The Cost of United States Citizenship Abroad
BY JESSICA DORFMANN

Harvard International Law Review
December 3, 2013

Citizenship in the United States affords many benefits - most notably the right to live, work, and vote in a global powerhouse nation. But, in recent years, Americans have been relinquishing their citizenship in record numbers – total annual renunciations have jumped more than ten-fold since 2006. For United States citizens living abroad, the hidden costs of their citizenship are high and the advantages relatively few. The United States is the only country in the world to still practice citizenship-based taxation regardless of residence. And this archaic policy is not only unjustified, but is frustrating and alienating expatriates across the globe.

What does “citizenship-based taxation” mean in practice? Every year, on top of their domestic taxes, United States citizens residing abroad must report virtually all of their foreign financial accounts, income, and assets to the Internal Revenue Service (IRS). In general, citizens pay the difference between their domestic taxes and what they would have been taxed in the US – so, if a citizen’s domestic taxes are higher than what they would owe in the US, they pay no additional taxes. However, an exemption from additional taxes is not an exemption from the inconvenience, penalties, and hidden costs that come with filing US taxes abroad. The policy is designed in part to discourage wealthy United States citizens from establishing offshore bank accounts or leaving the country in order to avoid paying US taxes. But the vast majority of expatriates are not living abroad to duck taxation – they have simply moved away for work, education, or family reasons and have not returned. Many non-resident citizens have inherited United States citizenship by birth, but have never actually resided there– they’ve received no services from the US government, yet must file American taxes every year or face severe penalties.

This brings us to the first problem with the United States’ taxing of non-residents – there are no philosophical grounds for it. Taxation is typically rationalized for two reasons: either the state is providing the taxpayer with services, or the taxpayer’s revenue is being generated within the borders of the taxing country. The United States government would argue that their policy prevents wealth generated within the United States from being whisked away into tax-free foreign bank accounts, but this argument neglects to acknowledge the masses of expatriates who have earned their income elsewhere, but are still on the hook to the IRS. As mentioned before, there is a large population of foreign-bornAmericans who have never received anything from the United States government besides an eagle-embossed passport (that they had to fork out about $165 USD for). Why should these men and women be held hostage to the IRS by an accident of birth?

The United States also does little to inform dual citizens and expatriates of their obligation to file American taxes. Yet in 2009 the IRS began a harsh crackdown on those who had failed to file. Many American citizens went years or even decades before realizing they were obligated to report to the IRS and now must pay tax failure penalties radically out of proportion to what they actually owe in taxes. In attempting to punish tax dodgers, the US government is heaping financial penalties, stress, and even criminal charges upon the blameless.

Finally, having to file American taxes is hugely disadvantageous to US citizens living abroad even if they pay more in domestic taxes than they would in the United States. For one thing, there is a substantial investment of time and money – to deal with the complicated process, expatriates often have to hire expensive tax accountants that specialize in taxes in both the United States and their home country. On top of that, United States citizens are barred from making certain types of investments. For example, because of the requirements for how assets must be reported, foreign mutual funds are completely impractical for United States citizens to report and, therefore, can’t be held. This makes planning for retirement in a foreign country challenging. American’s living abroad also get “the worst of both worlds” when it comes to taxation. It’s a common practice for countries, including the United States, to designate certain savings accounts, investments, or capital gains on specific assets as “tax-preferred”. United States citizens living abroad cannot take advantage of tax-preferred vehicles in either the United States or their home country – unless the treatment is identical in both countries.

At its core, citizenship based taxation makes it harder for American citizens to live and thrive outside of the United States. This is a significant obstacle to the freedom of Americans to emigrate abroad in an increasingly globalized world. The United States has also implemented barriers to renouncing American citizenship. Citizens with a total net worth of over $2M USD, or a high income, must pay a 15% “exit tax” on the capital gains of their worldwide assets. And there’s been discussion about increasing the cost – when Facebook co-founder Eduardo Saverin relinquished his U.S. citizenship in 2011, U.S. Senator Chuck Schumer proposed increasing the exit tax rate to 30% and banning Saverin from returning to the United States for life. The U.S. Department of the Treasury also publishes, on a quarterly basis, the names of American citizens who have relinquished their citizenship, a practice used to “name and shame” renouncers. The Economist has dubbed these obstacles “America’s Berlin Wall”. It is no wonder that American expatriates frequently report feeling frustrated, harassed, and persecuted – the United States system has been built to punish them for merely residing outside of its borders.

The United States needs to get with the times and abolish citizenship-based taxation. The policy is tremendously unfair and detrimental to Americans living abroad, and it serves to anger and alienate citizens, many of whom have a lot to contribute to the United States in terms of international experience and skills. It is ironic that a citizenship so widely desired has come to feel like a burden for so many.