On February 2, 2015 the Obama Administration acknowledged the plight of certain US citizens residing abroad and proposed limited relief. In the "General Explanations of the Administration's Fiscal Year 2016 Revenue Proposals"1, known as the "Green Book," the Administration proposed a change to US law (the "Proposal") that would allow certain dual citizens to renounce their US citizenship without the fear of delinquent tax filings, penalties, the US exit tax, and the other consequences to being a covered expatriate.
The details of the Proposal, and the chances of being given the effect of law, while interesting, are less so than the Administration's motive for advancing it. Politicians don't get re-elected by winnowing away their constituency base or enacting legislation that has the effect of raising tax (even in small measures). Normal people, even politicians, behave rationally so there must be a reason for the Proposal. Could the Proposal play a small part in a more subtle strategy that might involve foreign opposition to FATCA and IGA-partner domestic legislation?
Some Canadian dual citizens who wish to renounce US citizenship may qualify
In the Green Book under the heading "Simplify the Tax System: Provide Relief for Certain Accidental Dual Citizens," individuals who became dual citizens of the US and another country at birth, remain a dual citizen of that other country, and have minimal contacts with the US would be able to renounce US citizenship without having to file delinquent US tax returns and escape the US exit tax, and other negative consequences of being considered a covered expatriate.
Specifically the Proposal provides:
...an individual will not be subject to tax as a US 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 18˝;
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.
This is a positive development because it represents an official acknowledgement of one unfortunate result of citizenship based taxation: US citizens are taxed on their worldwide income regardless of whether they have ever set foot in the US or availed themselves of US citizenship.
As drafted, the Proposal would apply to a certain subset of individuals who had citizenship foist upon them without the benefit of ex-ante counseling as to their choice of parents or place of birth. And that of course includes everybody who was ever (or will be) born. However, these individuals are unique because as US citizens, by parentage or place of birth, they are then taxed on their worldwide income.
Will the Proposal become law, and is the back door unlocked?
It is important to remember that the Proposal is not law, and it is not even proposed law. It is simply a portion of the Administration's 2016 revenue proposals. Before it can become law, the entire budget proposal is vetted independently by both the House of Representatives and the Senate, they then agree (or not) on a consolidated version, which becomes the budget resolution and is binding on both houses of Congress, but is not yet law. The budget resolution becomes the blueprint for actual appropriation and bill-making process. In other words, there is a lot of work before the Proposal will become law, if at all.
In Canada we are accustomed to Parliament passing a budget bill every year; however in the US, the law-making process is much less certain. The last time the US approved a true budget bill was in 1997 during the fifth and sixth years of the Clinton Administration. In that year, the Democratic Party controlled the Executive Branch and little else because both the House of Representatives and the Senate were controlled by the Republican Party. Thus, although it is a rare event that budget bills get passed into law, the last time it happened (as now) the President's political party was the opposite of the controlling party in both houses of Congress.
In spite of the apparent long-odds that the proposal will become law, there is a back-door that could give the Proposal the effect of law without being processed through the Congressional meat grinder. The back door was left unlocked by Congress in 2008 when it enacted section 7701(a)(50) of the Internal Revenue Code, which provides:
Termination of United States Citizenship
A. In General. An individual shall not cease to be treated as a United States Citizen before the date on which the individual's citizenship is treated as relinquished under section 877A(g)(4).
B. Dual Citizens. Under regulations prescribed by the Secretary, subparagraph (A) shall not apply to an individual who became at birth a citizen of the United States and a citizen of another country.
Clearly, Congress has given the US Treasury the authority to adopt special rules to determine the date on which an individual lost his US citizenship, provided he was a dual citizen at birth. Section 7805 authorizes the Treasury to issue such regulations in temporary, and therefore effective form, and since the regulations would be legislative in nature the only notice required is that found in the Administrative Procedures Act (as little as 30 days). In other words, regulations that carry the weight of law could be issued quickly.
Of course, hammering the terms of the Proposal into regulations would likely require some work because they would have to reflect Congress's intent when it adopted 7701(a)(50)(B). However, once regulations are issued they are difficult to legally overturn. Provided Congressional intent is clear, the US Supreme Court2has stated that regulations are given controlling weight unless they are "arbitrary, capricious, and manifestly contrary to the statute."
Why would the Administration propose relief to people who wish to renounce US citizenship?
The Proposal possesses a visceral, and even humanitarian, resonance. However, the fact is that when taxpayers renounce their US citizenship, thereafter they neither vote nor pay taxes. It must be a universal truth that politicians do not get reelected by giving any type of relief to individuals who will, by definition, become non-voters. Further, the Office of Management and Budget calculates that, if it becomes law, the Proposal will result in a loss of revenue of $403m from 2016 – 2025.3 Politicians in the US frequently face pointed, uncomfortable questions from their constituents at election time when they've raised taxes, slight though they may be.
Even though the Proposal estimates a modest drain on the public coffers, the Proposal may prove to be a net benefit because revenue loss is only one side of the equation. The other side of the equation is the cost to the IRS required to process 5 years of tax returns for thousands of annual expatriates. According to the most recent statistics available, only 9%4 of the US citizens residing abroad owe US tax, thus the IRS's administrative cost to process the tax returns for renouncers could easily exceed the revenue collected. Waiving the filing requirements for these US citizens who are dual at birth could therefore be net accretive.
Another possible cost-saving motivation could be the compliance burden associated with FATCA. In 2015, foreign financial institutions will begin to report the holdings of US customers. If the Proposal is given the force of law, many of these individuals, who otherwise would have been reported, will be excepted if they renounce their US citizenship.
Is there another motive to relieve these dual citizens from tax and filing obligations?
If the foregoing cost-benefit analysis seems to stretch the bounds of logic, you're likely paying attention. The simple fact of the matter is that the Proposal is unlikely to find a champion in Congress because, while the right thing to do, it is not the type of platform that has the sizzle required to get anyone re-elected.
If we assume that the Proposal faces strong political headwind, as I believe we must, why is it there? Is there a strategy the Administration is pursuing in which the Proposal plays a role? Otherwise, why waste the paper, or even pixels?
One reason that makes some sense is that the Proposal was included in order to quell opposition to FATCA in IGA-partner jurisdictions. Recall that IGAs are typically not self-executing and require domestic legislation to go into effect. Many of these IGA partner countries may find it difficult to pass legislation that disparately treats those with only domestic citizenship and those who have dual citizenship. The Proposal would make renouncing US citizenship for some a much less draconian process, and thus may stem domestic legal challenge.
For example, in Canada there is active litigation that challenges the legality of the legislation that implements the IGA. According to the Statement of Claim, both plaintiffs were born dual citizens. If the Proposal were given the effect of law, and if they qualified under the terms, presumably they would be entitled to renounce their US citizenship and avoid the appurtenant filing obligations, failure to file penalties, and tax obligations. Whether that would be sufficient to nullify the lawsuit is a question for Canadian constitutional and litigation lawyers, of which I am not.
Regardless of the Proposal's chance of being given the effect of law, the Administration's motivation for bringing it forward, or the narrow class of individuals to whom it would apply, the Proposal is positive step. It is evidence that the unenviable predicament faced by dual citizens living abroad has been heard in Washington, DC and there may be the political will to affect change. Change may come quickly or not at all, but it will never come until there is understanding of the issue. The Proposal is an indication that understanding may be taking hold.
2. Mayo Foundation for Medical Education & Research v. United States, 562 U.S. ____; 131 s. Ct. 704, (2011); Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984).
4. National Taxpayer Advocate 2011 Annual Report to Congress at 156. Citing Memorandum for Secretary Geithner from J. Russell George, Treasury Inspector General for Tax Administration, Management and Performance Challenges Facing the Internal Revenue Service for Fiscal Year 201113 (Oct. 15, 2010).
Moodys Gartner Tax Law is only about tax. It is not an add-on service, it is our singular focus. Our Canadian and US lawyers and Chartered Accountants work together to develop effective tax strategies that get results, for individuals and corporate clients with interests in Canada, the US or both. Our strengths lie in Canadian and US cross-border tax advisory services, estateplanning, and tax litigation/dispute resolution. We identify areas of risk and opportunity, and create plans that yield the right balance of protection, optimization and compliance for each of our clients' special circumstances.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.