reasons, well aside from US tax, for doing so. For example, the proposal recognized that it may be illegal for an individual who is a citizen of a particular country to hold another citizenship. This is generally the case, for example, in GCC countries.

The proposal recognized that many such dual nationals wish to formally expatriate the US, but noted they must be able to certify US tax compliance for the 5 years prior to the year of expatriation: “Because U.S. citizens are subject to U.S. Federal income tax on their worldwide income, dual citizens who choose to expatriate may be required to pay a significant amount of U.S. tax before they are able to certify that they have satisfied their U.S. tax obligations for the five taxable years preceding the year in which they expatriate.” The Administration seemingly recognized that worldwide taxation is simply not appropriate when an individual has had only very minimal contact with the US despite technically being a US citizen under the US tax laws.

Details of the Proposal

The 2016 Budget Proposal exempted certain individuals from both (i) annual US worldwide income taxation and (ii) taxation as a “covered expatriate” under the Exit Tax regime of Code Section 877A. (Note – No mention was made of exemption from the punishing taxes imposed on US recipients of gifts or bequests from “covered expatriates” under Code Section 2801).

The Administration’s proposal provided as follows:

“[A]n individual will not be subject to tax as a U.S. citizen and will not be a covered expatriate subject to the mark-to-market exit tax under section 877A if the individual:

1. became at birth a citizen of the United States and a citizen of another country,

2. at all times, up to and including the individual’s expatriation date, has been a citizen of a country other than the United States,

3. has not been a resident of the United States (as defined in section 7701(b)) since attaining age 18½,

4. has never held a U.S. passport or has held a U.S. passport for the sole purpose of departing from the United States in compliance with 22 CFR §53.1,

5. relinquishes his or her U.S. citizenship within two years after the later of January 1, 2016, or the date on which the individual learns that he or she is a U.S. citizen, and

6. certifies under penalty of perjury his or her compliance with all U.S. Federal tax obligations that would have applied during the five years preceding the year of expatriation if the individual had been a nonresident alien during that period.”

Many individuals will not qualify for the benefits of this proposal because the tests are very stringent. For example, the individual must have attained his dual nationality at birth – he must have been born both a US citizen and citizen of another country. Obtaining another country’s citizenship by naturalization will not count. In addition, the individual must never have held a US passport, or, if he did, it must have been for “the sole purpose of departing from the United States in compliance with 22 CFR §53.1” Generally, the referral to 22 CFR §53.1 deals with a US citizen’s entry or departure from the US. Section 53 provides that it is unlawful for a US citizen to enter or depart, the United States, without a valid US passport, unless an appropriate exemption applies. The Administration’s proposal limits eligibility for those who hold a US passport. The proposal permits obtaining a passport only for “departure from the US”. Due to the passport limitations contained in the Administration’s proposal, it will be feasible for only a handful of persons. Specifically, the proposal can benefit one who has never had a US passport (in my practice the dual nationals I have met have all held US passports at one time or another), or one who obtained a US passport as a child after being born in the US strictly so that he could leave the US with his parents in order to return to their homeland.

While the Proposal in its current form is untenable for many “Accidental” dual nationals, I believe it’s still a good sign. Resurrecting the Proposal in the 2017 Budget gives us hope that future laws may indeed recognize there is a difference between a “technical” and “formal” definition of US citizenship and a substantive or meaningful definition, the latter of which is the only one that should attract “citizenship-based” worldwide US taxation.

Accidental Americans are Speaking Up

Accidental Americans are making themselves known and trying to gather force in order to bring a legal challenge to the constitutionality of citizenship-based taxation. One such group is the Alliance for the Defeat of Citizenship Taxation (ADCT). You can learn more about ADCT and the lawsuit it intends to mount here.

The real significance of the Obama budget proposal is …

The Obama administration is recognizing that U.S. taxation on worldwide income is appropriate only when (1) an individual who is a “dual citizen from birth” has (2) not met the test for being a U.S. resident under S. 7701(b) since attaining the age of 18 1/2.

Conclusion …

Once again we see that:

(1) Even for some U.S. citizens

(2) actual “U.S. residence” is a relevant factor in determining the appropriateness of U.S. taxation on worldwide income.