The American Diaspora —
Innocents Abroad
By Robert L. Williams
A. Introduction
The United States is the only country in th...
$99,200 exclusion from U.S. income taxation,
plus a housing cost exclusion of up to $14,000;
• they are dependent on a for...
depend on the acquisition of either the certificate or
the passport, and the failure to renew or possess a
passport has no...
U.S. Citizens Born Abroad Before December 24, 1952
Child born before noon May 24, 1934 If U.S. parent had previouslya
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Innocents Abroad


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Naturalization and Citizenship: Be Careful What You Wish For--You Might Find It Taxing

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Innocents Abroad

  1. 1. The American Diaspora — Innocents Abroad By Robert L. Williams A. Introduction The United States is the only country in the world that subjects its citizens to global U.S. income and transfer taxes regardless of residence or domi- cile,1 and regardless of the location of assets.2 While a million immigrants become naturalized U.S. citi- zens every year, a limited but increasing number of high-profile Americans are relinquishing or re- nouncing U.S. citizenship to attain the same status as the rest of the world’s citizens: taxation only on the basis of residence and domicile. U.S. citizenship has long been principally deter- mined by the English common law doctrine of jus soli — birth on American soil.3 As discussed below, U.S. citizenship at birth also follows from one’s birth abroad to two U.S. citizen parents if at least one U.S. citizen parent had previously resided in the United States (no time limit is specified).4 Children born abroad to a single U.S. citizen parent acquire U.S. citizenship at birth if that parent was in the United States for a prescribed time before the child’s birth. If those children were born between May 24, 1934, and October 10, 1952, they retained their U.S. citi- zenship if they were later in the United States for a prescribed citizenship ‘‘retention’’ period.5 Foreign citizens (anomalously referred to as ‘‘aliens’’ in U.S. tax and immigration law) are sub- ject to worldwide U.S. income taxation only if resident in the United States. B. Significance of Establishing U.S. Citizenship An estimated 6.2 million U.S. citizens live abroad.6 Aside from employees of U.S. multina- tional companies that pay for their expatriates’ tax compliance, anecdotal evidence suggests that most Americans overseas have not been compliant in U.S. tax return filing or reporting because: • they are ignorant of those obligations; • they would not owe significant U.S. income tax if they did file because (1) they pay more foreign taxes than U.S. taxes, and foreign tax credits would eliminate their U.S. tax liability; or (2) their foreign earned income is under the 1 Eritrea and the Philippines are apparently not exceptions to this statement. See Phil Hodgen, ‘‘Does the United States Stand Alone?’’ Hodgen Law International Tax (May 15, 2012). 2 Sections 2001(a), 2501, and 2512(a). 3 14th Amendment, U.S. Constitution (1868). In the interest of simplicity, this article omits discussion of the varying rules applicable to citizenship or nationals in the U.S. territories or outlying possessions, which historically have included Ameri- can Samoa and Swains Island, the Panama Canal Zone (1904- 1979), the Philippines (until July 4, 1946), the Northern Mariana Islands, Puerto Rico, the U.S. Virgin Islands, and Guam. This article also omits reference to citizenship of illegitimate children of a U.S. citizen parent. For a discussion of that topic, see Robert McWhirter, ‘‘The Citizenship Flowchart,’’ American Bar Asso- ciation Criminal Justice Section (2007) (a two-page flowchart with 48 pages of box chart notes, which can be purchased online from the ABA Criminal Justice Section). 4 Immigration and Nationality Act of 1952 (INA) section 301(c); 8 U.S.C. section 1401(c). 5 For historical details, see McWhirter, supra note 3, at 3. 6 The State Department probably has a pretty clear idea, but no one knows. A 2011 State Department estimate put the figure at 6.2 million. See Association of Americans Resident Overseas, ‘‘6.32 Million Americans (Excluding Military) Live in 160-Plus Countries’’ (undated). Robert L. Williams is a former EY international tax partner who has written two books on corpo- rate and private international wealth taxation. He does not profess competence on matters of U.S. immigration and nationality law. However, a clear understanding of the basic tenets of that specialty insofar as it defines American citizenship has been an essential prerequisite over the last 30 years of his international tax practice. He is indebted to Steven P. Trow for imparting that understanding and for his review of and comments on this article. Errors and omissions are solely those of the author, but his opinions are believed to be shared by most Ameri- cans abroad as well as international tax practitio- ners. In all cases, readers should seek the advice of a U.S. immigration lawyer on questions of citizen- ship, visas, and expatriation. FATCA and now the OECD have co-opted the world’s financial institutions into global reporting of residents’ offshore financial assets. Since alone in the world, the United States persists in taxing its citizens globally, the world now needs to know just who is an American citizen. The answers — and the ramifications — are more complex than you might think. tax notes™ VIEWPOINT TAX NOTES, August 18, 2014 861 (C)TaxAnalysts2014.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.
  2. 2. $99,200 exclusion from U.S. income taxation, plus a housing cost exclusion of up to $14,000; • they are dependent on a foreign spouse and have minimal income of their own7 (even though they may have substantial joint finan- cial accounts); or • they don’t even know they are U.S. citizens (‘‘accidental Americans’’). This intentional or unintentional malfeasance of overseas Americans is hardly worth the effort the IRS has recently devoted to it. To put the problem in perspective, the IRS loses an estimated $400 billion annually through domestic tax noncompliance8 and pays an annual $5 billion to victims of refund identity theft. In contrast, the Foreign Account Tax Compliance Act is expected to raise less than $1 billion annually and cost the financial community much more than that in the first year alone.9 To the IRS’s credit, on June 18 it finally granted a virtual amnesty from penalties to nonresident Americans whose failure to file was the result of negligence, inadvertence, or unawareness of their liability for U.S. taxes.10 Several developments have significantly in- creased the importance of accurately determining the U.S. citizenship of foreign residents: recent Justice Department criminal charges against several European banks for helping U.S. domestic resident citizens hide assets or income offshore; three rounds of IRS offshore voluntary disclosure programs; and Treasury, through FATCA, co-opting the offshore financial world and foreign governments to report and withhold on U.S. financial accounts abroad. C. U.S. Citizens From Birth 1. Persons born in the United States. In 1868 the 14th Amendment proclaimed that all persons born in the United States and subject to its jurisdiction are citizens of the United States and of the state in which they reside. The amendment was required to give citizenship to emancipated black slaves, fol- lowing President Lincoln’s 1863 Emancipation Proclamation. The term ‘‘United States’’ includes the continental United States, Alaska, Hawaii, and the U.S. possessions of Guam, Puerto Rico, and the U.S. Virgin Islands, and (since November 1986) the Commonwealth of the Northern Mariana Islands.11 The italicized language excludes the acquisition of U.S. citizenship by children born in the United States to diplomats who have full diplomatic im- munity from arrest. Children born in the United States to other foreign officials acquire U.S. citizen- ship at birth. 2. Children born abroad to two U.S. citizen par- ents. A second category of ‘‘at birth’’ citizens is children born abroad (outside the United States and its outlying possessions) to parents who are both U.S. citizens, provided one parent has previously resided in the United States for any length of time.12 3. Children born abroad with one U.S. citizen par- ent. A child born abroad after December 23, 1952, is a U.S. citizen from birth if the U.S. citizen parent was physically present in the United States or a posses- sion for 10 years before the child’s birth, of which five years were after the parent was 14.13 That period is shortened for children born after November 13, 1986; the U.S. citizen parent needs to have been physically present in the United States or a posses- sion for only five years before the child’s birth, of which two years were after the parent was 14.14 All three categories of U.S. citizens (native born, foreign born with two U.S. citizen parents, and foreign born with one U.S. citizen parent) are U.S. citizens from birth by operation of law. That person may obtain evidence of U.S. citizenship by getting a certificate of nationality from the Department of Homeland Security or a U.S. passport from the State Department.15 However, U.S. citizenship does not 7 A U.S. citizen married to a nonresident alien cannot file a joint return; she must file married filing separately, reporting her own income. 8 A Forbes article notes the IRS’s figure that Americans underpaid their taxes by $450 billion in 2006, with some $40 billion to $70 billion attributable to overseas noncompliance. Ashlea Ebeling, ‘‘How Much Tax Cheating Is Really Going On?’’ Forbes (Sept. 16, 2013). 9 See Robert L. Williams, ‘‘A FATCA Primer for Trusts, Trust- ees, and Companies,’’ Tax Notes, Jan. 13, 2014, p. 203. 10 IRS, ‘‘Instructions for New Streamlined Filing Compliance Procedures for Non-Resident, Non-Filer U.S. Taxpayers.’’ 11 INA section 101(a)(38); 8 U.S.C. section 1101(a)(38). The statute confers U.S. citizenship to persons born in the United States (including specified territories under its control). Persons born in its outlying possessions, which include Swains Island and American Samoa, are noncitizen nationals of the United States. McWhirter, supra note 3, at 5. 12 INA section 301(c); 8 U.S.C. section 1401(c). 13 INA section 301(a)(7); 8 U.S.C. section 1401(a)(7). Service abroad in the U.S. military or foreign service or with specified international organizations is counted as U.S. presence. Ab- sences of up to 12 months total during the required residency period are also permitted. INA section 301(a)(7); 8 U.S.C. section 1401(g); McWhirter, supra note 3, at 29. 14 INA section 301(g); 8 U.S.C. section 1401(g), as amended by the Act of November 14, 1986, section 12. 15 Most foreign nationals, when they belatedly discover they are also U.S. citizens, don’t want that status. But giving it up may be difficult. En passant, a fellow international tax practitio- ner with considerable experience mentioned the not infrequent problem in which a person born outside the United States plainly meets the statutory test of being a U.S. citizen, with all its attendant tax problems, but the embassy or consulate will not recognize that status, thus preventing the person from being able to expatriate. This is usually because of ‘‘insufficient’’ evidence of the parent’s prior residence in the United States. Try winning that argument with the IRS. Even more weirdly, the COMMENTARY / VIEWPOINT (Footnote continued on next page.) 862 TAX NOTES, August 18, 2014 (C)TaxAnalysts2014.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.
  3. 3. depend on the acquisition of either the certificate or the passport, and the failure to renew or possess a passport has no effect on the acquisition of U.S. nationality. For senior citizens (62 years or older as of 2014), the rules are more complex because there is a U.S. residence requirement for both the U.S. citizen parent and a child born abroad before December 24, 1952. Moreover, the rules have changed retroac- tively over time, as shown by the table on the following page. D. Citizenship by Naturalization or Derivation U.S. citizenship can also be acquired after birth, by naturalization or derivation. Naturalization is generally available after five years of U.S. residence as a lawful permanent resident (LPR) — that is, a green card holder — or three years of U.S. residence for an LPR who is residing in the United States with a U.S. citizen spouse.16 From January 13, 1941, until February 26, 2001, derivative citizenship was ac- quired automatically by an LPR child who was under the age of 18 when one or both parents naturalized, as long as the child was then residing in the United States in the legal and physical custody of the naturalizing parent(s).17 The Child Citizenship Act of 2000, effective Feb- ruary 27, 2001, extended citizenship automatically to an LPR child who is residing in the United States before age 18 in the legal and physical custody of a naturalized or U.S. citizen parent.18 E. A Modest Proposal The complexity of the above rules on ‘‘just who is an American’’ may justify referring to the intended overseas class as ‘‘innocents abroad.’’ It would seem that much of the complexity of FATCA, the foreign bank account report,19 and Form 8938 reporting of foreign financial accounts,20 as well as the future multijurisdictional OECD Combined Reporting System for reporting of foreign financial accounts, would probably disappear if the United States simply changed its tax laws to tax only U.S. citizens who are resident within the United States — cosi fan tutti. Not only that, but in a single stroke Congress could dramatically improve the global competitive- ness of U.S. multinationals and significantly in- crease job opportunities for Americans abroad, all at a negligible cost in tax revenue. Those of us who have lived abroad and spent a lifetime in international taxation see no reason not to put the United States in line with the rest of the world — namely, to tax only ‘‘United States resi- dents’’ on their worldwide incomes, worldwide gifts, and worldwide estates. There should be no taxation based on nationality at all. The United States could treat the termination of U.S. tax residence as a taxable event and give new arrivals a step-up in basis for all assets as of the date of the commencement of tax residence (like Canada does). To secure that benefit, arrivals could be required to file a form listing all their assets, their original cost bases, and their asserted fair market values as of the first date of tax residence. Failure to file the form accurately for an asset could void the step-up. If a taxpayer could not afford to pay any exit tax, he could enter into a tax deferral agreement with the IRS. People the world over understand residence- based taxation, so this would be an easier sell to new immigrants, and U.S. taxation would be lim- ited to only gains realized or accrued during U.S. residence. Income tax treaties could abate the tax if there were reciprocity for persons coming to take up U.S. tax residence upon departure from the United Kingdom, for example. The United States gets little tax from Americans overseas today. Most of them live in high-tax coun- tries and have no U.S. income tax in any event because of FTCs and the section 911 foreign earned income exclusion. But as we all know, Congress couldn’t care less about this subject, and this is all a non-starter. Better to place your money on a geneti- cally modified flying pig. In the meantime, it is essential to broaden the common understanding of U.S. citizenship among people who do not live in the United States, as well as the global financial community, which will have to deal with FATCA- like regimes with multiple countries, and in time deal with an OECD Common Reporting System. (Table appears on the following page.) same embassy reached one conclusion for the daughter (she was given a U.S. passport) but a different one for the son (a refusal to decide), even though the U.S. mother was the same and the facts were the same. 16 INA sections 316(a) and 319(a); 8 U.S.C. sections 1427(a) and 1430(a). 17 McWhirter, supra note 3, at 7 (citizenship being acquired at the ‘‘last qualifying event’’). Both parents had to naturalize unless one was deceased or already a U.S. citizen, or there was a legal separation and the naturalizing parent had custody. Id. at 14-15. 18 Amending INA section 320; 8 U.S.C. section 1431. Alterna- tively, a U.S. citizen parent abroad could obtain citizenship for a non-LPR child by showing the parent met the U.S. residency requirement or had a parent who met the same requirements. 8 U.S.C. section 1433. See McWhirter, supra note 3, at 25. 19 Form FinCEN 114, required to be filed on the Bank Secrecy Act online portal with effect from 2013. 20 Like FATCA, a part of the March 18, 2010, Hiring Incentives to Restore Employment Act. COMMENTARY / VIEWPOINT TAX NOTES, August 18, 2014 863 (C)TaxAnalysts2014.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.
  4. 4. U.S. Citizens Born Abroad Before December 24, 1952 Child born before noon May 24, 1934 If U.S. parent had previouslya been present at any time in the United States, including a mere sojournb Child born after noon May 24, 1934 and before January 12, 1941 If U.S. parent had previously been present in United States,c as above and Child was subsequently present in United States for any of five retention periods below • for five years between the ages of 13-21 if begun before December 24, 1952 (only applies to children born before December, 24 1936);d or for five years between the ages of 14-28 (with absences totaling less than one year if begun before October 27 1972);e or • for two years between the ages of 14-28 (with absences totalling less than 60 days);f or • the child had a U.S. government em- ployee parent;g or • the child restored lost citizenship with an oath of allegianceh Child born between January 13, 1941, and December 23, 1952 If the U.S. citizen parent had previously lived in the United States for 10 years before the child’s birth at least 5 years of which had been after the parent’s age 16;i or had been in the U.S. military from De- cember 7, 1941, to December 31, 1946 and lived in the United States or a U.S. possession for 10 years after the child’s birth, five of which had been after age 12; or had been in the U.S. military from Janu- ary 1, 1947, to December 24, 1952, and had been physically present in the United States or a possession for 10 years before the child’s birth, 5 of which had been after age 14k and The child himself had subsequently re- sided in the U.S. for any one of the four minimum ‘‘retention’’ periods (above) to retain U.S. citizenship (note that none of these retention requirements apply to children born on or after October 10, 1952)j a Section 1993 of Revised Statutes (48 Stat. 797) and INA section 301(h), 8 U.S.C. section 1401(h) as added by the Immigration and Nationality Technical Corrections Act of 1994, section 101(a)(2) (retroactively establishing that citizenship could be ac- quired through a U.S. citizen mother as well as a U.S. citizen father). b See rulings cited by McWhirter, supra note 3, at 20, para. 33. c INA section 301(h), 8 U.S.C section 1401(h). d Act of May 24, 1934, section 1, Pub. Law 73-250, 48 Stat. 797; Nationality Act of 1940 section 201(g); the December 24, 1936 date is relevant as the date on which any child born thereafter abroad would not be able to meet this five-year retention test before it was expanded by the INA of December 24, 1952. e INA section 301(c), 8 U.S.C 1401(c), retroactive to children born after May 24, 1934, as amended in 1957, 616, Pub. Law 85-316, 71 Stat. 639 to allow absence of less than 12 months. f As amended in 1972, section 1, Pub. Law 92-582, 86 Stat 1289 to require only two U.S. years’ U.S. presence, retroactive to chil- dren born on or after May 24, 1934, with an absence of less than 60 days permitted, 8 U.S.C section 1401(b). g Nationality Act of 1940, which also exempted from the retention requirement children whose parents worked for U.S. compa- nies abroad. McWhirter, supra note 3, at 21. h INA section 324(d), as amended by the 1994 Immigration and Nationality Technical Corrections Act, 8 U.S.C section 1435(d). i Nationality Act of 1940, section 601, 54 Stat. 1174. j The retention requirement was repealed by the 1978 Amendment, INA section 301(d), 8 U.S.C section 1401(d), Act of October 19, 1978, section 1, Pub. Law 95-432, 92 Stat 1046. Children under the age of 26 on that date have no retention requirement. Thus, any child born after October 10, 1952, has no retention requirement. The extent to which ‘‘accidental Americans’’ can rely on failure to meet the retention tests to cause an expatriation is somewhat limited by the ‘‘unawareness’’ doctrine which pro- vides that a child who did not know of his U.S. citizenship before age 26 (when he would need to commence his U.S. resi- dence to satisfy the retention requirement) was excused from that requirement. In contrast, a child who was aware of his U.S. citizenship but did not know of the retention requirement was not excused from it. See McWhirter, supra note 3, at 21. k See McWhirter supra note 3, at 28. COMMENTARY / VIEWPOINT 864 TAX NOTES, August 18, 2014 (C)TaxAnalysts2014.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.