1.          What is Residency Based Taxation?

Residency Based Taxation (or RBT) is a system of taxation where a nation imposes tax on income generated within its borders.  Citizens of a nation with Residency Based Taxation pay tax on income in the place where the income was generated.  If they live and generate income abroad then their offshore income is taxed abroad and not taxed by the nation of their citizenship.

Note: There are variations in the way countries implement Residency Based Taxation.  The terms provided here reflect our expectation, given discussions to date (see Question 7), of the way that RBT would be implemented by the U.S., subject to the yet-to-be established anti-tax avoidance provisions.

All developed nations have a system of Residency Based Taxation except the United States.  The United States is the only country other than North Korea and Eritrea which taxes its citizens on their income regardless of where it is generated, no matter where they live (and for no matter how long they have lived there) and, but for a limited number of international bilateral treaties for the avoidance of double taxation, regardless of whether they are also taxed on the same income in their country of residence.  This system is known as Citizenship Based Taxation (or CBT).

Because the United States taxes citizens, whereas other countries tax residents, Americans living abroad face potential taxation by more than one jurisdiction:  the United States and their country of residence (and/or where the income is generated).

2.       Why does the United States tax citizens on their worldwide income if no other developed nations do?

The United States government first began taxing citizens’ income in the 1860’s as a way to raise revenue for the Civil War.  At that time, the government imposed a higher rate of taxation on the U.S. income of Americans abroad as a penalty for living abroad, where they were deemed to be evading their service to the nation during the war.  In later legislation, the taxation of non-resident U.S. citizens was expanded to include their worldwide income, with the justification being broadly that taxation was the citizens’ duty to the nation and just payment for the privilege of citizenship.  (See #6 below for a rebuttal to this argument.)

Citizenship Based Taxation was challenged in the United States Supreme Court in 1924.  In Cook v Tait the Supreme Court ruled in favor of the constitutionality of Citizenship Based Taxation, again on the basis that Americans derive benefits from their U.S. citizenship regardless of where they choose to locate themselves or their assets.  The law has not been challenged in the courts or debated in Congress since.

3.      What has Democrats Abroad been doing to advocate for Residency Based Taxation?

Democrats Abroad has supported Residency Based Taxation for decades.  Since before our official recognition by the Democratic National Committee in 1976, Democrats Abroad has fought to limit the taxation of Americans abroad, not simply supporting a change to Residency Based Taxation.  Our quadrennial platforms have explicitly called for Residency Based Taxation since 1996.  At our Congressional Door Knocks over the years, we have had innumerable discussions on Capitol Hill about Residency Based Taxation.  

Congressional leaders worked at a breakneck pace to pass the 2017 Tax Cuts and Jobs Act in around 6 weeks.  Despite the work of Democrats Abroad and our colleague organisations representing Americans living outside the US, the bill passed into law had enormous benefits for large corporations and the very wealthiest American citizens.  There was nothing in the new law to help Americans abroad.  In fact, the 2017 Tax Cuts and Jobs Act  includes TWO NEW TAXES that will likely drive many American business owners abroad to close the companies they run in their country of residence.

4.      Why is Residency Based Taxation important now?

Because the Tax Cuts and Jobs Act was passed so incredibly quickly there is a lengthy list of provisions that require fixes. These include provisions that were accidentally left out of the bill, and provisions which, due to hasty drafting and haphazard editing, have unintended and unwanted effects from their original intent.  Many Americans are now suffering as a result of all these errors and omissions, including American business owners abroad.  Although a “technical corrections bill” is badly needed, more than two years following the implementation of the law no action has been taken; there is no suggestion that a bill will be passed this year.  

We are working very hard to bring these problems to  Congressional attention, and believe that the low probability that Congress will pass a corrections bill gives greater support for the need for a stand alone bill to enact a switch from Citizenship Based Taxation to Residency Based Taxation.

See also #6 - Arguments in support of RBT

5.      What can Americans abroad do to support the campaign for Residency Based Taxation?

Democrats Abroad (in collaboration with other organizations advocating in support of Americans living abroad) is waging a grassroots campaign in support of Residency Based Taxation.  We encourage activists to call, write and email elected officials to seek their support for this reform.  For regular reports on the work of the Democrats Abroad Taxation Task Force and notifications about our grassroots campaign sign up here. (Membership in Democrats Abroad is essential.)

6.      Why should Congress support Residency Based Taxation (RBT)?  What are our most persuasive arguments?

Congress should support RBT for these reasons:

• Non-resident Americans face taxation in both the jurisdiction where we live and in the United States.  The United States is essentially alone in taxing citizens on their worldwide income.
• Although the Foreign Earned Income Exclusion ensures that a large amount of ordinary income is not subject to U.S. tax, investment (unearned) income does not qualify for the exemption.  In fact, there are a number of income types left out of the exclusion.  These income types are often double-taxed;  taxed in the U.S. as well as in the taxpayer’s country of residence/where the income is generated.  The Foreign Tax Credit (for taxes paid in the non-resident citizen’s country of residence) often does not zero out taxes owed to the United States.
• Types of income subjected to double or punitive tax treatment include amongst others:  

• foreign retirement savings plans;
• capital gains;
• non-qualified non-U.S. pension plans;
• social welfare payments from foreign governments;
• bequests to surviving foreign spouses; and
• due to provisions in the 2017 tax act, profits generated by foreign companies owned by Americans abroad.

Americans abroad advocacy groups have been speaking to Congress for years and years about the terrible burden Internal Revenue Code flaws cause for Americans living outside the U.S. with no success in generating concern.  Implementing RBT would sweep all these problems away for those who elect not to file.

• The community of Americans living abroad suffers from the misunderstanding, the misperception and the simple ignorance of Congress (and regulators).  The vast majority of the 9 million Americans abroad are ordinary, working class Americans who moved abroad in order to pursue a family relationship, an education, or a job, and we decided to remain.  We are not wealthy “fat cats” and “high rollers” living overseas in order to game the international tax system.  In fact, most Americans abroad live in high-tax countries with a higher overall tax burden than the U.S.
• U.S. taxpayers declare income earned abroad on forms designed to capture a lot of information about the source of the earnings, especially investment income. Preparing the forms often requires the assistance of a specialist tax return preparer experienced in dealing with the tax issues of U.S. non-resident taxpayers.  For non-resident Americans, preparing tax forms with declarations of income earned abroad is very complex, time-consuming, stressful and costly, even when no tax is due.  (See our 2017 research on the tax filing experience of non-resident Americans, “Can We Please Stop Paying Twice.”)
• The existing Internal Revenue Code includes a laundry list of provisions that discriminate against Americans abroad.  That is because Congress routinely passes laws - about taxation, immigration and citizenship, banking, social welfare and more - without giving due consideration to the impact the laws have on Americans living outside the U.S.  It has happened AGAIN, with the 2017 Tax Cuts and Jobs Act including TWO NEW TAXES that will cause enormous financial harm for American business owners abroad.  While Democrats Abroad and others work tirelessly to bring the needs and concerns of the Americans abroad community to Congressional attention, we find ourselves either forgotten or thrown under the bus.  When tax policy makers neglect us very serious financial harm is done.  If Congress were to enact Residency Based Taxation Americans abroad would be assured that no further harm can come to us through unintended adverse tax policy making.
• IRS outreach to Americans abroad about tax compliance has been woefully inadequate over time.  As a result many Americans abroad – including officials in United States embassies and consulates - are ignorant, misinformed or confused about U.S. tax filing and reporting obligations.   Americans abroad need easily accessible advice and support from the IRS in order to file returns accurately and in a timely manner.  
• Globalization and the integration of economies will continue to increase the number of Americans living abroad and enduring the burden of double taxation, complex and costly tax filing and reporting.  Inadvertent IRS neglect and tax code mistreatment will continue to haunt Americans abroad, not to mention the impaired access to financial products brought on by foreign account and financial asset reporting.
• Companies that hire Americans to fill jobs in countries which tax citizens at a lower rate than the U.S. normally provide extra compensation to their American employees for the purpose of meeting their U.S. tax obligation.  This is known as “tax equalization” and it makes Americans approximately 40% more expensive to hire than those of other nationalities and thus less competitive.  
• Americans abroad are ambassadors of American culture and values and promoters of U.S. interests and business enterprise.  This is a meritorious service to the nation and not one that should be rewarded with discriminatory tax treatment nor with onerous tax and financial account reporting requirements which convey the suspicion that Americans abroad are tax dodgers and money launderers.
• CBT creates serious tax enforcement difficulties for the IRS.  Mandatory taxpayer-provided reports on foreign bank and other financial accounts can be used by the IRS to enforce taxation of foreign-sourced income (as well as to address other financial crimes such as money laundering).  These reports carry heavy penalties for compliance failures.  The burden of CBT tax filing is, therefore, compounded by the financial account reporting that supports CBT enforcement.

7.      Who in Congress supports RBT?  Who do we need to ask to support RBT?

As of this date there is no Congressional bill proposing the establishment of Residency Based Taxation.  Rep. George Holding introduced a bill to enact RBT in the 115th Congress.  It was a great milestone for RBT advocates.  At the start of the 116th Congress Rep. Don Beyer (D-VA) and Rep. George Holding (R-NC) were acting as bi-partisan champions for RBT.  While we know from the many hundreds of meetings we’ve had on Capitol Hill since the beginning of 2017 that there is support from many members for RBT, until there is a bill for lawmakers to examine it will be difficult for any to go on record as supporters.

Until a bill is introduced and cosponsors are added, we will continue reaching out to Senate and House members explaining this is an urgent legislative priority for overseas constituents.  We are asking the members of Congress we speak to about this issue to reach out to Congressman Holding for a briefing on the proposal.  We ask that they give it due consideration and, thereafter, their support.

In our outreach about RBT Democrats Abroad has principally targeted the members of the House Ways & Means Subcommittee on Tax Policy and the Senate Finance Committee’s Subcommittee on Tax and IRS Oversight.  Persuading members serving on these committees to support RBT is paramount, but we hope to be helping Congressman Holding to generate a large group of Congress-wide co-sponsors for the bill.

8.      What are the current arguments in favour of Citizenship Based Taxation (CBT) that we need to overcome?

For the reasons outlined in #6, Democrats Abroad believes that CBT is wrong as a matter of both principle and a matter of policy.  There are a few academic papers on the subject that make these arguments in favor of CBT:

• Because non-residents receive benefits from the United States government (travel on a U.S. passport, pass on U.S. citizenship to children born abroad, gain access to the U.S. for certain non-citizen family members, re-enter the U.S. at will, work in the U.S., and receive personal and property protection from the U.S. while abroad) they should pay U.S. tax.  (“Fair payment” argument.)

Rebuttal:  The United States is not unique in providing these benefits to their overseas citizens and other countries do so without taxing their offshore income.  Also, with the exception of voting, non-resident citizens pay a fee for these services, whether the service is as routine as renewing a passport or as unusual as evacuation from a war-torn nation.  Further, non-resident Americans do not use a range of public services (schools, roads) and lose access to a variety of social welfare programs when they move abroad, including the ability to use their Medicare benefits for healthcare in their country of residence.

• Taxation is the social obligation we bear for being part of the U.S. Community.  We have, as it were, a moral obligation to support our fellow citizens. (The “social obligation theory” of taxation.)

Rebuttal:  This is perhaps the most convincing justification for CBT (amongst a selection of unconvincing arguments) however, the problem for cross-border citizens becomes which fellow citizens do we have the obligation to support because we have a connection to more than one (and possibly more than two).  And, at what point does the obligation stretch the bounds of reason.

• The right to vote in federal elections obligates the citizen to pay taxes in order to ensure that voters bear the economic consequences of their political participation.

Rebuttal:  Voting would not have served as the original justification for taxing non-resident citizens on their worldwide income since non-resident citizens were only granted the right to vote by absentee ballot in 1975.

Non-resident citizens do not lose or relinquish their vested interest in the U.S. upon relocating abroad; they may have property and very often have family remaining in the U.S and they may intend to return to the U.S. at some point.

Although voting from abroad by absentee ballot has been improved markedly over the last decade, it still presents many challenges that make it challenging for Americans abroad to vote.

Most other countries (France and the UK, for example) allow non-resident citizens to vote even though they do not tax non-resident citizens on their foreign sourced income.

In some countries (such as Italy and France) non-resident citizens are entitled to parliamentary representation, whereas no seat in Congress is allocated to non-resident Americans.

• Citizenship Based Taxation promotes neutrality in taxpayer’s choice of where to reside, as the citizen pays taxes no matter where he/she lives and has no motivation to move abroad for lower taxes.

Rebuttal:  Research indicates that for non-resident Americans taxes are not an important factor in the decision about where to reside; the main motivators are family, jobs and education.

Those for whom tax is a deciding factor are likely to be persons that nations would like to attract for their skills or wealth.  While CBT may discourage Americans from leaving the U.S., CBT may also discourage attractive immigrants from moving to the U.S. and becoming naturalised citizens.  Tax and skilled immigration policy may, therefore, be at odds with each other, putting the U.S. at a competitive disadvantage to other nations also interested in attracting skilled foreign workers.

The tax and compliance barriers CBT imposes on movements to and from the United states suggest that it undermines the value that we place on free movement itself.

9.  What does Democrats Abroad believe a move from Citizenship Based Taxation to Residency Based Taxation would look like?

Democrats Abroad has no fixed view on the implementation model for RBT.  We would support an RBT structure that is straightforward, bereft of loopholes for tax cheats and modest in its qualifying criteria for non-resident taxpayers who seek an exemption from U.S. tax filing.

We will continue having discussions with Congressman Holding and others working on RBT to maximize the likelihood that the final proposal fulfils the criteria we believe are key to a responsible and sustainable system that prevents abuse.

10.  What do we know about the Congressman’s RBT proposal?  Does it meet DA’s broad criteria for support?

The Holding RBT proposal is incomplete, however what is included so far we support.  It articulates criteria for eligibility.  It defines types of income that would be eligible for exclusion from reporting and which are not; U.S.-source income does not qualify for the reporting exclusion.  It includes language for transitioning back to U.S. residency and it calls for - but does not as yet include - provisions to protect the law from abuse by those seeking to avoid paying taxes.  We will see the anti-abuse provisions in the next draft.

11.  What provisions need to be made in the policy in order to prevent millionaires and billionaires from taking advantage of Residency Based Taxation to avoid U.S. tax?

Democrats Abroad believes strongly that any RBT policy adopted should not be vulnerable to abuse by wealthy Americans using offshore residency to avoid paying tax to the U.S.

First, Residency Based Taxation will not exempt Americans from reporting U.S.-sourced income - only foreign-sourced income.  So wealthy Americans who generate their income in the U.S. will not escape their obligation to report that income under Residency Based Taxation.

Further, Americans who generate earnings abroad seeking an exemption under Residency Based Taxation from reporting their offshore income to the IRS will need to satisfy criteria that demonstrate their offshore residency.  They may need to address concerns that they are migrating abroad for the purpose of shielding foreign-source income from U.S. taxation by registering their “departure” with a statement that provides the IRS with some withholding calculated on the unrealised gain in the value of their offshore assets.   This “departure tax” or “exit tax” would likely include a large exemption so that ordinary Americans abroad incur no liability.  

It bears repeating that evidence demonstrates that Americans living abroad are ordinary, hard-working Americans who moved abroad to pursue a relationship, an education or a job.  By far, we are not millionaires and billionaires shopping for a low tax jurisdiction where we will reside for the purpose of shielding our income from U.S. taxes.

For high net worth RBT applicants, payment deferrals or suspensions would provide the IRS with an oversight mechanism that ensures the migrant is exiting the U.S. with the intention of staying abroad rather than for the purpose of shielding a year or some years’ income windfall from U.S. taxation.

NOTE:  Although Democrats Abroad and others have given the problem of RBT abuse a great deal of thought and consideration, for the moment the above is all speculation.  There is as yet no Residency Based Taxation bill under Congressional consideration.  We are currently discussing how best to ensure the policy is not made vulnerable to abuse by those who would use offshore residency as a tax avoidance mechanism.  

12.  Will Residency Based Taxation jeopardize Social Security benefits paid to Americans living abroad?  There is always a concern that the Social Security Trust Fund will go broke.  Could the government use RBT as an excuse to withdraw social security benefits from Americans abroad, claiming that it is necessary to prolong the life of the SSTF?

The Social Security Act signed by FDR under the New Deal as this information indicates, enables Americans living abroad to collect social security on the same basis as Americans living in the U.S.  

The Act was amended in 1935 (Survivor’s Insurance), 1956 (Disability Insurance), 1965 (Medicare) and 1972 (Supplemental Security Income) and could well be amended again.  Although everything from minor SSA amendments to comprehensive social security reform (GW Bush supported converting SSI from a public fund to private accounts) has been floated over time, Social Security is deemed to be the most successful anti-poverty program in U.S. history.  Making material changes to it will be difficult - and excluding qualifying Americans abroad might even violate the Constitution’s “equal protections” provisions.

In the highly unlikely event that Congress changes the eligibility criteria and deems non-residents ineligible to receive SS benefits it is reasonable to assume that existing benefits recipients would be grandfathered and Democrats Abroad would fight strongly for such a legislative provision.

13.  I do not reside in the U.S. but I currently pay U.S. tax on my U.S. retirement income; I do not pay tax in my country of residence.  Under RBT would I instead pay tax in my country of residence?  I live in a country with a higher tax rate than the U.S. so I would lose out in that situation.

The work being done to create a RBT proposal is not complete but we anticipate that under RBT Americans abroad would still pay U.S. tax on U.S. source income.  This would be consistent with the way Residency Based Taxation is administered in many developed countries.

14.  I do not reside in the U.S. but all my income is generated from my U.S. retirement account.  Under Residency Based Taxation I will STILL face taxation on my U.S. retirement plan withdrawals by the U.S. IRS and by the tax authority in my country of residence.  Why under RBT must I still report my U.S.-source income to the IRS?

Since most retirement plans are funded from pre-tax contributions by or on behalf of the retirement plan account holder, U.S. tax is imposed on those funds upon withdrawal from the plan post retirement (and also at the time they are converted from a conventional type retirement plan into a Roth type fund.)  Depending upon the terms of the existing tax treaty the U.S. has signed with the American retiree’s country of residency, those retiring abroad may well face taxation on retirement plan withdrawals by both the U.S. and the account holder’s country of residence.

This serious problem for retired Americans living abroad would normally be resolved in the double taxation treaty, as would other issues that result in double taxation.

[For example, conversely, in many countries ALL retirement plans are Roth-type plans, which take contributions from post-tax funds.  Withdrawals from these funds post-retirement are not taxed.  Rarely do the U.S. tax treaties properly recognise non-U.S. funds structured in this way and account for the tax already paid to the non-resident citizen’s country of residence.]

These matters should be addressed in the U.S. Model Tax Treaty and then reflected in updates to existing tax treaties.  Unfortunately, no new tax treaties or treaty updates have been approved by the Senate since 2010, when U.S. Senator Rand Paul (R-KY) was first elected.  Although Congressional and Treasury officials believe his concerns are misplaced, Senator Paul objects to the agreements for invasion of privacy concerns, saying they would allow excessive inter-governmental sharing of financial information on citizens.  Before Paul's election, tax treaties were routinely approved by the Senate.  Under Senate rules, one senator can place a "hold" on a motion for a vote, preventing it from reaching the Senate floor.

There are tax advocates working to address these problems which are very serious for retirees abroad and we endorse and support their work by accounting for it in our own literature on the tax discrimination faced by Americans abroad.

We do not, however, believe that Congress would accept an RBT model that exempts Americans abroad from tax due on their U.S. source income.  Aside from the fact that it is outside of international norms, pushing for it would likely destroy any chance of RBT being incorporated into a tax reform package.

15.  Why not ask for a simplification of the process that would make it easier for citizens abroad to pay taxes to both the U.S. government and the government of their country of residence?  Are we not undermining our own efforts for tax justice by arguing that we should pay less tax, therefore decreasing government revenues?

We have been examining the ways that the Internal Revenue Code discriminates against Americans abroad and talking to Congress about how to remedy this problem for many years now.  These slides outline the recommendations we have been discussing to enact those remedies.  Ideally, we would find fixes to each problem area but leave the existing structure in place to continue to tax Americans abroad with the ability to pay.  Unfortunately, generating Congressional attention on these problems has not been possible, even with the help of the National Taxpayer Advocate.

We now have an opportunity to sweep away the problems with one major reform.  The work being done to craft a RBT proposal is not yet complete but will have as one of its aims that the reform would be revenue-neutral to the federal budget.  

16.  Since bona fide non-resident Americans can apply the Foreign Earned Income Exclusion and the Foreign Tax Credit, isn’t Citizenship Based Taxation actually an issue of the privileged?

Citizenship Based Taxation is not a problem only for the privileged.  Nearly every American abroad must file U.S. taxes for their worldwide income or face huge penalties, even if they don't owe anything.  Declaring even ordinary types of overseas income can be enormously complex.

Further, the tax code includes provisions that discriminate against Americans abroad and their families who can least afford it.  For example:

1. pensioners are taxed on their foreign unemployment and social welfare payments as these are considered unearned income and don't fall under the exclusion

2. when an American abroad dies, there is no marital deduction on bequests to foreign surviving spouses

3. when retirees withdraw money from their foreign retirement plans – plans not recognised by the U.S. as previously taxed and income not recognised as “earned” and so ineligible for the FEIE -  those withdrawals will be subjected to U.S. tax.

As a result there are millions of Americans abroad who are extremely stressed about their tax issues and are spending money for U.S. tax advisors that they cannot afford or lots of time trying to fill out their own tax forms each year.  As the revenue results for the U.S. government are very low (.2% of Federal tax revenue), the only people gaining anything from this system are tax advisors.  It is not true that Citizenship Based Taxation is only a problem for the privileged.

17.  Citizenship Based Taxation is a non-partisan issue that the Republicans also support.  Should we be working with them on RBT?

It is our understanding that Republicans Overseas has also endorsed the existing - though as yet incomplete - Holding proposal to implement RBT.  What has yet to come is the anti-avoidance provisions. All the organizations representing Americans abroad have weighed in on this matter and we look forward to what the House Ways & Means Committee presents to Rep Holding.

All of our policy positions are drawn from our belief that government should help create opportunity for all.  Democrats Abroad supports tax reforms that help reduce inequality, boost opportunity and raise enough revenue to meet public needs, predominantly from those with the greatest ability to pay.  Democrats Abroad does not, therefore, support RBT in any form and at any cost.  At this point in the process of developing the legislation, we are at one with all the other organisations working in support of RBT.  We are all working hard to persuade Congress that this policy is urgently needed and long overdue.

18.  It is my understanding that the Republicans Overseas support Territorial Taxation for Individuals (TTFI) instead of Residency Based Taxation (RBT)?  What is the difference?  

Under RBT Americans living abroad would be exempted from declaring the income they generate in their country of occupancy;  under the typically defined system of TTFI all Americans regardless of their country of residence would be exempted from declaring the income they generate outside the U.S.A.  

Republicans Overseas supports the Holding Proposal which conforms with the definition of RBT, but they are calling it TTFI.  We believe their reasoning is that they think there is merit in branding the proposed system TTFI so that it parallels the system of corporate taxation passed into law in the 2017 Tax Cuts & Jobs Act, known as Territorial Taxation for Corporations (TTFC).  The presumption is, perhaps, that if Congress supported territoriality for corporations then they will surely support territoriality for individuals.  We don’t care what it is called, though for now we want to use the term that is technically correct and doesn’t misinform anyone about what the Holding Proposal does and doesn’t include.

It is easy to imagine tax lawyers and accountants building elaborate structures that send otherwise taxable income into offshore vehicles that puts it out of the reach of the US Treasury.  As neither the RBT nor the TTFI concepts have been fleshed out with terms approximating an actual policy proposal it is not possible to define and distinguish them any further.