Under RBT, Americans abroad would be taxed under the same rules currently applied to non-resident aliens.
Americans abroad with a Departure Certificate under RBT (referred to hereafter as non-resident Americans) would not be subject to U.S. income tax on their foreign source income.
Non-resident Americans with U.S. source investment income, Social Security income, pension income, rents and royalties would be subject to U.S. withholding tax.
Non-resident Americans who have ECI connected to U.S. trade or business would be required to file the 1040NR.
Non-resident Americans would no longer be subject to the FBAR and FATCA regimes.
Non-resident Americans would not contribute to U.S. Social Security.
Non-resident Americans must limit their presence in the United States to maintain their nonresident status. The substantial presence test of Section 7701(b) of the tax code currently applicable to non-resident aliens will also apply to Americans abroad with a Departure Certificate. The substantial presence test allows for a maximum of 182 days in the U.S., for any one year, and for a maximum average of 121 days a year over a three year period.
The estate of a deceased non-resident American would be subject to U.S. estate tax law
applicable to all non-residents, if the individual had been abroad for at least two years at the
time of death. If overseas residence is less than two years prior to death, U.S. estate taxes
An American establishing residence abroad subsequent to RBT becoming effective must:
- file an application for the Departure Certificate with the IRS;
- provide proof of foreign residence ;
- provide proof of residence in a foreign tax home;
- pay any U.S. income taxes due up to the date of establishment of overseas residence;
- pay a Departure Tax, if applicable.
The IRS will send the American abroad meeting the above conditions a Departure Certificate identifying the U.S. citizen or former green card holder as a non-resident American, no longer subject to U.S. income taxation applicable to U.S. residents. An American with a Departure Certificate would thus be treated by foreign financial institutions as a "Non-US Person" and consequently not be subject to the FATCA reporting requirements and SEC regulations.
- Clear rules must specify the period within which the IRS must deliver the Departure Certificate.
- No renewal or further notification would be required, as long as the non-resident American remains in the same country; if the individual moves to another country, he or she would be required to inform the IRS of the new address overseas.
- Filing a U.S. resident tax return when a U.S. citizen moves back to the U.S. automatically makes the Departure Certificate expire.
- Filing for RBT should be able to be done retroactively; just because someone does not meet a specific deadline, should not force transition years to automatically be treated as full tax years.
- Children resident abroad with U.S. passports apply for a Departure Certificate when they reach the age of 18 and are still resident abroad. Up to the age of 18, they are covered by their parents’ Departure Certificate(s).
American diplomatic personnel, government employees stationed overseas as well as members of the U.S. armed forces stationed abroad would be deemed U.S. residents and would be subject to U.S. taxation on their worldwide income.
Congress may determine that Americans with specific kinds of temporary overseas mandates of less than two years be deemed U.S. tax residents and subject to taxation on their worldwide income under the current Section 901 foreign tax credit rules and Section 911 foreign earned income exclusion rules.
Americans residing in countries deemed by the IRS to be tax havens would continue to be treated as U.S. tax residents. The law would grant the IRS the authority to designate certain countries as tax havens. The list of countries so designated should include only countries where the tax laws have been designed to attract rich foreigners with fiscal privileges. Low tax countries, such as countries in the Persian Gulf, where excise taxes on oil or minerals substitute for income taxes, are not prima facie tax havens, nor are countries where very high indirect taxes such as the VAT or high social security taxes or payroll taxes lead to low income tax rates. Absence of a U.S. tax treaty with a foreign country should not be, a priori, a criteria for labelling a country a tax haven. Classification of countries as tax havens should be the rare exception.
Americans abroad who return to the United States to reside would again be automatically subject to the ordinary tax rules for U.S. residents; their Departure Certificate would automatically expire. However, the market value of all assets, except U.S. real estate, U.S. based pension funds and possibly U.S. based family company shares, held on the date of taking up U.S. residence would become the cost basis for future capital gains determination. Foreign pension funds owned at the time of taking up U.S. residence would be automatically considered “tax qualified” by the IRS and would not be subject to PFIC rules. U.S. real estate and U.S. based pension funds would retain their original cost basis.
RBT will simplify not only the U.S. tax code but also IRS administration in implementing the law. It will lead to automatic compliance through the withholding taxes on U.S. source income.
The Departure Tax is a mark-to-market tax, based on the unrealized capital gains on the value of assets on the date of Departure. The tax is due, however, only if certain thresholds of assets or income tax paid in recent years are met. It is a capital gains tax on unrealized capital gains on all investments, with the exception, for reasons stated below, of U.S. real estate, primary residence abroad and U.S.-based and foreign-based retirement plans or pension funds.
The Departure date for Americans who are already resident abroad when RBT becomes effective will be the date that they file for the Departure Certificate.
The Departure Tax should not impair the mobility of average income American citizens in the world. The Departure Tax should not be applicable to Americans born with dual nationality and who return to the country of their other nationality, nor to Americans who were born of foreign parents in the United States and left as child with their parents, nor to Americans whose parents are both American but who have lived essentially all their lives overseas.
To transition fairly to RBT, Americans who have established residence abroad two years or more prior to the RBT law becoming effective and who have been compliant in their U.S. tax filing prior to the new RBT law would not be subject to the Departure Tax.
The Departure Tax should be viewed as an anti-abuse measure aimed at wealthy individuals who might consider leaving the U.S. for tax reasons.
The Departure Tax is applicable if both of the following two thresholds are met:
- total assets exceed $5 million, excluding U.S. real estate, foreign residence and U.S-based and foreign-based pension funds and retirement savings accounts, or average income tax over the last five years exceeds $190,000, indexed to inflation, and
- unrealized capital gains on foreign assets exceed $650,000, indexed to inflation.
These thresholds are modelled on Section 877A which applies to individuals renouncing U.S. citizenship or green card status. However, the Departure Procedure will be a separate section of the law and the thresholds are more favourable for those applying for a Departure Certificate. It is important to encourage individuals to maintain their citizenship with RBT rather than to renounce their citizenship. Certain punitive provisions of the law applicable to individuals who renounce U.S. citizenship under Section 877A will not apply in any way whatsoever to Americans and green card holders who leave the United States with a Departure Certificate under RBT. They retain their full rights of citizenship.
With the new Departure Procedure in place, Section 877A may most likely no longer be necessary and can possibly be repealed. Handling citizenship renunciation is the purview of the State Department, not the IRS. In fact, with the Departure Procedure in place, the number of renunciations of U.S. citizenship is likely to decline sharply.
As an anti-abuse measure in the Departure Procedure, an exception to the mark-to-market procedure will provide for securities meeting specific criteria to remain subject to the ordinary rules of capital gains taxation for a period of two years starting with the date on the Departure Certificate. This exception will apply to all securities linked to prior employment in the United States, including stocks, stock options, phantom shares, incentive shares, founders shares issued in new ventures, etc. Mark-to-market will take place, as provided in the normal rules, on the second anniversary of the Departure Certificate, except for the securities which have been disposed of during said two-year period and have been taxed under the ordinary capital gains tax rules.
U.S. real estate and U.S. pension funds and retirement savings accounts are excluded from assets subject to mark-to-market tax rules upon departure because U.S. source income continues to be subject to U.S. taxation. U.S. real estate property remains subject to local real estate taxes, withholding tax on rent and capital gains tax whenever the property is sold, in accordance with general international tax practice and U.S. federal and state tax policy. Since Americans resident abroad will be taxed like nonresident aliens, they are subject, under FIRPTA (Foreign Investment in Real Property Tax Act), to 10% withholding on the gross proceeds (which may be reduced under applicable procedures) at the time of the sale to ensure compliance with any capital gains tax.
U.S. pension funds are also excluded from the assets subject to the Departure Tax because the income flow will be subject to U.S. tax when they convert to a revenue stream upon retirement. Furthermore, they cannot be realized at the time of Departure.
There is also good reason to temporarily exempt shares in closely held family businesses from the Departure Tax until the time those shares are sold. If such a business sends a manager/family member overseas for several years to grow a business and they are bona fide overseas residents under RBT, the Departure Tax would put handcuffs on expanding U.S. family businesses worldwide by forcing a tax on hard to value and illiquid shares. The manager/family members sent overseas could choose between paying the Departure Tax immediately or reporting such holdings when they leave the U.S. and the shares would remain subject to US capital gains tax when sold.
Foreign pension funds and retirement savings accounts as well as a foreign residence are excluded from assets subject to the Departure Tax because they cannot be realized at the time of Departure. Furthermore, for Americans who have resided overseas many years, foreign pensions and retirement savings accounts and investment in a home represent a life-time savings; when they moved overseas, their assets were significantly less. Excessive taxation of savings of citizens who have resided most of their adult life abroad would be unfair. Americans who have resided overseas more than two years and who are compliant with their U.S. tax filing obligations are fully exempted from any Departure Tax.
Estate taxes for deceased non-resident Americans under RBT
Americans who have a Departure Certificate and who die overseas will be subject to the rules presently applicable to deceased non-resident aliens owning U.S. assets under Code Section 2012 (b)(1), provided that overseas residence was established more than two years prior to death. These rules provide for all U.S. situs assets, including real estate, securities, trusts, partnerships, etc., that exceed $60,000 to be subject to U.S. estate taxes. Estate taxes paid in the country of residence of the deceased on account of U.S. assets would continue to be creditable against U.S estate taxes.
The estate and gift tax exclusion for non-resident aliens was set at $60,000 by the Miscellaneous Revenue Act of 1988. The exclusion is absurdly low when compared to the $5 million exclusion for estates of U.S. persons reconfirmed by Congress in December 2012. The $60,000 limit should be substantially increased to reflect the current estate exclusion of U.S. residents, particularly since Code Section 2012 (b)(1) will apply to both foreigners and U.S. citizens residing abroad with a Departure Certificate.
The ACA proposal includes seven measures designed to prevent abuses of RBT, in general, and more specifically to prevent high net worth individuals from taking up residence abroad for the sole purpose of reducing their U.S. taxes:
The Departure Procedure would require proof that, at the time of applying for the IRS Departure Certificate, the American citizen is considered a resident of a foreign country and is subject to taxation in that country, on the same basis as non-U.S. citizens who are residents of that country.
The Departure Procedure would require proof that all income taxes due up to the date of Departure have been paid and that the Departure Tax, if applicable, is paid. The American citizen would file a final tax form with the IRS, namely Form 1040 up to the date of establishment of overseas residence, using the same dual-status taxation procedures that apply to foreign taxpayers.
Americans who have resided abroad less than two years prior to the RBT law becoming effective and who have assets or U.S. income tax liability exceeding the thresholds mentioned above would be subject to a Departure Tax, even if they had been compliant in their U.S. tax filing. The date of departure for Americans already resident abroad when the law is passed is the date that they file for the Departure Certificate.
The sale of securities linked to prior employment in the United States would be subject to ordinary U.S. capital gains taxation for a period of two years following the date of departure; mark-to-market would take place on the second anniversary of the departure for securities which have not been disposed of during the two-year period.
Estates of individuals who lived overseas and established foreign residence less than two years before death would continue to be subject to the U.S. estate tax. Estates of individuals who resided more than two years overseas prior to death would be taxed the way non-resident aliens are taxed, on the condition that the exemption is increased far above the current $60,000 level to reflect the exclusion allowed for U.S. residents.
The Treasury would designate certain countries tax havens; Americans residing in those countries would be treated as U.S. residents and remain subject to U.S. income taxes. As stated above, an American with a Departure Certificate who moves from one country to another must report the change of residence to the IRS. If this move is to a country deemed to be a tax haven, the Departure Certificate is no longer valid and the individual is taxed henceforth as a U.S. resident.
Congress may determine that Americans with specific short-term overseas employment contracts of less than two years remain subject to U.S. taxes as though they were U.S. residents.