I described in my last post how, at the tender age of 23, I arrived at what others have called the “oh my god” moment – discovering that the government of a country where I haven’t lived for many years apparently expected me to be filing and potentially paying taxes, simply for having the citizenship of that country.
I am speaking about the United States’ unique policy of citizenship-based taxation (CBT), which means that from the US government’s perspective, it doesn’t matter that I have resided in the United Kingdom (where I am also a citizen) with my family since I was a minor. As a US citizen, “the rules for filing income, estate, and gift tax returns and paying estimated tax are generally the same whether [I am] in the United States or abroad. [My] worldwide income is subject to US income tax, regardless of where [I] reside.”
In reality this discovery was the first in a long series of “oh my god” moments as I attempted to unpick and understand the implications of citizenship-based taxation, which is the topic of this post.
The more I learned, the clearer it became that as long as I:
a) remain a US citizen, and
b) refuse to uproot my life to move to the US under duress;
I was, am and forever will be running the gauntlet of the USA’s extraterritorial tax system – with its complex, onerous and punitive rules and enforcement mechanisms on overseas citizens – because my life is by definition “offshore”.
What could I do to square my situation and not be ‘delinquent’?
On discovering the initial CBT bombshell I panicked because I wasn’t ‘compliant’, which was disturbing in itself for someone who has always been law-abiding. “So what?” says the rational but uninformed onlooker (including myself, as a first reaction), “just start filing this year and all will be well.” Unfortunately, as one becomes more informed about the USA’s taxation policies for overseas Americans, straightforward responses show themselves to be unworkable or to carry risks that aren’t always possible to estimate.
It wasn’t clear what I should file
First, I couldn’t confidently figure out exactly what forms and schedules I needed to file for the current tax year as an overseas citizen. I consider myself to be an intelligent person, but I didn’t find the IRS instructions to be user-friendly in the slightest.
I tried to seek information elsewhere, visiting message boards online which offered conflicting amateur advice and plenty of horror stories about honest mistakes being fined by the IRS. I looked into getting professional help, but the prices that these niche, international tax specialist firms were charging was an awful lot of money for 23-year-old me, and filing with professional help still seemed to be risky when I read that even tax preparers struggle with the complexities of overseas citizens’ returns, and have been known to make mistakes for which their clients have to pay. There was also the profound indignation I felt towards paying an accountant thousands of dollars to show that I don’t even owe any money to the US (given that I earn my salary and am taxed on it in the UK).
I then discovered that there were potentially large penalties, or even the threat of incarceration, involved because of certain things I hadn’t been filing, even if I hadn’t owed any actual taxes. In particular, because I hadn’t been reporting any of my UK bank accounts to the US Financial Crimes Enforcement Network every year, I could theoretically be liable for imprisonment under US law, or face large financial penalties – $10,000 per account for every year not reported is the minimum fine for when the IRS agrees that you didn’t know you had to file, or that you were acting in a ‘non-wilful’ way.
With the concept of ‘wilfulness’ being somewhat nebulous to prove (how do you prove you didn’t know something?) and open to their own interpretation, it seemed like there was some risk, however impossible to quantify, that entering the system could create a nasty situation for me before my adult life had really begun. Again, as someone who had always been law-abiding, all this talk of penalties and prosecution was terrifying, even if the chance it would affect me was small.
I then discovered more alarming news. Back in the days when I had thought I was free to save and plan for my future in the country where I live, I decided to start saving a bit of money and made small investments in some UK-listed mutual funds – nothing remotely exotic, just small holdings in things like a FTSE 100 tracker fund.
According to US tax law, I shouldn’t be investing outside of America. If one happens to have US citizenship, even a FTSE 100 tracker fund held in the UK by a UK citizen and resident is a “passive foreign investment company”, or PFIC, to the US government. A PFIC has one of the most complex tax forms that need to be filled out for every mutual fund held (once one has more than $25,000 invested across non-US mutual funds), with the IRS estimating each form to take 22 hours of preparation per year. They carry a very punitive tax rate (39.6% or up to 50% of capital gains).
The chorus all over the internet from professionals and armchair accountants sang unanimously: “do not buy or sell any mutual funds ever without legal and accounting help!” Well, s***. I was far under the $25,000 mark but I stopped my monthly payments going into my investment account and I haven’t bought or sold anything since – all I am comfortable saving while subject to this system is cash.
How I should file – quiet disclosure, Streamlined Compliance Program, OVDP?
Beyond the question of what to file was how to file as a ‘delinquent’ who was not in the system yet. It turned out I couldn’t just start sending in tax returns from the current year – I would have to ‘back-file’ a number of years or risk the IRS punishing me for earlier non-filing (which, according to forums and tax advisers’ websites, they had been known to do).
So, perhaps I should just send in filings covering the last few years and then keep filing each year going forward. That surely wouldn’t be too difficult. Except that the IRS refers to this approach as “quiet disclosure” and discourages it strongly. They want non-compliant overseas filers to formally announce their non-compliant status when they file for the first time by entering one of two main programs: the ‘streamlined’ procedure (file three years of federal returns and schedules, five years of bank account reporting, and an explanation of why your non-filing was non ‘wilful’) or the Overseas Voluntary Disclosure Program (8 years of tax returns and FBARs, plus any taxes due, interest charged on the taxes that weren’t paid before, a 20% penalty on whatever was owed, and often a 27.5%, or in some cases 50%, penalty on the highest offshore account balance). Streamlined clearly looked better from a financial perspective, but then one has no assurance that the IRS will agree that the non-filing was ‘non-wilful’ (so they could decide to prosecute you), whereas the OVDP is meant to protect you from any chance of prosecution (in exchange for inordinate amounts of money and by the looks of it, whatever sanity you had left).
Trying to come into compliance means exposure to the risk of penalties
So, the ‘rational’ choice to enter the system and start filing turned out to to have a lot of risk attached to it – the risk of being fined for making mistakes on complex forms that I have never filled in before, the risk of not filing all the forms and schedules I am supposed to, the risk of being fined because the IRS might decide that I wasn’t reporting my bank accounts on purpose, the risk that I couldn’t continue to invest optimally for my future, because once I was in compliance I would no longer have the excuse of ignorance to keep saving into my UK mutual funds without encountering ‘PFIC’ filing.
I probably would have been content to kick the can down the road and ignore the situation for a while, but then I learned about FATCA. FATCA (the Foreign Account Tax Compliance Act) was pushed through by the Obama administration. It is a law which requires Foreign Financial Institutions (i.e. banks and other institutions operating outside of the US) to report to the IRS the accounts of their American customers, or face a 30 percent withholding penalty on their transactions in American financial markets. Naturally, being cut off from US markets would be like telling the US to pull the trigger on the gun pointed at their head for many international financial firms, so they have all signed up and agreed to share the information, and/or decided to dump their American customers for being too much compliance hassle (especially smaller customers).
Suddenly, I feared that my banks in the UK might already know that I was a US citizen (I opened the accounts a long time ago and do not recall whether they asked me about my dual citizen status). Even if they didn’t know, it could be a matter of time before they ask me to confirm or deny it. I read about others in Europe receiving letters asking for legal proof that they are not American, or saying that the account will be closed because they are American.
What would I do if my banks asked me if I’m American? Lie to them? Pretend that I’m not American for the rest of my life and hope that the rules change? Tell the truth and potentially have my accounts closed, or have my details passed to the IRS before I’ve decided what to do? All of this heightened my paranoia that it was only a matter of time before the IRS was coming to ‘get me’. I didn’t yet have enough money saved up that I would reach the FATCA reporting requirement of $50,000, but after some years of saving money I would, so it didn’t make sense to ignore the situation.
Move to the US to escape the nightmare?
At this point the rational onlooker, racking their brain, often asks, “why don’t you just go back to the USA if it’s so complicated to live outside?” Of all the potential options available to me for dealing with this situation, this the very last thing I would do. Why should I be forced by bad policies to leave my home in Europe and come to live in the US when I am doing absolutely nothing wrong? It’s a human right to be able to freely leave and return to one’s own country (see Article 13 of the Universal Declaration of Human Rights). Surely it is an obvious corollary right to be able to leave and NOT return to one’s country.
Damned if I did, and if I didn’t
So, to recap, the options so far were (in no particular order):
1) Enter the system with specialist professional help, incurring professional expenses and risking penalties for previous non-filing and for mistakes or omissions the preparer might reasonably make;
2) Enter the system without professional help and face a bigger risk of penalties for omissions, mistakes, and penalties for previous non-filing;
3) Do nothing, and risk getting found out later on and having to incur even bigger expenses and penalties than in options (1) and (2);
3.a) Lie to my banks if they ask me if I’m American, risking whatever punishment that would entail under UK law;
3.b) Freely admit to my bank that I’m American if they ask, and risk having my account shut and/or being highlighted to the IRS without my knowledge by my own bank and the UK government;
Renunciation: the nuclear option
There was, and is, one final, nuclear option – to legally renounce my US citizenship. This would mean shedding my US passport and right to return to the country forever. If I had never lived in the US, or was sure I never wanted to live there, this option would make the most sense.
However, I’m not a so-called “accidental American”. I do have an emotional attachment to the US through my family and childhood experiences. As I described in my first post, I have spent my life considering myself to be as American as I am English, and I hate the thought of telling my father and relatives that I am not a US citizen anymore. My citizenship belongs to me as a birth right and I feel that it is wrong on a very deep level that anyone would be forced by tax policy to consider giving up their citizenship to live a free and normal life.
That said, even if I decided that the situation was totally unworkable in the long run and renunciation was the least bad option, it would not be an easy task. I would still have to enter the tax system and be able to prove five years of compliance (thus exposing myself to the penalty risks and expenses). I would then have to pay $2350 to complete the renunciation process, which is almost one month of the average gross salary in the UK, and a price much higher than any other country’s renunciation fee.
All this, and for what?
In the period after the initial “oh my god” moment I felt seriously paranoid, scared and confused about what I should do. The whole concept of citizenship-based taxation was so bizarre to me, and its enforcement rules so disproportionate, that trying to come to terms with it all could be best described as disorienting. ‘Surely this is all just a big misunderstanding,’ I often thought, ‘or a bad dream!’
I didn’t even speak to anyone outside my immediate family about the situation until after I decided to become compliant (a decision I will explain in my next post), because I was worried that people might think I was somehow to blame.
It is bad enough that innocent Americans (dual or otherwise) overseas are discovering these rules by accident, but it is shocking that when looking to understand and make things right, we are faced with such an abysmal and often terrifying set of choices that the dramatic and irrevocable act of giving up our citizenship is on the shortlist of options for dealing with it – and often seems to be the only real option to live freely and normally once more.
Why does the US government want to make our lives so difficult when we have done nothing wrong? Why are they burdening us to continually prove that we are innocent, and invading our privacy using third parties and foreign governments to make sure that we’re telling the IRS the truth? Why are they terrorizing us with threats of bankrupting penalties, incarceration and (very recently) passport revocation? What exactly are they hoping to achieve, when the vast majority of us do not even make enough money to owe taxes to the US?
Can they talk about the ‘land of the free’, or being ‘leaders of the free world’ with a straight face anymore?
 The reports are known as FBARs, and all Americans overseas have to file them for each of their local accounts annually if the overall balance is $10,000 or higher at any time in the year