Source: https://www.taxconnections.com/taxblog/defining-residence-for-income-tax-purposes/
Timestamp: 2020-08-08 12:35:35
Document Index: 69750283

Matched Legal Cases: ['§\n7701', '§ 7701', '§ 7701', '§ 7701', '§ 7701', 'sui generis', '§ 911', '§12', '§12', '§ 206', '§ 206', '§ 92', '§ 92', '§ 92', '§ 92', '§ 92', '§ 206', '§ 206', '§ 7', '§ 114', '§ 7701', '§7701', '§ 7701', '§ 7701', '§ 7701', '§ 901', '§ 911', 'art. 4', 'art. 24', '§ 877']

Defining Residence For Income Tax Purposes | TaxConnections
Defining Residence For Income Tax Purposes
Written by Edward Zelinsky | Posted in Defining Residence For Income Tax Purposes
In this paper, I place the United States’ adherence to citizenship-based taxation in the context of the states’ tax systems. Fortyone states impose general income taxes on the worldwide incomes of their respective residents. 1 These state tax systems are important repositories of experience that confirm the administrative benefits of citizenship-based taxation. Domicile today plays an important role in state tax systems as a gap-filler when more objective statutory residence laws fail to assign any state of residence to the taxpayer. Citizenship is an administrable proxy for domicile and serves a similar gap-filling role in the taxation of individuals whose income and activities straddle national boundaries.
For income tax purposes, most states today define residence as either domicile (the traditional definition) or as statutory residence, typically formulated as an individual’s satisfaction of an objective test such as 183 days spent in the state. 2 In contrast to the relatively objective nature of statutory [*272] residence laws, the fact-intensive domicile inquiry focuses upon the taxpayer’s intent to return to the taxing state and his permanent allegiance to that state, rather than his immediate physical presence in the state. 3 As the domicile inquiry is factually complex, it is both manipulable by the taxpayer and difficult for the tax collector to enforce. The contemporary domicile standard is best understood as a gap-filler invoked by the states when the more objective test of statutory residence fails to assign the taxpayer to any state of residence.
The states’ difficulties enforcing domicile-based taxation highlight the administrative benefits of citizenship-based taxation. As long as residence is understood for tax purposes in terms of domicile, citizenship is an efficient proxy for such domicile. The states’ experience defining residence supports the United States’ citizenship-based approach to federal income taxation. Under the Internal Revenue Code, citizenship serves as an administrable proxy for domicile and fulfills the same gap-filling function played by domicile under the states’ income taxes.
As a preliminary matter, I would observe that the conventional narratives used to denigrate citizenship-based taxation do not impress me. The alleged uniqueness of the United States’ worldwide taxation of its citizens’ incomes does not embarrass me. 4 The United States is also unusual in the strength of its protections for religious liberty 5 and free speech. I do not apologize for that uniqueness either.
Moreover, when one looks at the cases in the English-speaking world, U.S. law is not as unique as some suggest. When residence is defined, explicitly or implicitly, as domicile, the outcomes are typically similar to those that citizenship-based taxation achieves in a more efficient manner. 6
I am equally unimpressed by the alleged horror stories of U.S. citizens renouncing their citizenships because of U.S. income tax burdens. 7 In the context of the millions of U.S. citizens living abroad, the 3,417 U.S. citizens who renounced U.S. citizenship in 2014 is a relative handful of individuals [*273] who elected to surrender U.S. citizenship. 8 I also confess that anecdotes about Boris Johnson leave me unimpressed. 9
The Civil War origins of citizenship-based taxation, 10 while of historic interest, similarly tell us nothing about the value vel non of citizenship-based taxation today. Legal rules often persist because they serve purposes originally unintended by their authors. 11 Citizenship-based taxation is one of these.
Finally, the difficulty of collecting income tax from many U.S. citizens who live abroad is not, by itself, reason to abandon the effort to tax them. It is also difficult to collect income tax from the domestic cash economy, including illegal activity. That difficulty, however, does not lead us to abandon the effort to reach this hard-to-tax cash income.
The Persistence of Residence-Based Income Taxation
Instead of these premises, I start from the proposition that residence-based income taxation is and will continue to be a permanent part of international and U.S. domestic tax systems. Some argue that we should move to source-based taxes for active business income and for easily allocable income such as real estate rents. 12 Justice Ginsburg, in her recent dissent in Wynne, 13 argues that the U.S. Supreme Court is forcing the states toward such source-based income taxation by requiring, as a constitutional matter, that states of residence offer credits to their respective residents for income taxes paid to the states of source.
Yet, even if source-based taxation predominates, we will continue to need residence-based taxation for passive income such as interest, dividends, royalties, capital gains from stocks and bonds, and other forms of income derived from these kinds of mobile intangible investments. [*274] The maxim mobilia sequuntur personam, 14 while typically deployed talismanically, nevertheless corresponds in the income tax context to an important truth: even if source-based taxation becomes dominant, we will still need residence-based taxation for interest, dividends, royalties, capital gains from stocks and bonds, and other similar kinds of passive income generated by intangible investments. If these forms of highly mobile, intangible income were to be taxed only on the basis of source, it would be easy for individuals to avoid taxation by moving their intangible properties to low-and no-tax jurisdictions. Without residence-based taxation of intangible incomes, an individual could transfer his stocks, bonds, bank accounts, patents and other intellectual property to a custodian in a low-or no-tax jurisdiction and thereby avoid any significant tax on the income generated by these forms of highly-mobile, intangible property. 15 To avoid this scenario, tax systems must allocate investment income such as dividends, interest, and royalties to the jurisdiction in which the investor resides.
III. Defining Residence: Domicile v. Statutory Residence
Once it is granted that residence-based income taxation will persist in one form or another, we must define residence for tax purposes. Traditionally, residence meant domicile, an individual’s permanent home looking at all of the facts and circumstances reflecting an intention to return. Most U.S. states that impose an income tax declare that those domiciled in the state are residents for tax purposes, taxable by the state of residence on their worldwide incomes. 16
Over time, most U.S. states also concluded that, for tax systems, domicile is too subjective to be the sole criterion for residence for income tax purposes. The result has been the emergence of what in the domestic U.S. context have come to be called “statutory residence” laws. 17 Under this more mechanical approach to residence, the fact-intensive domiciliary test for residence is paralleled statutorily by simultaneously defining residence for income tax purposes using limited, relatively objective criteria. The objective criteria for statutory residence are typically the number of days spent in the state, whether an individual has a home in the [*275] state, or a combination of such limited and objective factors. 18 To date, no state has been willing to exclusively rely upon the more mechanical rules of statutory residence to the exclusion of the facts-and-circumstances test of domicile.
Michigan’s income tax statute is illustrative. For Michigan income tax purposes, the term “resident” means an individual domiciled in the state: “Domicile” means a place where a person has his true, fixed and permanent home and principal establishment to which, whenever absent therefrom he intends to return, and domicile continues until another permanent establishment is established… If an individual lives in this state at least 183 days during the tax year … he shall be deemed a resident individual domiciled in this state. 19
Michigan’s statute reflects all of the themes of contemporary state income tax law with respect to defining residence: An individual domiciled in Michigan is a resident for income tax purposes. Domicile is an individual’s permanent home. Domicile entails the fact-based determination whether an individual “intends to return” to Michigan, regardless of his current presence vel non in the Wolverine State. Independently of her domicile status, an individual is objectively “deemed a resident” for tax purposes in any year she lives in Michigan for “at least 183 days.” 20
The reasons for the dual definition of state residency for income tax purposes – domicile or statutory residence – start with revenue: if there are two chances to tax an individual as a resident, the tax collector is more likely to succeed with one of these approaches. On a more principled basis, both the traditional concept of domicile and more objective statutory residence laws have their respective strengths and limitations and, thus, complement each other.
Domicile: Manipulable, Difficult to Enforce
The sprawling, fact-based nature of the concept of domicile makes it manipulable by the taxpayer and difficult to enforce by the tax collector. Under a system of self-assessment, the subjective manipulability of the test of domicile leads some – likely many – individuals to play with the tax collector a game of “catch me if you can.” There is a vast literature, indeed a thriving industry, advising clients how to situate their respective domiciles in low-tax states like Florida and Nevada. 21 The facts-and circumstances [*276] quality of the domicile inquiry makes that inquiry intrinsically unwieldy and difficult for the tax collector to enforce.
Consider, for example, the decision of Maryland’s Court of Special Appeals in McDermond v. Comptroller of the Treasury. 22 Mr. McDermond resided in Maryland and worked as an executive for Under Armour. Mr. McDermond moved to the Netherlands in 2006 to supervise Under Armour’s European operations. When he relocated to the Netherlands, Mr. McDermond did not sell his Baltimore home but instead leased it to his brother. When Mr. McDermond returned to Baltimore for business trips in 2006 and 2007, he stayed “in hotels or temporary housing.” 23 “In preparation for his move to the Netherlands, McDermond sold his car, closed his Maryland bank accounts, and moved some of his furniture and many of his personal possessions to the Netherlands.” 24 He acquired a Dutch driver’s license but abandoned his effort to speak to Dutch.
On his trips back to Baltimore, Mr. McDermond attended his church in Baltimore. He continued to contribute to that church while he lived in the Netherlands. While living in the Netherlands, Mr. McDermond told the Baltimore jury commissioner that he was a nonresident living abroad. This resulted in the government (not Mr. McDermond himself) cancelling his status as a Maryland voter. However, while employed by Under Armour in the Netherlands, Mr. McDermond renewed his Maryland driver’s license. The license renewal form included a certification under penalties of perjury that he was a Maryland resident.
In an apparent effort to bolster Mr. McDermond’s claim to be a nonresident of Maryland, Under Armour amended the written terms of his employment. Originally, Mr. McDermond and Under Armour contemplated a two-year assignment in Europe. Subsequently, Under Armour stated that it expected Mr. McDermond to remain abroad indefinitely. For the tax year in question (2007), Mr. McDermond spent ninety-nine days in the United States. Of these, forty were working days in Baltimore while the remaining days in the United States were nonworking days. In 2008, Mr. McDermond’s European assignment for Under Armour ended and he returned to Maryland to continue to work for Under Armour. 25
On these facts, Maryland’s Comptroller, Maryland’s Tax Court, and the Circuit Court for Baltimore City concluded that Mr. McDermond was domiciled in Maryland in 2007 and, as a Maryland resident, owed Maryland taxes for that year on his worldwide income. 26 Maryland’s Court of Special Appeals agreed, observing that an individual’s domicile is “his true, fixed, permanent home, habitation and principal establishment, without [*277] any present intention of removing therefrom, and to which place he has, whenever he is absent, the intention of returning.” 27
The appeals court concurred with the Maryland Tax Court that, notwithstanding the amendment of the nominal term of Mr. McDermond’s employment, Under Armour and Mr. McDermond anticipated that he would be abroad in the Netherlands for only two years. 28 In fact, that is what happened as Mr. McDermond stayed and worked in the Netherlands for twenty-two months. Four other factors, according to the appeals court, supported the finding that Mr. McDermond was domiciled in Baltimore in 2007: namely, his retention of a Maryland driver’s license, his “failure to make any social, civil, or other connections in the Netherlands,” his attendance at his Baltimore church when he returned to the United States, and his “failure to affirmatively cancel his Maryland voter registration.” 29
What is striking about the McDermond case is how typical it is. Indeed, the appeals court thought McDermond so unexceptional that the court consigned its McDermond decision to the judicial purgatory of “unreported” opinions, not citable as precedent. The state courts churn out fact-based domicile tax decisions like McDermond on a regular basis. 30 These cases reflect the sprawling, fact-based nature of the domicile inquiry; the continuing efforts of taxpayers to manipulate that facts-and circumstances inquiry to avoid paying state income taxes on the basis of domiciliary residence; and the states’ difficulties enforcing the subjective standard of domicile.
The uncertainties of the fact-and-circumstances test of domicile are confirmed by the efforts of the states to codify that test. Those codification efforts result in laundry lists of factors that provide no more certainty about the domicile inquiry than does the case law.
Kansas’s regulations, for example, 31 identify a variety of facts to be considered in determining an individual’s domicile. These
facts include where the individual, her spouse, or her children attend school, 32 and where they “regularly participate in sporting events, group activities, or public performances.” 33 However, the Kansas regulations caution that none of these enumerated facts is determinative 34 and that “any other fact” may be “relevant to the determination” of a person’s domicile. 35
[*278] Maine similarly declares that “no single factor” determines a person’s domicile. 36 Among the myriad facts which are potentially relevant are the location of an individual’s “fraternal, social or athletic memberships” as well as “the location of a church or other house of worship of which [an individual is] a member.” 37 Also potentially relevant to Maine’s domicile inquiry is where an individual keeps her pets. 38
In the same vein, the Cooperative Agreement on Determination of Domicile promulgated by the North Eastern States Tax Officials Association 39 identifies as relevant to the determination of an individual’s domicile such vague factors as the individual’s “overall living pattern or life style.” These unwieldy documents do not reflect a failure of draftsmanship. Rather, they confirm the inherently sprawling nature of the fact-based domicile inquiry. Determining an individual’s “true, fixed and permanent home” 40 is an inherently messy enterprise. Individuals can accordingly manipulate the domicile standard while tax collectors find that subjective standard difficult to enforce.
The States’ More Objective Statutory Residence Laws
In contrast to the unwieldy, facts-and-circumstances quality of the law of domicile, the states’ more objective statutory residence laws are both easier for the taxpayer to avoid and for the state to enforce. A law like Michigan’s leads to a relatively straightforward inquiry: Was the taxpayer in the state on 183 days during the taxable year? If so, she is deemed a resident for income tax purposes, subject to state taxation on her worldwide income. 41 If not, the tax collector can still assert that the taxpayer is domiciled in-state and, therefore, taxed as a resident on that alternative basis. The dual definition of state residence resembles those states’ traffic laws that include both an objective speed limit (e.g., 65 miles per hour) and a more subjective prohibition on “unsafe” driving. At 70 miles per hour, the driver violates the objective limit. At 60 miles per hour, the driver complies with it. However, even at 60 miles per hour, the driver may be driving unsafely if, for example, the weather and visibility are poor. This, however, is a more subjective, fact-dependent inquiry than looking at the car’s speed.
Similarly, a statutory residence test like Michigan’s requires the relatively focused, mechanical inquiry whether the taxpayer is in-state for at least 183 days of the year. The taxpayer who does not trigger that test may [*279] still be taxed as a resident if he is deemed to be domiciled in Michigan. As the legion of cases like McDermond establish, domicile is a factually messy inquiry into the taxpayer’s intent to return, considering all of the facts and circumstances.
The Persistence of Domicile
Given the rise of statutory residence rules, the manipulability of the traditional standard of domicile, and the states’ difficulties enforcing that subjective, fact-based standard, why do the states continue to define residence as domicile for income tax purposes?
There is undoubtedly an element of inertia in the states’ continued use of the concept of domicile to define residence for income tax purposes. Domicile is the traditional way of defining residence. As the states developed their statutory residence laws, they initially adopted those laws to supplement, rather than replace, the fact-based definition of residence as domicile. 42 The historic definition of residence as domicile was already on the books and was deeply embedded in practice and case law. 43 Moreover, the dual definition of residence for state income tax purposes – domicile or statutory residence – bolsters states’ revenues by giving a state two chances to classify any individual as a resident, subject to state taxation on his worldwide income.
Benefits-based justifications can also be advanced for defining residence as domicile, but these justifications are not persuasive. 44 The essence of domiciliary status is an individual’s long-term intent, as reflected in all of the facts and circumstances, to return to the jurisdiction in which she is domiciled. An individual currently living elsewhere, the argument might run, benefits presently from the public services which maintain the jurisdiction of domicile for her eventual return. 45
The problem with this benefits-based argument is that the domiciliary resident who lives outside her state of domicile is, on a day-to-day basis, receiving her most salient public services in the state where she currently lives, not the state of domicile to which she ultimately intends to return. In comparison with the benefits received from the state in which she presently lives, the public services derived from her state of domicile are deferred and attenuated. These future benefits are not a convincing basis for justifying income taxation today by the state of domicile, in comparison with income taxation by the state providing her benefits currently.
An alternative characterization is that a domiciliary resident currently living elsewhere should pay tax to her state of domicile as a form of prepayment for the benefits she will receive when she eventually returns there. 46 However, when she returns, she will then pay resident income tax [*280] for the benefits she is then receiving. There is no reason the domiciliary resident living in another state should pay tax twice, once today as a prepayment for future benefits and once again in the future for benefits received when she actually returns to the state of domicile.
When an individual moves to a new state, she is not required to pay an entrance fee to compensate the state for its prior operations during the years before the new resident relocated there. There is no reason that a domiciliary resident of this state should be required to pay the equivalent of that entrance fee in the form of resident-based income taxes during the years she lives elsewhere.
Another potential argument for defining residence as domicile for income tax purposes is that domicile represents a foundational relationship with the state to which the individual will eventually return. 47 According to this argument, Mr. McDermond was a member of the Maryland polity while he lived in the Netherlands and, hence, should be taxed as a member of that polity.
This a plausible argument in terms of the nation-state: i.e., Mr. McDermond’s prime political membership remained in the United States while he lived abroad. However, the relationships of U.S. citizens to their respective states are today not robust. Few U.S. citizens today believe that it is psychologically or politically significant when they move from State A to State B or
attach great meaning to a political affiliation with one state as opposed to another. 48
VII. Domicile as Gap-Filler
The best argument today for defining residence for income tax purposes as domicile is that domicile is a default setting, a gapfiller to make sure that everyone is a taxpaying resident somewhere. Statutory residence laws, with their relatively bright lines, are easier for the government to enforce, but also easier for some (particularly affluent) taxpayers to avoid. The traditional theory is that everyone has a domicile and, thus, must be a taxpaying resident somewhere. Domicile today serves as a gap-filler when more mechanical statutory residence rules are under-inclusive.
Suppose, for example, that a tax-conscious retiree spends part of the year at his home in Michigan and part of the year at his house in New Mexico. New Mexico’s objective test of statutory residence is 185 in-state days during the year. 49 Suppose that this retiree is careful to live for 180 days in each of these two states, spending the remaining five days of the year elsewhere. Under these circumstances, neither state can assert statutory residence against this individual since he only lives in either state for 180 days, just short of the mechanical criteria for statutory residence. If statutory residence were the only basis for asserting resident status for income tax purposes, this retiree would owe no residence-based state income [*281] taxes anywhere, since he would not be a resident of either Michigan or New Mexico.
Specifically, this individual would owe no state taxes on his dividends, interest, royalties, and capital gains from stocks and bonds since such passive investment income generated by intangible assets is taxed by the state of residence 50 – and this individual would have no state of residence if residence were only defined in objective statutory terms. Moreover, under federal law, no state could tax this individual’s pension, 401(k), or individual retirement account (IRA) distributions since only the state of residence can tax retirement distributions 51 and this individual carefully conducts his affairs to avoid classification as a statutory resident in the two states in which he owns homes.
In this example, the concept of domicile fills the gap left by statutory residence laws. For income tax purposes, domicile assigns a state of residence to this retiree on the basis of facts-and-circumstances indicating a permanent intention to return.
There is, in this setting, the danger that the concept of domicile, in practice, will overtax this individual if both New Mexico and Michigan claim to be his state of domicile and both tax his worldwide income on the basis of residence. 52 We should, in such cases of dual residence, develop rules requiring the apportionment of the dual resident’s income between his two states of residence.
However, for present purposes, the critical point is that the U.S. states persist in using domicile as an alternative test of residence for income tax purposes. While the continuing use of domicile may in part be attributable to inertia, tradition, and revenue considerations, domicile also plays a gap-filling role when taxpayers keep their in-state presence below the mechanical threshold triggering statutory residence.
Domicile as gap-filler is a diminution of domicile’s historically dominant role in defining residence. Before the rise of statutory residence rules, domicile was the traditional definition of residence. 53 Statutory residence laws were originally adopted to supplement, rather than subordinate, domicile as the criterion for residence for income tax purposes. 54 Characterizing domicile as filling the gaps left by objective statutory residence rules demotes domicile to the status of junior partner, in practice secondary to the statutory residence laws originally envisioned to support the traditional concept of domicile.
However, despite the difficulties of enforcing the test of domicile, the gap-filling function of that test has proved compelling. Consequently, few states have eschewed domicile as an alternative, subjective basis for asserting [*282] residence for income tax purposes – despite the manipulability and unwieldy nature of the subjective domicile inquiry.
VIII. Citizenship as a Gap-Filling Proxy for Domicile
In sum, most states have retained the sprawling, fact-based concept of domicile for state income tax purposes rather than making objective statutory residence laws the exclusive tests of residence. This suggests that, under a residence-based income tax system, the federal government, looking at the states’ experience, would similarly decline to define residence in purely mechanical terms and would instead insist on a gap-filling definition of residence, like domicile, to apply when objective definitions of residence prove under-inclusive.
In fact, the federal government takes this dual definition approach when it identifies when an alien is a U.S. resident for tax purposes and, thus, taxed by the United States on his worldwide income. Emulating the states, the Internal Revenue Code promulgates an objective test of an alien’s physical presence in the United States. This mechanical test of an alien’s substantial physical presence is analogous to the states’ statutory residence laws. Also emulating the states, the Code supplements this test of physical presence with the domicile-like criterion of “permanent residence.” 55 An alien who triggers either of these rules is taxed by the United States as a resident on his worldwide income.
Section 7701(b)(1)(A)(ii) of the Internal Revenue Code 56 is a federal analogue to the states’ statutory residence laws. Section 7701(b)(1)(A)(ii) eschews any inquiry into intent, facts, or circumstances and instead establishes an objective test of an alien’s residence for income tax purposes, a test denoted in the Code as “substantial presence.” The federal test of “substantial presence” is not precisely like state statutory residence laws because an alien’s “substantial presence” in the United States is based on her physical presence in the United States measured over a three-year period, not a single year. 57 Nevertheless, §
7701(b)(1)(A)(ii) resembles state statutory residence laws as a relatively focused, objective effort to assess non citizens’ residence in the United States on the basis of a mechanical test of physical presence rather than more subjective, facts-and circumstances inquiries about an individual’s intent and ultimate location.
Alternatively, if a noncitizen flunks the objective test of substantial presence but holds “permanent resident” status under U.S. immigration law, he is subject to taxation on his worldwide income as a U.S. resident. This statutory pattern for aliens resembles the states’ dual income tax definitions of residence. Just as the states take two bites of the residence apple, the Code has two alternative tests for taxing an alien on his worldwide income. If an alien triggers either of these tests, he is deemed to be a U.S. resident, taxed by the United States on his worldwide income.
[*283] However, there is an important difference between the Code and the states’ tax systems: rather than asking whether the alien taxpayer is domiciled in the United States, § 7701(b)(1)(A)(i) 58 uses an objective proxy for domicile, namely, whether the alien holds a “green card.” Thus, under the Code, permanent residence status under federal immigration law serves a gap filling function analogous to domicile in the state law context. If an alien’s physical presence in the United States falls below the threshold identified by the substantial presence test, the alien’s green card nevertheless subjects him to U.S. taxation on his worldwide income. 59
For income tax purposes, an alien’s green card serves as an administrable proxy for his U.S. domicile. An individual who is a permanent U.S. resident for immigration law purposes is implicitly deemed domiciled in the United States for federal income tax purposes even if, in the short-run, his physical presence in the United States is not “substantial” under the objective test of § 7701(b)(1)(A)(ii). Immigration status is an objective, domicile-like gap-filler, taxing as a U.S. resident an alien who falls short of the mechanical substantial presence test.
Against this background, let us now play a thought game: Suppose that Congress, heeding the critics of citizenship-based taxation, were to consider expanding § 7701(b)(1)(A)(ii) to make its objective “substantial presence” test applicable not just to aliens but to citizens as well. Looking at the states’ income tax definitions of residence and at the Code’s similar, two-definition approach to the tax status of aliens, it is unlikely that Congress would make the substantial presence test (or any similar mechanical test of physical presence in the United States) the sole criterion for imposing worldwide income taxation. Rather, the states’ experience and the current version of § 7701(b)(1)(A) pertaining to aliens suggest that Congress would augment any mechanical test of physical residence with a parallel test of domicile, or something like domicile.
For a U.S. citizen, the analogue to an alien’s immigration law status as a permanent resident is the citizen’s citizenship. Thus, by this thought game, we wind up with the status quo. As the states’ experience demonstrates, domicile as a factually unwieldy definition of residence for income tax purposes is manipulable by the taxpayer and is difficult for the states to enforce. Domicile is nevertheless a useful, gap-filling approach to residence for income tax purposes since mechanical tests of residence can also be manipulated and can be under-inclusive. Citizenship (like permanent resident status) is an efficient proxy for domicile. Thus, the states’ experience buttresses the United States’ citizenship-based approach to income taxation. Citizenship is an efficient, administrable proxy for domicile.
Just as statutory residence laws can be under-inclusive, citizenship can be over-inclusive as a proxy for domicile. However, U.S. citizenship-based income taxation is abated through many devices such as credits for foreign [*284] income taxes, 60 the generous exclusion from gross income for foreign earned income and for housing allowances, 61 and treaty provisions to avoid double taxation. 62 In light of these devices, U.S. citizenship serves the same gap-filling function as does state domiciliary status, taxing the relatively affluent U.S. citizen when he does not pay income tax to the nation in which he currently resides.
I thus confess that, just as I am unimpressed by stories about Boris Johnson or by complaints that U.S. citizenship-based taxation is sui generis, the self-serving pleadings of U.S. citizens living abroad leave me unconvinced. If a U.S. citizen makes less than the amount of income excluded by § 911 or pays creditable income taxes to his country of residence at a rate equal to or exceeding his U.S. tax rate, this citizen pays no income tax to the United States. U.S. citizenship-based taxation is gapfilling, requiring U.S. income tax payments only when a relatively well-paid U.S. citizen pays no tax where he lives.
The most compelling example of over-inclusiveness is the so-called “accidental” U.S. citizen who does not know and cannot realistically be expected to know that she is a U.S. citizen, subject to worldwide income taxation. The Internal Revenue Code already contains provisions which facilitate the renunciation of U.S. citizenship by such accidental citizens. 63 It is possible that these provisions should be expanded further.
On balance, however, citizenship is an administrable proxy for domicile and serves the same gap-filling function as does domicile in the states’ income tax systems. Other nations’ residence-based income tax systems confront factually unwieldy determinations of residence similar to the messy, fact-intensive tax controversies routinely decided by the U.S. state courts on the subject of domicile. 64 The U.S. system of citizenship-based taxation eliminates these sprawling controversies, replacing the factually subjective domicile inquiry with the bright line rule of citizenship.
Moreover, among those who advance a benefits theory of citizenship taxation, 65 the right to return to the United States is frequently cited as the most important benefit of a U.S. passport. This argument suggests that U.S. citizens who reside abroad for extended stays view the United States as a permanent location to which they will someday return. The right of return indicates permanent allegiance. Hence, U.S. citizenship again proves to be a reasonable proxy for U.S. domicile.
The states’ difficulties enforcing domicile-based taxation highlight the administrative benefits of citizenship-based taxation. As long as residence is understood for tax purposes in terms of domicile, citizenship is an efficient proxy for such domicile. The states’ experience defining residence supports the United States’ citizenship-based approach to federal income taxation. Under the Internal Revenue Code, citizenship is an administrable proxy for domicile and serves the same gap-filling function played by domicile under the states’ income taxes.
1 Walter Hellerstein, Kirk J. Stark, John A. Swain & Joan M. Youngman, State and Local Taxation: Cases and Materials 373 (10th ed. 2014)
[hereinafter State and Local Taxation].
2 Id. at 379-82.
3 See infra notes 21-40 and accompanying text.
4 Cf. Jacqueline Bugnion, Concerns About the Taxation of Americans Resident Abroad, 148 Tax Notes 861, 862 (2015) (“The United States
is the odd man out with this attitude.”); Teri Sprackland, London Mayor to Relinquish U.S. Citizenship, 146 Tax Notes 963 (2015) (“Only the
United States, apart from Eritrea, taxes all its citizens … .”).
5 See, e.g., EEOC v. Abercrombie & Fitch Stores, 135 S. Ct. 2028 (2015) (protecting the right of a practicing Muslim to wear a headscarf in
the prospective workplace); Reed v. Town of Gilbert, 135 S. Ct. 2218 (2015) (holding that tighter restrictions on sign advertising church are
content-based regulations which violate the First Amendment); see also John T. Noonan, Jr., The Lustre of Our Country: The American
Experience of Religious Freedom 9 (1998) (“The American experience has lighted up the skies.”).
6 Edward A. Zelinsky, Citizenship and Worldwide Taxation: Citizenship As an Administrable Proxy for Domicile, 96 Iowa L. Rev. 1291-93
(2011) [hereinafter Zelinsky, Citizenship and Worldwide Taxation].
7 See, e.g., Bugnion, supra note 4, at 862.
8 Sprackland, supra note 4, at 963. Moreover, “there were only 483 individuals who gave up their U.S. citizenship during the quarter ending
June 30, 2015.” Andrew Velarde, Theories for Expatriation Numbers Abound, but Answers Elusive, Tax Notes Today 174-1 (2015).
9 See Robert Goulder, Should London Mayor Boris Johnson Pay U.S. Taxes?, Forbes (Jan. 26, 2015),
www.forbes.com/sites/taxanalysts/2015/01/26/should-london-mayor-boris-johnson-pay-u-s-taxes/.
10 See generally Reuven S. Avi-Yonah, The Case Against Taxing Citizens 3 ) (Univ. of Mich. Law Sch. Law & Economics Working Paper
No. 12, 2010) (“Citizenship-based taxation of Americans living overseas began during the Civil War.”).
11 Alexander M. Bickel, The New Age of Political Reform: The Electoral College, The Convention and The Party System 3-4 (1968) (“We
have, of course, many institutions and arrangements that, as they function, no longer conform to the original scheme, and we have bent most
of them quite effectively to the purposes of our present society… .”).
12 See, e.g., Fadi Shaheen, International Tax Neutrality: Reconsiderations, 27 Va. Tax Rev. 203, 205 (2007) (proposing “source-based
taxation”).
13 Comptroller of the Treasury of Maryland v. Wynne, 135 S. Ct. 1787, 1813 (2015) (Ginsburg, J., dissenting).
14 Indiana Dep’t of State Revenue v. Bethlehem Steel Corp., 639 N.E.2d 264, 268 (1994) (“The long-established rule for taxing tangible
property, mobilia sequuntur personam, held that such property followed the person of the owner. Under this rule, the owner’s place of
domicile had the sole authority to tax his personal property.”).
15 See generally Edward A. Zelinsky, Apportioning State Personal Income Taxes to Eliminate the Double Taxation of Dual Residents:
Thoughts Provoked by the Proposed Minnesota Snowbird Tax, 15 Fla. Tax Rev. 533, 540-41 (2014) [hereinafter Zelinsky, Apportioning
State Personal Income Taxes].
16 For an example, consider Conn. Gen. Stat.§§12-701(a)(1) (defining a resident as an individual “domiciled in” Connecticut or an individual
who “maintains a permanent place of abode in” Connecticut and is present in Connecticut “more than one hundred eighty-three days of the
taxable year”) and§§12-701(a)(19) and 701(a)(20) (defining a Connecticut resident’s “Connecticut adjusted gross income”).
17 Zelinsky, Apportioning State Personal Income Taxes, supra note 15, at 543-45.
18 See supra note 16 and accompanying text; see also State and Local Taxation, supra note 1, at 379-82.
19 Mich. Comp. Laws § 206.18(1)(a) (1967).
20 Mich. Comp. Laws § 206.18(1)(a) (1967).
21 See, e.g., Andrew Berger, Florida Domicile: Steps to Establishing It and Pitfalls to Beware, Fla. Condo & Hoa Law Blog (Aug. 31, 2012),
http://www.floridacondohoalawblog.com/2012/08/articles/estate-tax/florida-domicile-steps-to-establishing-it-and-pitfalls-to- beware/; Layne
Rushforth, Establishing Legal Domicile in Nevada, The Rushforth Firm (May 21, 2014), http://rushforth.net/pdf/domicile.pdf.
22 McDermond v. Comptroller of the Treasury, No. 1299, 2015 Md. App. LEXIS 412 (Md. Ct. Spec. App. July 9, 2015).
23 Id., at 3.
25 Id., at 8.
27 Id., at 12 (quoting Shenton v. Abbott, 178 Md. 526, 530, 15 A.2d 906 (1940)).
28 Id., at 17-18.
29 Id., at 18-19.
30 See, e.g., Cause v. Dep’t of Revenue, 2015 Or. Tax LEXIS 148 (Or. T.C. Nov. 19, 2015); George v. Dir. of Revenue, St. Tax Today, Nov.
23, 2015 (Del. Tax App. Bd. Nov. 17, 2015); Morgan L. Holcomb & John Mule, Persistence of Residence, St. Tax Today, Aug. 30, 2012
(discussing residence determinations in state courts); Zelinsky, Apportioning State Personal Income Taxes, supra note 15, at 542 n.31
(collecting domicile tax cases).
31 Kan. Admin. Regs. § 92-12-4a(b)(7) (2009).
32 Kan. Admin. Regs. § 92-12-4a(b)(7)(P) (2009).
33 Kan. Admin. Regs. § 92-12-4a(b)(7)(R) (2009).
34 Kan. Admin. Regs. § 92-12-4a(b)(7) (2009).
35 Kan. Admin. Regs. § 92-12-4a(b)(7)(S) (2009).
36 Maine Revenue Service Provides Guidelines on Residency Status for Income Tax Purposes, St. Tax Today, Dec. 28, 2015.
39 Northeastern States Tax Officials Association Releases Cooperative Tax Agreement, St. Tax Today, Nov. 4, 1996.
40 Mich. Comp. Laws § 206.18(1)(a) (1967).
41 Mich. Comp. Laws § 206.18(1)(a) (1967).
42 See Tamagni v. Tax Appeals Tribunal, 695 N.E.2d 1125, 1128 (N.Y. 1998).
44 Zelinsky, Citizenship and Worldwide Taxation, supra note 6, at 1314-23.
45 Id. at 1315-16.
47 Zelinsky, Apportioning State Personal Income Taxes, supra note 15, at 559-60.
49 N.M. Stat. Ann. § 7-2-2S (2014).
50 Zelinsky, Apportioning State Personal Income Taxes, supra note 15, at 540-41.
51 4 U.S.C. § 114 (2015).
52 Zelinsky, Apportioning State Personal Income Taxes, supra note 15, at 542-43.
53 Tamagni v. Tax Appeals Tribunal, 695 N.E.2d 1125, 1128 (N.Y. 1998) (discussing the history of New York’s statutory residence law).
55 I.R.C. § 7701(b)(1)(A)(i) (2015).
56 I.R.C.§§7701(b)(1)(A)(ii)-(b)(3) (2015).
57 I.R.C. § 7701(b)(3)(A) (2015).
58 I.R.C. § 7701(b)(1)(A)(i) (2015).
59 I.R.C. § 7701(b)(1)(A)(i) (2015).
60 I.R.C. § 901 (2015).
61 I.R.C. § 911 (2015).
62 See, e.g., U.S. Treasury, United States Model Income Tax Convention of November 15, 2006, art. 4(3) (containing provisions to assign a
single state of residence to dual residents); Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income and on Capital Gains art. 24, U.S.-U.K., July 24, 2001, S. Treaty Doc. No. 107-19 (2002).
63 I.R.C. § 877(c) (2015) (special relief for certain dual citizens and minors).
64 Zelinsky, Citizenship and Worldwide Taxation, supra note 6, at 1324-42.
65 Id. at 1345.
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36 comments | Tags: Defining Residence For Income Tax Purposes, Edward Zelinsky
36 thoughts on “Defining Residence For Income Tax Purposes”
Mr. Zelinsky,
How would you react to this comment, and what advice would you give to this individual?
https://www.taxconnections.com/taxblog/the-united-states-imposes-a-separate-and-more-punitive-tax-system-on-us-dual-citizens-who-live-in-their-country-of-second-citizenship/#comment-17725
Are you unimpressed by their plight?
Thank you for writing this article Mr. Zelinsky. You have reaffirmed that my decision to renounce US citizenship was one of the best choices I’ve ever made, sad as it was.
I no longer have to be a victim of US exceptionalism and folks like you abetting US’s aberrant, unethical, immoral behaviour. Seems harming disabled children and the elderly are the new American values. Extorting the worlds financial sector via bad faith FATCA to steal assets belonging in other nations’ economies, hypocritically making US #1 tax haven without a modicum of embarrassment leaves me certain USA has lost its moral compass; makes one ashamed to be American.
Although you scoff at, remain unimpressed about the numbers of those renouncing believe me they are doing so with immeasurable anger. These policies have created yet another group out in the world harbouring ill-will towards the US, their irreplaceable soft power good-will abroad squandered for a pittance. Personally I actively and loudly support any effort to #BDS USA and change of reserve currency; you’ve been poor stewards of this privilege.
When asked if I’m American as result of a Boston accent I’ve been unable to fully shed I now proudly say NO, I’m Canadian and take a HUGE breath of relief.
Excellent reply Laura – Pretty much sums up my thoughts & feelings to a ‘T’….not really sure how Professor Zelinsky can rationalise the CBT when 99.9% of the Westeruu world does not – he must also be a member of the flat earth society ;-)…I’ll paraphrase Mark Twain here — suppose your were an idiot, and suppose you were a professor who supports CBT; but I repeat myself…
The US offers credits on EARNED income tax paid abroad, but it taxes UNEARNED income from foreign social welfare benefits such as unemployment or disability that a US person taxpayer may receive when living abroad, taking food out of the mouths of the disadvantaged. Your analysis does not address this unfairness at all whatsoever.
Anything above a certain amount is taxed and is not credited. The tax is onerous.
Ihr Name deutet darauf hin, dass Sie osteuropäische Vorfahren haben. Hat sich Ihr Ur-Urgroßvater formal 100% korrekt ausbürgern lassen? Haben Sie noch alle Unterlagen? Nein?
Dann erstellen Sie sofort eine Steuererklärung auf polnisch/tschechisch/russisch. Das können Sie nicht? Dann ist das Ihr Problem und gehen Sie zu einem Spezialisten der Ihnen gerne für enige Tausender eine völlig unnötige Erklärung verfasst. Ansonsten drohen Ihnen vernichtende Strafen, welche völlig abseits jeglicher Verhältnismäßigkeit stehen.
Es scheint gerade so, als sei „compliance“ eine Art religiöses Gebot, dass absolut umunmstösslich ist.
Did not understand it? your problem!
I couldn’t care less how unembarrassed you are. What is important is to challenge
a pompous delivery of your fatuous arguments in support of the status quo.
In basing it’s income tax obligations on citizenship rather that residency, the US has only one other conformist ally, Eritrea. This is how expatriate Americans rich and poor are punished, so as to dissuade others from leaving the country.
I don’t blame any expatriate American who seeks to avoid compliance. I am not an American and I’m lucky because I can move about without any penalty. The ridiculous part is, I know some foreigners who have become residents in the US but who pay no US income tax because they are not US citizens.
If the US fell into line with the internationally adopted practice, this couldn’t happen.
I was born in the USA by Scandinavian parents. They brought me back to Norway as soon as I was born, as they wanted me to grow up with my Scandinavian family. I have no memory of the US, no links to the US. I was learning English in school like the other kids, and was even quite bad at it. Why should I pay for my parents choices? Do you know how much I already pay to my own country (not the US)? Narrow minded people can only see the world from their own subjective perspective. Not impressed!
Kevin from Geneva says:
Citizenship is not a proxy for domicile, only those attempting to justify an unjustifiable taxation system such as citizenship-based taxation can attach value to this argument. Citizenship is a basic human right enshrined in the UN universal declaration of human rights, as is the right to leave and enter one’s country of origin at will. Citizenship doesn’t come with strings attached and certainly does not carry in any way whatsoever an inherent fiscal obligation or duty of reciprocity. Citizenry (the residents of a given jurisdiction, constituting its society) on the other hand does. The US diaspora does not partake in US society, especially those born outside the US who have never lived in the US. They receive strictly nothing material from the US that can objectively justify their taxation by the IRS as non-residents, including embassy and consular services that are charged a fee. Other countries such as France actually do more for their diasporas than the US. It is worth noting that the US diaspora is not officially represented in Congress as the distinct group that it is although it is certainly taxed as one (taxation without representation, hint, hint). The French diaspora is represented in the French parliament and is not taxed. Furthermore, the US diaspora, although taxed by the US Federal government may find itself unable to register for US Federal elections due to prevailing laws in certain states barring non-resident state citizens from registering as voters! Of the 244 existing tax jurisdictions in the world, only the US and UN-Security Council-condemned Eritrea still practice CBT, the other 242 practice residence-based taxation. Of the historical 8 or so nations that practiced CBT only 2 remain today, the others (such as Mexico and the Philippines in the 1980s) have ditched this dogmatic, anachronistic concept and opted for a modern, pragmatic and fair standard; residence-based-taxation. It is time for the professor to pull off his isolationist blinders, get himself a sense of practical reality and join the 21st century.
I read a lot of academic papers, but this one is seriously one of the most flawed that I have read in quite some time. You seem unimpressed by many things that actually matter. Your fellow citizens have to struggle and have their lives limited because of their archaic, senseless doubling of tax codes. You also seem to use the very old and debunked argument of people living in no-tax countries. We know now that over 90% of Americans abroad live in countries with a higher tax rate than the US.
You also seem to justify this nonsense by the US being some sort of special defender of freedom of religion or speech. I would love to introduce you to citizens of other countries that have died serving next to our own troops in places like Afghanistan. In one case, a family that lost a father rescuing US troops. On top of that, your fellow citizens, who you seem to think are worthless scum, often do more for the US on a daily basis than many do in a lifetime.
The US does not have a monopoly on defending either speech or religion.
What you also fail to recognize is that your fellow citizens in other countries already live under a tax code of that country. The so called tax treaties between the US and those countries are flawed, to say the least. The system of two tax codes and a tax treaty is much more problematic than any domicile issue that you mentioned. However, it does seem designed to take money out of other countries’ tax base, mainly because people like you feel the the US is entitled to it.
I will not go in to the myriad of issues caused by citizen-based taxation, because I am sure that you will be unimpressed. I also do not want to go in to every mistake that you made in this piece. It is so flawed, that we could re-write the entire thing. However, I would like to express my lack of being impressed about your slanted, and nonprofessional piece.
“Finally, the difficulty of collecting income tax from many U.S. citizens who live abroad is not, by itself, reason to abandon the effort to tax them.”
So here’s the thing: the US isn’t really making any effort to tax US citizens abroad. Sure, if someone volunteers to be compliant, the Treasury will take their money. But otherwise the IRS is perfectly aware that it has no authority to collect from the citizens of other countries who have no US assets or income, so it does not waste resources trying to find such people. (The US has collection-assistance agreements with only five countries, and citizens of those countries are exempt.) FATCA is causing all kinds of banking problems for US citizens living in some countries (though not others) but the IRS isn’t pursuing non-residents in search of tax revenue.
One reason that renunciation rates are so low is that CBT is in fact very easy to ignore. Global compliance rates are estimated to be around 11 to 16 percent (1 million returns filed for 6 to 9 million US persons abroad) and have not seen any significant increase since FATCA was passed in 2011. Participation numbers for the offshore streamlined program are laughably low.
Non-compliant US persons abroad, particularly dual citizens, have very few reasons to enter the US tax system, and little to fear from the IRS. For most of them, CBT is a complete non-issue.
Problems with your statement that Citizenship Based Double Taxation is not an issue:
* It might not be an issue except that it is so unfathomably complex to comprehend and with lots of gray areas in how US tax applies on varies income and assets when one lives outside the US.
People then go to a compliance professional to try an sort it out, then get sucked into compliance
* People are taught to obey laws not ignore them.
* Tax treaties give in to the double tax claim rather than providing exemptions and protection.
* Because of one-way FATCA, European banks will start asking for social security numbers in 2020 of U.S. person account holders. FATCA is a broke law in that the U.S. will not provide reciprocal information as promised to many nations.
* CBDT is a source of financial terrorism of many. The powers of the U.S. Leviathan are mighty.
Administrative benefit doesn’t justify theft by the U.S. of resources belonging to the economies of other countries.
The core of what you have written is an attempt to justify theft that benefits you as an American homelander. So all that your arguments amount to, to quote you, are “self-serving pleadings”.
I must have missed all the US religious freedom and free speech interventions in my country.
I think you’ll find that most americans overseas are not that concerned with having to pay an uplift on their rates of tax if their country of residence has a lower tax rate. The US is such a tax haven domestically that the electorate didn’t blink when Romney’s tax returns showed an average tax rate of 12%.
It is all the situations where the rules don’t line up and the taxpayer gets crushed between 2 or more tax regimes that do not work together. They are concerned with US taxation on mortgage repayments (phantom FX gains), with being taxed on their contributions to pensions (which would not be taxable if they were domestic and making contributions to an IRA), to having to calculate their capital gains in two currencies so when they sell an investment for a loss they can still have a US tax liability, to having an unhedgable FX exposure as all their income, savings and expenditure is in a foreign currency (incl their retirement) but their tax calculations on many things are not, to not getting credit for income taxes (eg CSG in France – ruled an income tax by french courts but not accepted by the IRS), to having to pay mark to market taxes on any uplift in investments that they are not on not allowed to touch so have to borrow money to pay their US PFIC tax bill (when your pensions reside in a third country) And now with EU rules on investment funds, americans in the EU have effectively no legal access to investment funds at all, in the EU due to PFIC or the US due to KID/PRIIP.
Oh and BTW treaties only work for people with only two countries in their lives which is not realistic to rely on. Americans overseas just want the same rights, options, simplicity and flexibility in their life that americans living in america have. The US should grant them that right by creating a tax regime fit for purpose. Maybe a wholesale exemption of income from “comparably taxed regimes” (like CFC white list rules) and functional currency rules (like those who available to companies).
But would the US really lose much by abandoning CBT? Maybe they could pick that up by dealing with carried-interest loopholes or putting a limit on like kind exchange exemptions on property.
There are many proud americans fighting for the good of the country and its industries who live overseas and will always live overseas who do not wish to renounce. It is not because, as you say, they want any US services or the option of returning. It is because they are proud americans.
Mr. Zelinsky, your ideas are theoretically interesting but practically don’t work. In order to understand the implications of citizenship-based taxation on the ground, I think you owe it to your audience to take a moment and imagine yourself in the following hypothetical scenario:
You were born in the UK, moved with your parents to the United States as a child, and have continued to live and work exclusively in the United States since. You are a middle-class citizen and own a small medical practice. Because of your upbringing, you are a proud American and a proud Brit. You enjoy taking occasional vacations in the UK and think you might even retire there one day. Now imagine the UK practices citizenship-based taxation. You don’t want any trouble in the future, so you remain compliant with British tax laws. Of course you also plan your finances to minimize your tax and avoid situations that result in tax liability to the UK. This means you don’t have a Roth IRA since it would be seen as a trust by the British Government, which would be heavily taxed and require highly complex reporting. The UK views American mutual funds as Passive Foreign Investment Corporations (PFICs), which are heavily taxed and therefore there is no point in having one. The only reasonable place to invest your money is in British mutual funds. You are effectively prohibited from using 529 plans for your kids, since these are heavily taxed and require complex reporting to the UK as well.
It gets worse Mr. Zelinsky. It costs you about $500 per year in accounting fees to file your personal tax return to the IRS. It costs $1500 for a personal return to the UK since this accounting is highly specialized. Thankfully you have not needed to file a UK return for your practice, which is incorporated as a small business in the US and therefore not subject British tax law. Because you are self-employed, you use this small business to save for your retirement. Here is the real kicker however: in 2017 Prime Minister Theresa May introduces Her Majesty’s Tax Cuts and Jobs Act which states that if you are a >10% shareholder in a foreign corporation, you must pay individual tax rates on that company’s income (a new regime unbelievably termed ‘GILTI’), and you must pay a one-time 15% tax on all retained earnings (the ‘Transition Tax’). Facing a sudden 15% confiscation of your retirement fund and loss of any ongoing benefit of incorporation, you frantically call your expensive accountant. She is dumbfounded by the new changes, so you call around to tax law firms for help. One firm quotes you $5000-$8000 to implement a restructuring to avoid the 15% confiscation and keep the benefit of incorporation, saying they are there to “create value for you.” At the end of the day, your maneuvering prevents you from needing to pay any tax to the UK, but you pay a lot more to the IRS and to your accountants/lawyers.
Mr. Zelinsky, I am a dual US/Canadian citizen living in Canada. The above scenario I’ve asked you to imagine is exactly my own and that of many other professionals in Canada, without exaggeration. While an argument can be made in theory, as you have done, that citizenship-based taxation is generally fair, the reality is that it can’t be implemented fairly and efficiently. Canada is a high tax nation, and I am not some rich tax evader. I should not need to worry about taxation from the US. If persons are abusing inadequate laws and regulations which define residence/domicile to evade tax, then those laws and regulations need to be bolstered. Citizenship-based taxation as a means to ‘gap-fill’ unfairly lumps unequivocally foreign residents such as myself and ‘Accidentals’ into the same boat as tax evaders.
Mr Zielinski you show yourself to be completely out of touch with reality. I really appreciate the stories shared in the comments section from others – they are wholly accurate from my perspective as a dual UK/US citizen. I married a BRITISH man 27 years ago. I live 100% of my time in the UK and only visit the US to see my mother, family and friends. I pay $750 a year to have a specialist file my US return, on income and investments solely generated within the UK. The tax treaty between the UK and USA require complex reporting and my tax return to the US is often 75 pages long or more. While in the UK my tax return is about three pages long and something I can do myself. The complexity of the bureaucracy is suffocating and mind blowing and would be humorous if it weren’t so serious. If people like you continue to muddy the waters and contribute to an untenable situation such is citizen based taxation and FATCA then I fear there is only one drastic solution left: that all countries worldwide each adopt their own reciprocal system of citizen-based taxation on their citizens and “Accidentals” abroad. Perhaps causing anarchy on a global scale and facilitating a spectacular crash and burn of this unfair and immoral tax code would drive home how utterly arrogant and untenable this situation is.
Your statement of: “U.S. citizenship-based taxation is gapfilling, requiring U.S. income tax payments only when a relatively well-paid U.S. citizen pays no tax where he lives.” is absolutely false.
Even though we make a middle-class salary here in Switzerland, which has relatively low taxes but an incredibly high cost-of-living, we end up owing the US every year at tax time. We pay our Swiss taxes 100% in full, of course. This is double taxation on the US’s part. I don’t care how many exemptions & credits are written into the US’s tax law for Expats, this is double taxation, plain and simple.
One major problem with using citizenship as a proxy for domicile is that the incidence of dual (and even triple) citizenships has exploded over the past few decades. In 1924, when Cook v. Tait was decided, obtaining a second citizenship almost always resulted in the loss of US citizenship. In the decades since Afroyim v. Rusk, dual citizenship has become much more common. So, if citizenship is a proxy for domicile, which country gets to claim the domicile of the dual citizen? Most tax treaties have tiebreaker clauses for residence, however US citizens are unable to use these tiebreakers because of the “saving clause” that the US insists on putting in its treaties. Perhaps there needs to be a citizenship tiebreaker clause for dual US citizens.
Many who retain their US citizenship do so not because they plan to return, but because they cannot afford to renounce. First there is the US$2350 administrative fee charged by the Department of State for anyone wanting a Certificate of Loss of Nationality, which is now required to formally exit the US tax system. For many middle class US expats this is not affordable, especially if there are multiple family members with US citizenship. Furthermore, under s877/877A, five years of US tax compliance is required to avoid covered expatriate status and an exit tax, even for Accidental Americans. For those with incompatible “foreign” investments and business structures, compliance will be expensive.
Which brings me to the burden of citizenship based taxation that you are so unimpressed with. Certainly, those with only salary income below the s911 threshold have only a compliance burden and not a tax burden. However, the Internal Revenue Code taxes many “foreign” investment vehicles in a very punitive manner. Consider the PFIC rules. If a long-term dual citizen living outside the US has invested for her retirement using index funds (and often index funds that own US shares or US-domiciled index funds) without realising that the US considers these investments PFICs (and before around 2009 no one in the expat community even knew what a PFIC was), coming into US tax compliance and renouncing citizenship could result in a significant amount of “interest on tax deferral” under s1291. Or, consider the entrepreneurial expat who owns a corporation in the country where he lives. TCJA has just handed that entrepreneur a huge US tax bill under s965 for which there will be no foreign tax credit because there is no taxable transaction where he lives. Then there’s the problems faced by expats living in my home country, Australia. Our government mandates contributions to employees’ superannuation accounts by all employers. Voluntary contributions can also be made to these tax advantaged accounts. There are several ways that these funds might be structured, and none of them fit neatly into the Internal Revenue Code. After retirement, the Australian tax on withdrawals from these accounts is zero. For many retired US expats, the US tax on their super is the last straw. These punitive taxes on foreign investments and business structures are particular problems for the US emigrant rather than the temporary US expat. But there’s no way to emigrate out of the US tax system short of renouncing US citizenship. Other countries prize their diasporas – the US taxes its diaspora out of existence.
callaina70xo (@callaina70xo) says:
Dear Professor Zelinsky,
First of all, thank you for writing a thorough paper on an issue that does not receive enough attention. I myself am a proponent of logical consistency, bright lines, and justice. I appreciate your time and effort towards bringing these into the extremely complicated situation which is compliance with US income tax laws for people who have US citizenship but do not live in the US. That being said, I would like to take this opportunity to provide some hopefully constructive criticism by pointing out a flaw in one of the assertions upon which your argument is based.
I believe that having US citizenship cannot justly be considered a proxy for having US domicile. I will refrain from providing examples of “accidental Americans”, because you have indeed addressed this. Actually, I really appreciate your stating that provisions should be further expanded towards facilitating renunciation by this subset of citizens. However, I do not think it is possible or just to draw a line on which US citizens outside of the country qualify as “accidental.” If not mistaken, I infer that you would designate it as those who were unaware, and could not have reasonably been expected to be aware, of their citizenship and tax obligations to the USA. However, for one, this could punish those accidentals who were aware of it, and even complied with the American tax laws, and for two, it also excludes people who did spend significant parts of their lives in the USA and then left of their own volition to establish permanent homes elsewhere, with the inapropriately and, for many, prohibitively high cost of renouncing or relinquishing US citizenship.
As you have stated, domicile is a complicated, subjective issue (where does one have property, bank accounts, social activities, personal ties, etc.?) And it has been pointed out that Great Britain in a court case used the fact that a man retained his British citizenship and passport while living in other countries, to suffice as evidence that he could be considered domiciled in Great Britain, and therefore was liable to taxation. However, the problem with converting that over to the USA, is that, while it does have freedom of religion and speech, that does not make the US unique–but what does is the high cost of renunciation. The current paperwork fee is financially prohibitive for many common non-wealthy folk. It is currently almost 2 months’ salary for me personally, for example. It is even more of a financial hardship for those living in countries whose currency is much weaker than the US Dollar, and are further from being able to afford to renounce (let alone hire accountants who specialize in US income tax on the international front–this can cost 5 figures per year in USD, sometimes just to be told you don’t owe). Unable to prove tax compliance, they face additional barriers to renunciation.
I have said nothing about wealthy people here. But have provided examples of other types of people who are essentially trapped with US citizenship despite being unmistakably–by all other reasonable assessments–domiciled elsewhere. It is quite clearly *not* because of allegiance that they still have the citizenship. I understand that a lot of things your country does do not embarrass or bother you, but to be completely honest, I actually do hope that that fact does bother you, at least little bit.
Also, I would be remiss if I didn’t mention people with disabilities who receive subsistence allowance from the governments where they permanently live, but due to also having US citizenship, owe taxes to the US on their “unearned income.” If the disability is mental, they are not legally allowed to renounce, putting them in a serious bind, with their livelihoods potentially in jeopardy.
In conclusion, I believe that the government should begin removing the barriers to renunciation and relinquishment, namely the inordinately high cost, not only to those commonly referred to as “acciental”, but to *all* US citizens who make this choice freely for themselves. On top of that, the often extreme complexity–and hence, cost–of complying with US tax laws internationally should be simplified. This will greatly help US citizens abroad who then still voluntarily choose not to renounce, for personal reasons, especially if they don’t have to do with domicile; for example, some choose to keep it while they still have relatives in the US, to mitigate the risk of a visa denial when one of them gets very sick or dies, and an urgent visit is needed. In any case, citizenship should not be something one is unwillingly forced to keep. Sadly, it is in some countries, but the US edging ever more cloesly on being one, is something that should embarrass a morally upstanding person.
Thank you if you have actually read this.
“Unable to prove tax compliance, they face additional barriers to renunciation.”
Just so you’re aware, there is no requirement to prove tax compliance prior to renunciation. Tax questions will not be asked during the renunciation interview. Renouncing without subsequent compliance makes one a “covered expatriate” with continued “tax citizenship”, but for a person with no US financial ties (assets, income, future social security etc.) this is meaningless. (Tax advisors won’t tell you this, of course. It would be bad for business.)
Accidental US citizens, or long-term expatriates who left the US behind, are free to renounce without paying any attention to their US tax obligations. More and more are doing so. We all agree that the fee for renunciation is currently obscene and should be dropped to something reasonable, on par with passport renewal, in line with what other countries charge.
Thank you for replying to my comment, Ms. Williams. I appreciate your helping me to be informed on this important and controversial matter, and I am glad to hear you agree that the fee to renounce or relinquish is completely outside the realm of being reasonable.
I renounced last year. I have lived my entire economic life outside the USA, never filed a US tax return in my life, and I have no intention of filing any now. All my assets and income are in Europe, and I’m a financial minnow. I don’t expect to ever hear from the IRS, and I would ignore them if I did.
Another academic argument in support of US citizenship taxation made by someone (being a US citizen/resident) who isn’t affected by it. I have come to realize that it is almost truly impossible for someone who has lived their entire life in the USA to comprehend the injustice of US citizenship taxation. Sometimes one has to experience injustice firsthand to truly understand it.
I pay taxes. I can’t get medicare .I pay thousands to accountants and lawyers. I think we need the Vancouver Tea Party. If I wasn’t peace / love I would harass people going into the embassy
In my opinion, there are a number of logical flaws in this article. I will briefly mention a few of them
1)The basic argument of the article is that just like domicile is needed as a gap filler for the purposes of state tax, so to citizenship is needed as a gap filler as far as federal tax. This is a bad analogy for a number of reasons.
On a state level, the US is indeed in a unique situation of how to govern the relationship between the states, with cases like a citizen working in one state and living in another. All would agree he should pay state income tax somewhere, but the question is where.
This is not a simple question of tax law. But this is not at all analogous to Expats, who neither live or work in the US. The analogous case would be a person who once lived in NY, moved to NJ and works there, but NY still taxes the person because he once lived there.
2)The article assumes there is a need for a gap filler on a federal level just like there is a need for one on a state level. This is also incorrect. THe article mentions source based taxation as a possibility to govern state state tax.
While controversial on a state level, this seems to be an obvious solution on a federal level. A just law would be that if one’s residence is in the US, the worldwide income is taxable or if one’s source of income is in the US, then that income is taxable.
3)The article tries to learn the source of using citizenship as a gap filler on a federal level from how the US uses green cards as a test for how to tax resident aliens. This is problematic for two reasons. THe author seems to admit that using a green card as a test is a little strange, but since its the law, it can used to support citizenship as a test.
Additionally, It seems backwards to learn tax policy for US citizens from how the US taxes non-citizens. Surely citizens are significant enough to require an independent reasoning.
4)As an afterthought, while I know the case of Mr Mcdermond was brought up in light of state tax law, in a system of RBT, it is very possible he would have still been taxed on a federal level, because some countries, including my own, legislated that it takes a number of years to break tax residency.
All things considered, this article seems to be a very far stretch to protect CBT. IT makes use of the “associative property” (If A=B and B=C then A=C) in which both of the analogies are weak (state tax law = federal tax law, resident aliens = citizens) and then tries to connect the two (hence, state tax law = citizens).
Karl Steinke says:
If you move from Michigan to New Mexico, you can be subject only to the tax laws of New Mexico. This switch can be done with immediate effect.
If a U.S. citizen moves to Switzerland, this U.S. citizen can not opt-out of U.S. tax and reporting requirements without renouncing his citizenship. In order to renounce U.S. citizenship, one must first have another citizenship. Over 20% of the Swiss population are not Swiss citizens. Many were born in Switzerland.
In order to become a citizen, you must live in Switzerland for at least 12 years. There are also residence requirements of your city and Canton. If you move to Zurich for a job but then move to the suburbs several years later, the clock is reset. If you move to Germany for a job and then back to Switzerland, the clock is reset as well. Switzerland has to also accept you. This is not that easy.
Does it seem fair to you that someone could be subject to U.S. tax and reporting requirements FOR DECADES with no opt out?
It’s worth reminding people that US citizens who move abroad can *always* opt out of US tax and reporting requirements – by ceasing to file. The IRS has very limited ability to find and pursue such individuals.
There are three situations where it might not be advisable to become non-compliant:
1. If you live in but are not a citizen of Canada, France, Denmark, Netherlands or Sweden, there are mutual assistance agreements, where domestic authorities may collect tax and penalties (but not FBAR fines) on behalf of the IRS. You’d really have to put your head on a block for this to happen, however, simply disappearing likely won’t lead to the IRS taking action.
2. There is now a law in place that the IRS can request that your US passport be revoked or not renewed if you owe them a debt in excess of $51k. So perhaps unwise to take that risk if you do not have a second citizenship.
3. If you have significant family ties or financial connections to the US, such as income sources, assets, future pensions or social security, expected property inheritance, etc.
If none of those three conditions apply, and travel back to the US is not a priority, then you can make a strong case for not attempting to meet US tax and reporting requirements after leaving the country.
Note also that it’s not necessary to be compliant if you wish to renounce.
A more immediate concern for anyone living abroad with a US passport or birthplace is the potential discrimination they will face from financial institutions thanks to FATCA, who in many instances will deny or restrict the services available to US persons. Unfortunately there is no solution to this problem other than renunciation.
And since Accidental Americans by definition meet all three conditions outlined above, there is no reason whatsoever for them to consider entering the US tax system. If they need to renounce US citizenship because of FATCA discrimination, they can do so without attempting US tax compliance.
The tax situation is unfair because Americans abroad end up with the worst of both worlds. In Canada for example, income tax rates are higher than the US, but some other income streams are lower. Taken all together, it’s an acceptable amount of tax. But as an American in Canada, I get hit with the worst of both worlds because I end up paying the higher amount on each stream. So overall I pay far more tax than either Americans at home or Canadians at home.
Never Lived in US says:
Hello Professor Zelinsky,
Thank you for this excellent paper. I was so impressed by your arguments that I intend to propose my own native land of Israel to follow the lead of the US and switch to CBT.
As you surely know, every person born to a Jewish parent is entitled to an Israeli Citizenship. Much like every person born to an American parent is entitled to a US citizenship.
According to the Yeshiva University website, you seem to indeed be Jewish and thus entitled to Israeli citizenship. Therefore you will be required to file taxes in Israel.
Please familiarize yourself with the Israeli tax code which you must follow from now on (simply search מס הכנסה and follow the appropriate links. You might want to brush up on your Hebrew). Any objections may be submitted (in Hebrew) to the Israeli Knesset.
אם אתה מתנגד להצעה להלן על פיה תשלם מיסים לישראל על בסיס החלטה חד צדדית ושרירותית שלא נוגעת אליך במאום, אנא חשוב לעצמך איך מרגיש אדם שלא חי בארה”ב מעולם אבל נדרש לשלם לה מס.
This is a sad post. Your lack of empathy is from a position of privilege who has never been a slave to two incompatible tax systems. You only have to worry about as a tax domestic US citizen. If you were a US expat subject to two tax systems and experienced the hardships Citizenship Based Double Taxation imposes on US citizens you would have a different tone in this article.
The clear fact is, the US clearly punishes citizens who live abroad and anything “foreign” its punished. You will have a very difficult time trying to plan or live a normal life outside the US as a citizen. Your savings, pension, retirement, housing, children, spouse, insurance, business and well being will all be strangled, beaten and abused and you will pay thousands yearly to an international accountant for this privilege.
The US should not impose taxation on the tax residents of other countries, period. Citizenship Based Double Taxation was introduced to punish draft dodgers who fled the country during the civil war. The war ended in 1865. Theres no reason for the US to punish its citizens and make them noncompetitive in a global marketplace.
Jemima Rowling says:
This is the first public comment I have made about these issues. There is a great deal I can say, but I will stick to one example of the profound ignorance and sickening complacence of this article. My daughter is an accidental American, born in the UK, who recently renounced. Filling in her final US tax returns, she learns she has to pay several hundred dollars of tax on the tax-free bonus that she was given from the UK tax authority on the cash account (a Lifetime ISA) she opened to save to buy her first house. This is unearned income, and therefore taxable by the US, though my daughter’s earned income is far below the threshold to be taxed. It is a maddening injustice for the US to dip its hands into British assets and British benefits in this way, and for my daughter not to have the same opportunities as her contemporaries born on the same day in the same hospital.
Hopefully she tried all avenues and she or her advisor did the calculations using FEIE and not and whether she had access to the Foreign Housing Exemption. For taxpayers in the UK it is normally better to claim just foreign tax credits and not the Foreign Earned Income Exemption. I’m not sure if her excess UK taxes paid on earned income can then provide a credit against her unearned income as there may be some separation, but I think they both come under “other income” for a F1116 Foreign tax credit. Everyone’s situation is different and US tax is super complicated.
The “right of return” Prof Zelinsky cites is another in a long line of fictitious events to tax before any transaction occurs. That is tyranny.