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This complete review and historical summary of US taxation of overseas Americans was prepared by the late Andy Sundberg, ACA founder, in 2011.


A Brief History

1787 ON SEPTEMBER 17, 1787, THE CONSTITUTION OF THE UNITED STATES IS ADOPTED by a convention of States. Provisions in the Constitution related to taxes are contained among other subjects in the following:

Article 1, Section 7: “All Bills for raising Revenue shall originate in the House of Representatives; but the Senate may propose or concur with Amendments as on other Bills.”

Article 1, Section 8: “The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Exercises, to pay the Debts and provide for the common Defense and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States.”

Article 1, Section 9: “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.”

1788 BY JUNE 21, 1788 a sufficient number of states ratify the Constitution and it becomes effective.

1813 THE REVENUE ACT OF 1813 contains provisions for taxes when and as needed.

1861 CONGRESS ENACTS THE REVENUE ACT OF 1861 to pay for what is anticipated to be a short civil war. For the first time an income tax is levied at the Federal level in the United States. The rate of imposition is 3% on all incomes higher than $800 per year. (Revenue Act of 1861).

1862CONGRESS ENACTS A NEW REVENUE ACT introducing for the first time a progressive tax feature. Personal income tax is 3% for income between $800 and $10,000 while higher incomes are to be taxed at a rate of 5%. A standard deduction of $600 is introduced, along with other deductions. Income tax is to be withheld at source by the employer. (Revenue Act of 1862).

On July 1, 1862 Congress creates the Office of Commissioner of Internal Revenue.

1864 CONGRESS APPROVES TWO NEW LAWS that increase tax rates and expand the progressivity of income taxation. Despite protests by certain legislators regarding the unfairness of graduated rates, the 1884 act affirms this method of taxing income according to “ability to pay.”

1872 CONGRESS ALLOWS THE CIVIL WAR INCOME TAX TO EXPIRE, bringing an end to the first national tax for the population on a progressive basis. (Revenue Act of 1872).

1881 IN “SPRINGER V. U.S.”, THE SUPREME COURT REJECTS THE CLAIM that the Income Tax of 1864 was unconstitutional. Springer, the plaintiff, argues that the income tax was direct and thus subject to apportionment among the states... The Court, however, concludes unanimously that direct taxes encompassed only real estate or slaves. The Court holds that income tax “fell within the category of an excise or duty.” The Court defers to Congress in determining the scope of the power to tax...

1894 CONGRESS REINTRODUCES IN INCOME TAX. It is a modest provision assessing a rate of 2% for incomes over $4,000- (Wilson-Gorman Tariff Act of 1894).

1895 THE SUPREME COURT IN “POLLOCK V. FARM LOAN AND TRUST CO.” HOLDS that the income tax is unconstitutional since it is not apportioned according to the population in each state.

1909 PRESIDENT WILLIAM HOWARD TAFT, AS PART OF HIS 1909 TAX COMPROMISE, agrees to support a constitutional amendment authorizing federal income taxes. Not only would such an amendment settle constitutional questions once and for all, but it would also delay substantive action on the income tax, at least until ratification would be completed. Since ratification was far from certain, the amendment attempt might defuse the income tax issue indefinitely, allowing it to simply fade away. In making his case for the amendment to wary Republican legislators, Taft stresses the importance of avoiding another confrontation with the Supreme Court. Such a fight, he argues, will diminish public confidence in the Court and threaten one of the pillars of American government.

ONE OF THE STRONGEST OPPONENTS OF THE 16TH AMENDMENT, RICHARD E. BYRD, speaker of the Virginia House of Delegates makes an impassioned plea to reject it. He says:

“A hand from Washington will be stretched out and placed upon every man’s business; the eye of the Federal inspector will be in every man’s counting house… The law will of necessity have inquisitorial features, it will provide penalties, it will create complicated machinery. Under it men will be hailed into courts distant from their homes. Heavy fines imposed by distant and unfamiliar tribunals will constantly menace the tax payer. An army of Federal inspectors, spies and detectives will descend upon the state…Who of us who have had knowledge of the doings of the Federal officials in the Internal Revenue service can be blind to what will follow? I do not hesitate to say that the adoption of this amendment will be such a surrender to imperialism that has not been seen since the Northern states in their blindness forced the fourteenth and fifteenth amendments upon the entire sisterhood of the Commonwealth.”

1913ON FEBRUARY 3, 1913, THE 36TH STATE RATIFIES THE SIXTEENTH AMENDMENT to the Constitution, modifying Article 1, Section 9, and rendering constitutional the establishment of an income tax. The text of this amendment is:

“The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

ON OCTOBER 3, 1913, A NEW INCOME TAX LAW IS SIGNED BY PRESIDENT WILSON requiring taxes to be paid on all "lawful" income. Less than 1% of the population is required to pay income taxes. (Revenue Act of 1913).

1914 FIRST INCOME TAX RETURNS FILED ON FORM 1040. There are 357,515 taxpayers paying a total tax of $28 million. Average tax per capita of all U.S. inhabitants is twenty-eight cents.

1916 CONGRESS AMENDS THE LAW to remove the ambiguous question of what taxing "lawful" income means, and substitutes instead "from whatever source derived". In the new law, all income is taxable even if it is earned by illegal means. This new language also becomes the basis on which the taxation of overseas source income is justified. (Revenue Act of 1916).

1917 BECAUSE OF THE EXPENSE OF WORLD WAR I, THE FEDERAL BUDGET is almost equal to the total U.S. budget for all the years between 1791 and 1916. Congress enacts new tax provisions to lower exemptions and increase taxes. Amount of tax to be collected increases fourfold from $809 million in 1917 to $3.6 billion in 1918. (War Revenue Act of 1917).

1918 EFFORTS ARE MADE IN THE HOUSE OF REPRESENTATIVES TO EXEMPT FOREIGN SOURCE INCOME from the U.S. taxation because of alleged competitive disadvantages suffered by American corporations operating branches abroad. (Hearings Before the House Committee on Ways and Means on the Revenue Act of 1918, 65th Congress, 2nd Session 648 (1918)).

A NEW REVENUE ACT IS PASSED increasing taxes on incomes in excess of $1 million per year to a rate of 77%. The new act also introduces estate taxes and excess profits taxes. Still only 5% of the population has to pay income taxes. Americans working abroad are allowed to reduce their federal income tax liability with a tax credit equal to the amount of any foreign income taxes paid. Until 1918, all foreign taxes were treated as deductible expenses in the same manner as state and local taxes. (Revenue Act of 1918).

1921 CONGRESS ENACTS A NEW TAX LAW which is held to also apply to overseas Americans. Treasury Regulation No. 62 is issued applying the tax to overseas Americans under Article 3 of the Act, codified in Treasury Regulations, Section 1.1-l(b), T.D. 7332, 1975-1 C.B. 205,207. (Revenue Act of 1921).

A DETERMINED EFFORT IS MADE TO EXEMPT FOREIGN INCOME from U.S. tax in the case of U.S. Corporations that derive 80% of their income from foreign sources. The Treasury, Commerce and State Departments favor the exemption, but it runs into determined opposition in the Congress. The provision finally passes in the House, but is defeated in the Senate. (61 Congressional Record 7023, 7026 (1921)).

CONGRESS AMENDS THE TAX LAW to provide for an exemption for corporate income earned in a U.S. possession but not remitted to the United States. (Revenue Act of 1921, Chapter 262, 42 Stat. 271 (1921)).


"The principle was declared that the government, by its very nature, benefits the citizen and his property wherever found and, therefore, has the power to make the benefit complete. Or to express it another way, the basis of the power to tax was not and cannot be made dependent upon the situs of the property in all cases, if being in or out of the United States, and was not and cannot be made dependent upon the domicile of the citizen, that being in or out of the United States, but upon his relation as citizen to the United States and the relation of the latter to him as citizen. The consequence of the relations is that the native citizen who is taxed may have domicile, and the property from which his income is derived may have situs, in a foreign country and the tax be legal - the government having power to impose the tax." (Cook v. Tait, 265 U.S. 47(1924)).

1926 AFTER EXPRESSIONS OF GREAT CONCERN IN THE CONGRESS ABOUT THE COMPETITIVE HANDICAP CAUSED TO U.S. CITIZENS and U.S. corporations abroad, legislation is enacted giving full exclusion of overseas income from U.S. taxation if an American citizen is absent from the United States more than six months in any calendar year. (Revenue Act of 1926, Chapter 27, Section 213(b)(14), 44 Stat. 9 (1926).

1932 FEDERAL INCOME TAXES WERE CUT FIVE TIMES IN THE 1920'S, but the onset of the depression creates a need for new revenues. In 1932, only $1.5 billion is collected compared to $5.5 billion in 1920.

CONGRESS ENACTS A NEW TAX LAW raising tax rates and lowering exemption levels. The foreign earned income exclusion is taken away from the gross income definition section and becomes codified in I.R.C. Section 116, Exclusion from Gross Income. The law expands the applicability of the foreign earned income exclusion by permitting profit derived from a trade or business into which both personal services and capital have been injected to be considered 20% income and eligible for exclusion. (The Revenue Act of 1932, Chapter 209, Section 116(a), 47 Stat. 169, 204-05).

1933 INTERNAL REVENUE COLLECTIONS amount to $1.6 billion.

1934 CONGRESS NARROWS THE APPLICABILITY OF THE FOREIGN EARNED INCOME EXCLUSION by denying use of the exclusion for income paid by the United States or any federal agency. State Department employees overseas and other Federal employees on assignment abroad lose their tax exemptions. (The Revenue Act of 1934, Chapter 277, Section 116(a), 48 Stat. 680, 712). (See also Senate Rep. No. 665, 72nd Congress, 1st Sess. 31 (1932)).

1936 CONGRESS ENACTS A NEW TAX LAW but retains the codified language of the 1934 Act. (Revenue Act of 1934, Ch. 277, Section 116(a), 49 Stat. 1648, 1689 (1936)).

1938 CONGRESS ENACTS ANOTHER NEW TAX law but retains the codified language of the 1934 act. (Revenue Act of 1938, Chapter 289, Section 116(a), 52 Stat. 447, 498 (1938)).

1939 THE TOTAL NUMBER OF U.S. TAXPAYERS IS AROUND 4 MILLION. U.S. tax laws are first codified as an integral part of the U.S. Code – the Internal Revenue Code of 1939 (IRC 1939).

1941 THE 1941 REVENUE ACT lowers exemptions and increases taxes on excess profits being made on the war effort. Internal revenue collection increases to $7.4 billion. (The Revenue Act of 1941).

1942 CONGRESS TIGHTENS THE ELIGIBILITY FOR EXCLUSION OF OVERSEAS INCOME from the “6 months away from home” rule to a "bona fide" residence rule for an entire tax year. (Revenue Act of 1942, Chapter 619, Section 148, 56 Stat. 798, 841-2 (1942)).

1945 INTERNAL REVENUE COLLECTS $45 BILLION from 43 million taxpayers.

1951 A NEW TAX LAW IS WRITTEN AND CONGRESS REINTRODUCES A "PHYSICAL PRESENCE" RULE on the basis of absence from the United States for 17 out of 18 months, and maintains the "bona fide" foreign residence alternative. (Senate Report No. 781, 82nd Congress, 1st Session 52-53 (1951).) (Revenue Act of 1951, chapter 521, Section 321, 65 Stat 452, 498 (1951)).

1953 CONGRESS ATTEMPTS TO DO AWAY WITH THE "PHYSICAL PRESENCE" EXCLUSION AGAIN, but settles for a $20,000 exclusion for 17 out of 18 month "physical presence" overseas Americans. Total exclusion for the bona fide foreign resident is unchanged. (Technical Changes Act of 1953, PL 83-287, Chapter 204, 67 Stat. 615(1953)).

1954 CONGRESS REVISES AND ORGANIZES ALL TAX LAWS into a single new Internal Revenue Code (IRC 1954). Tax laws enacted in the future will be amendments to the code. (Tax Act of 1954).

1962 CONGRESS ELIMINATES OF THE TOTAL EXCLUSION FOR A "BONA FIDE" FOREIGN RESIDENT. A $20,000 per year overseas earned income exclusion is established, rising to $35,000 after three years abroad. Tax credit is given for taxes paid abroad on excluded income. The Act also introduces separate rules for "unearned income" abroad, and Subpart F rules for “controlled foreign corporations.” (Revenue Act of 1962, PL 87-834, Chapter 11, 76 Stat. 960 (1962)). (See Conference Report No. 2508 of 1 October 1962).

1963 THE OECD MODEL TAX CONVENTION, first published in 1963, and regularly updated since then, is the basic reference manual used by both OECD and non-OECD countries for the negotiation, application and interpretation of bilateral tax treaties coordinating their direct tax systems.

1964 CONGRESS ENACTS NEW LEGISLATION reducing the exclusion for physical presence and bona fide residents to $20,000, rising to $25,000 after three years abroad. Feb. 26, 1964, Pub. L. 88-272, title II, Sec. 237(a), 78 Stat. 128.

1966 CONGRESS ADOPTS MORE TECHNICAL CORRECTIONS. (Nov. 13, 1966, Pub. L. 89-809, title I, Sec. 105(e)(3), 80 Stat. 1567. Subsec. (d). Pub. L. 89-809 designated existing text as par. (1) and added par. (2)).

1969 CONGRESS ENACTS A NEW TAX law lowering income tax rates for both individuals and private foundations. (Tax Reform Act of 1969).

1970 CONGRESS ENACTS THE BANK SECRECY ACT (or BSA, or otherwise known as the Currency and Foreign Transactions Reporting Act) which requires American financial institutions to assist U.S. government agencies to detect and prevent money laundering. Specifically, the act requires financial institutions to keep records of cash purchases of negotiable instruments and file reports of cash purchases of these negotiable instruments of $3,000 or more (daily aggregate amount), and to report suspicious activity that might signify money laundering, tax evasion, or other criminal activities. (Bank Secrecy Act of 1970).

THE BSA REGULATIONS NOW REQUIRE ALL FINANCIAL INSTITUTIONS to submit five types of reports to the government. (not an exhaustive list of reports)
FinCen Form 104 Currency Transaction Reports (CTR): must be filed for each deposit, withdrawal, exchange of currency, or other payment or transfer, by, through or to a financial institution, which involves a transaction in currency of more than $10,000. Multiple currency transactions must be treated as a single transaction if the financial institution has knowledge that: (a) they are conducted by or on behalf of the same person; and, (b) they result in cash received or disbursed by the financial institution of more than $10,000. (31 CFR 103.22)
FinCEN Form 105 Report of International Transportation of Currency or Monetary Instruments (CMIR): Each person (including a bank) who physically transports, mails or ships, or causes to be physically transported, mailed, shipped or received, currency, traveler’s checks, and certain other monetary instruments in an aggregate amount exceeding $10,000 into or out of the United States must file a CMIR
Department of the Treasury Form 90-22.1 Report of Foreign Bank and Financial Accounts (FBAR): Each person (including a bank) subject to the jurisdiction of the United States having an interest in, signature or other authority over, one or more bank, securities, or other financial accounts in a foreign country must file an FBAR if the aggregate value of such accounts at any point in a calendar year exceeds $5,000. (31 CFR 103.24)
Treasury Department Form 90-22.47 and OCC Form 8010-9, 8010-1 Suspicious Activity Report (SAR): Banks must file a SAR for any suspicious transaction relevant to a possible violation of law or regulation. (31 CFR 103.18 − formerly 31 CFR 103.21) (12 CFR 12.11)
"Designation of Exempt Person" FinCEN Form 110: Banks must file this form to designate an exempt customer for the purpose of CTR reporting under the BSA (31 CFR 103.22(d)(3)(i)). In addition, banks use this form biennially (every two years) to renew exemptions for eligible non-listed business and payroll customers. (31 CFR 103.22(d)(5)(i))
The BSA also requires any business receiving one or more related cash payments totaling $5,000 or more to file form 8300.

1974 THE HOUSE WAYS AND MEANS COMMITTEE TRIES TO ABOLISH the foreign earned income exclusion. (H.R. 17488, 93rd Congress, 2nd Session, Section 311(1974)).

1975 THE HOUSE CONTINUES CONSIDERATION OF ABOLISHING the foreign earned income exclusion. (H.R. 10612, 94th Congress, 1st Session, Section 1011(1975)).

1976 THE SENATE RESISTS THE ABOLITION of the foreign earned income exclusion, but accepts that the exclusion should be modified to "prevent abuse". (Senate Report No. 938, 94th Congress, 2nd Session 210 (1976)).

THE TREASURY DEPARTMENT MAKES A STUDY OF TAX RETURNS of 1968 and estimates that the revenue gain from enactment of total elimination of the foreign earned income exclusion would be $60 million. Enactment of the proposed 1976 Tax Reform Act is estimated to yield a gain of only about $40 million.

THE CONFERENCE COMMITTEE REPORT ON THE TAX REFORM ACT of 1976 indicates an anticipated revenue gain of $44 million in 1977 and $38 million annually thereafter as a result of the amendments of section 911. When spread over an estimated 102,000 tax returns from abroad, the projected additional tax burden would amount to less than $500 per return. (H.R. Rep. No. 1515, 94th Congress, 2nd Session. 632 (1976)).

CONGRESS DECIDES TO AMEND THE TAX LAW so that the overseas earned income exclusion will be reduced to $15,000 (off the bottom). No tax credit will be given for taxes paid abroad on excluded income, and there will be no exclusion for income received outside of the foreign country in which earned if one of the purposes is to avoid local income tax abroad. (Tax Reform Act of 1976, Publ L. No. 94-455, 90 Stat. 1520 (1976)).

THE TAX COURT HOLDS IN “MCDONALD V. COMMISSIONER” that the market value of a Japanese apartment provided by an employer to a taxpayer was not excludable from the employee's income by reason of section 119 of the Tax Code. The court determined that the leasehold arrangement was primarily for the convenience of the employee, that occasional business use of the apartment did not make the lodging eligible as "business premises of the employer", and that acceptance of the lodging was not a "condition of employment" because it was not integrally related to the various facets of the employee's position. In addition, the court ruled that the value of the accommodations to the employee was the rental value (i.e. the local market value in Japan) of the apartment as negotiated by the employer and the Japanese landlord, rather than the price the employee would expect to pay for a similar apartment in the United States. (66 T.C. 223 (1976)).

THE TAX COURT RULES IN A SECOND JAPANESE HOUSING CASE, “STEPHENS V. COMMISSIONER”, that the housing supplied by an employer to an employee was includable in the employee's gross income at its full local value, despite a specific finding that "quarters reasonably equivalent to (the taxpayer's) style of living were not available at American prices". (66 T.C. 226, (1976)).

CONGRESS ATTEMPTS TO EXEMPT ITSELF FROM DOUBLE TAXATION: In the summer of 1976, legislation to exempt Members of Congress from double taxation by a state other than the one from which Members are elected is adopted by large majorities of both Houses, but President Ford then promptly vetoes it and it dies.

1977 CONGRESS, FOLLOWING VOLUMINOUS COMPLAINTS FROM OVERSEAS AMERICANS and their employers about the impact of the 1976 Tax Reform Act, postpones the effective date from January, 1976 to 1 January, 1977. (Tax Reduction and Simplification Act of 1977, PL 95-30, Section 302, 91 Stat. 126 (1977)).

TREASURY SECRETARY WILLIAM SIMON, as he is leaving office, calls for consideration of using the residence principle for taxing international flows of income. ("Blueprint for Basic Tax Reform", Department of the Treasury, Washington, D.C., January 17, 1977, Chapter on International Considerations).

THE TREASURY DEPARTMENT CARRIES OUT A COMPREHENSIVE STUDY of the 1975 tax returns filed by overseas Americans and finds that the tax impacts of the Tax Reform Act changes were far greater than the Treasury or the Members of Congress had anticipated. Based on the study of the 1975 data, the Treasury determines that the revenue gain from the Tax Reform Act amendments amounted to $381 million in 1977, rather than the $44 million that Treasury had estimated based upon its previous study in 1976 using 1968 tax return data. Further, the 1976 Tax Court decisions increased the burden on overseas taxpayers by an additional $65 million in 1976, yielding a total increase of $383 million over 1975 reporting practice, or an average $2,700 per return. (U.S. Department of the Treasury, Taxation of Americans Working Overseas 8 (1978)).

CONGRESS SUCCEEDS IN EXEMPTINGS ITSELF FROM DOUBLE TAXATION: In 1977, the newly seated 95th Congress once again initiates legislation to exempt Members from double taxation by their states of residence, other than the states from which Members were elected, and this time the legislation sails through both Houses in less than three months. The new President, Jimmy Carter, unlike his predecessor, promptly signs this bill on July 19, 1977, and it became the law of the land (Public Law 95-67).

1978 THE GENERAL ACCOUNTING OFFICE COMPLETES A TWO-PART STUDY of the impact of the Tax Reform Act changes. The first part is a non-scientific sampling of 367 firms employing Americans abroad. Eighty-five percent of the company officials surveyed believed that United States exports would decline by more than five percent as a result of the 1976 tax law and Tax Court decisions. The companies most severely affected were those operating in countries where living costs were high or where minimal taxes were imposed on foreigners. In the Middle East and Africa, Japan and Latin America tax increases were on average $4,700 per return.

The second part of the GAO study consisted of an econometric projection of the macro-economic effects of the Tax Reform Act changes and the 1976 Tax Court rulings. The GAO model assumed that there was a high in-elasticity of foreign demand for United States exports, and therefore the net effect of the 1976 changes would actually be an improvement in the U.S. balance of payments.

Because of the critical assumption of in-elasticity of demand for U.S. products, the GAO chooses not to base its recommendations on its own model and rather recommends to the Congress: "Because of the seriousness of the deteriorating United States international economic position, the relatively few policy instruments available for promoting United States exports and commercial competitiveness abroad, and uncertainties about the effectiveness of these, serious consideration should be given to continuing section 911-type incentives of the Internal Revenue Code, at least until more effective policy instruments are identified and implemented." (U.S. General Accounting Office, Doc. No. 78-13, Impact on Trade of Changes in Taxation of U.S. Citizens Employed Overseas (1978)).

THE HOUSE OF REPRESENTATIVES PROPOSES to repeal the 1976 changes in section 911 and reinstate computation of the earned income exclusion under the method in effect prior to the Tax Reform Act of 1976, but to limit the exclusion to persons who lived in countries other than Canada or Western Europe. (H.R. 13488, 95th Congress, 2nd Session (1978)).

THE SENATE APPROVES A PROPOSAL, sponsored by Senator Abraham Ribicoff, which replaces the foreign earned income exclusion with specific deductions for certain excess foreign living costs, including excess foreign housing costs, educational costs, and cost of living. (S. 2115, 95th Congress, 2nd Session (1978)).

THE CARTER ADMINISTRATION INTRODUCES A PROPOSAL similar to the Senate bill, including deductions for excess foreign housing and education costs, and for the travel costs of one trip to the United States every other year, but not including a cost of living deduction. The Administration also proposes special rules for foreign moving expenses and for deferral while abroad of tax on the gain from selling a home. (BNA, Daily Tax Report, Nov. 8, 1977, at G-6)).

CONGRESS VOTES FOR A TOTAL ELIMINATION OF OVERSEAS EARNED INCOME EXCLUSION to be replaced by the specific deductions along the lines of the Ribicoff proposal modified by the addition of several of the features of the Carter Administration's proposal including the deduction for one round trip voyage for a family to the United States (at the lowest cost economy fare) per year. (Foreign Earned Income Act of 1978, PL 95-615, Sections 201-210; 92 Stat. 3097 (1978)).

THE JOINT TAX COMMITTEE STAFF ESTIMATES that the 1978 revenue cost of the Foreign Earned Income Act will be $412 million, compared with $194 million had the 1976 Act provisions applied that year, and $538 million had the law which had been in effect prior to the 1976 Act applied. For the overseas American taxpayer, the 1976 Tax Reform Act had added $344 million to taxes in 1978, and the 1978 Tax Act eliminated $116 million. If the pre-1976 Tax Laws would have still been in effect, and had the 1976 Tax Court rulings not been made, overseas Americans would have paid $228 million less than foreseen by the 1978 Tax Law changes. (Staff of Joint Committee on Taxation, 95th Congress, lst Session, General Explanation of the Foreign Earned Income Act of 1978 (Comm. Print 1979)).

THE COURT OF CLAIMS HOLDS IN “ADAMS V. UNITED STATES” that the luxurious residence provided to the president of a Japanese subsidiary of an American oil company was excludable under section 119 of the Tax Code. The court stressed that for over 10 years the taxpayer had been required to live there as a condition of his employment and that certain rooms had been designed in whole or in part for business activities. The court also emphasizes that in Japan business success depends greatly on maintaining high social standing. (585 F. 2nd 1060 (Ct.Cl. 1978), 77-2 USTC Section 9609, 40 AFTR 2nd 5607 (J.Rep.,Ct.Cl 1977)).

THE TAX COURT ALSO REAFFIRMS THE “MCDONALD” DECISION IN “BORNSTEIN V. COMMISSIONER”, another Japanese housing case. The Tax Court denies the exclusion of housing allowances and easily distinguishes this decision from Adams on its facts. (37 TCM 1186, P-H T.C. Memo 78,278 (1978)).

THE TREASURY DEPARTMENT CARRIES OUT A COMPREHENSIVE STUDY of the 1975 tax returns filed by overseas Americans and finds that the tax impacts of the Tax Reform Act changes were far greater than the Treasury or the Members of Congress had anticipated. Based on the study of the 1975 data, the Treasury determines that the revenue gain from the Tax Reform Act amendments amounted to $381 million in 1977, rather than the $44 million that Treasury had estimated based upon its previous study in 1976 using 1968 tax return data. Further, the 1976 Tax Court decisions increased the burden on overseas taxpayers by an additional $65 million in 1976, yielding a total increase of $383 million over 1975 reporting practice, or an average $2,700 per return. (U.S. Department of the Treasury, Taxation of Americans Working Overseas 8 (1978)).

THE CONGRESS ASKS THE PRESIDENT TO PREPARE AND SUBMIT A REPORT on the treatment of U.S. Citizens living and working abroad (Foreign Relations Authorization Act for Fiscal Year 1979, PL 95-426, Section 611,. October 7, 1978) The provision states:

(a)The Congress finds that –

(1)United States citizens living abroad should be provided fair and equitable treatment by the United States Government with regard to taxation, citizenship of progeny, veterans’ benefits, voting rights, Social Security benefits, and other obligations, rights, and benefits; and
(2)Such fair and equitable treatment would be facilitated by a periodic review of the statutes and regulations affecting Americans living abroad.

(b)Not later than January 20, 1979, the President shall transmit to the Speaker of the House of Representatives and the chairman of the Committee on Foreign Relations of the Senate a report which –

(1)identifies all United States statutes and regulations which discriminate against United States citizens living abroad;
(2)evaluates each such discriminatory practice; and
(3)recommends legislation and any other remedial action the President finds appropriate to eliminate unfair or inequitable treatment of Americans living abroad.

THE HOUSE OF REPRESENTATIVES PROPOSES TO REPEAL THE 1976 CHANGES in section 911 and reinstate computation of the earned income exclusion under the method in effect prior to the Tax Reform Act of 1976, but to limit the exclusion to persons who lived in countries other than Canada or Western Europe. (H.R. 13488, 95th Congress, 2nd Session (1978)).

THE SENATE APPROVES A PROPOSAL, sponsored by Senator Abraham Ribicoff, which replaces the foreign earned income exclusion with specific deductions for certain excess foreign living costs, including excess foreign housing costs, educational costs, and cost of living. (S. 2115, 95th Congress, 2nd Session (1978)).

CONGRESS VOTES FOR A TOTAL ELIMINATION OF OVERSEAS EARNED INCOME EXCLUSION to be replaced by the specific deductions along the lines of the Ribicoff proposal modified by the addition of several of the features of the Carter Administration's proposal including the deduction for one round trip voyage for a family to the United States (at the lowest cost economy fare) per year.

1979 THE JOINT TAX COMMITTEE STAFF ESTIMATES that the 1978 revenue cost of the Foreign Earned Income Act will be $ 412 million, compared with $ 194 million had the 1976 Act provisions applied that year, and $ 538 million had the law which had been in effect prior to the 1976 Act applied. For the overseas American taxpayer, the 1976 Tax Reform Act had added $ 344 million to taxes in 1978, and the 1978 Tax Act eliminated $ 116 million. If the pre-1976 Tax Laws would have still been in effect, and had the 1976 Tax Court rulings not been made, overseas Americans would have paid $ 228 million less than foreseen by the 1978 Tax Law changes. (Staff of Joint Committee on Taxation, 95th Congress, lst Session, General Explanation of the Foreign Earned Income Act of 1978 (Comm. Print 1979)).PL 96-60, Section 407, amending Section 611 of PL 95-426

CONGRESS AMENDS THE FOREIGN RELATIONS AUTHORIZATION ACT FOR FISCAL YEAR 1979, PL 95-426, SECTION 611,. OCTOBER 7, 1978, and requests that the President transmit a new report to the Congress on Federal statutes and regulations that “treat United States citizens living abroad differently from United States citizens residing within the United States or which may cause, directly or indirectly, competitive disadvantages for Americans working abroad relative to the treatment by other major trading nations of the world of their nationals who are working outside their territory”. (PL 96-60, Section 407, amending Section 611 of PL 95-426)

THE PRESIDENT’S EXPORT COUNCIL ISSUES A REPORT IN DECEMBER 1979 that studied the rationale for taxing U.S. citizens abroad and concludes that Americans: "..are being taxed out of competition in overseas markets. The result is a sharp loss in the United States’ share of overseas business volume in vital economic sectors. The current situation contributes to our negative balance of payments, a loss of U.S. jobs to our competitors, and the decline in U.S. presence and prestige abroad." Among the Council’s recommendations is the following: "Work should begin immediately to encourage enactment of a new tax law to put Americans working overseas on the same tax footing as citizens of competing industrial nations". (The President’s Export Council, Subcommittee on Export Expansion, Report of the Task Force to Study the Tax Treatment of Americans Working Overseas, December 5, 1979.)

1980 PRESIDENT CARTER SUBMITS A NEW REPORT TO CONGRESS ON THE TREATMENT OF U.S. CITIZENS LIVING ABROAD. The President does not submit an analysis of current tax laws because the current law has only been in effect for one year. However he does provide some general observations on U.S. tax treatment of Americans overseas. These include the following:

Concepts of Income Tax Jurisdiction: There is no unanimous view of where taxing jurisdiction should lie when income involves international transactions. The two major views are referred to as source basis taxation and residence basis taxation. Most countries use a combination of both, taxing residents or domiciliaries on their worldwide income and taxing nonresidents and non-domiciliaries on income derived from sources in that country. The United States is virtually unique in taxing income not only on the basis of both residence and source, but on the basis of citizenship as well.

Source Basis Taxation: Pure source basis taxation would assign the right to tax income exclusively to the country where the income arises. Residents would be exempt from tax on all foreign source income, while nonresidents and residents alike would be taxed on income arising in the country. Pure source basis taxation is rarely practiced, but a number of income tax systems, especially of capital importing countries, do rely heavily on taxing income at the source. Argentina is an example of a country which taxes income almost exclusively on the basis of source. In such a case, source rules are very important. For example, if the country views employment income as having its source where the services are performed, it will only tax income from services performed within its territory; but if it views the source of employment income as where the payment originates, it will also tax income from employment abroad if paid for by a local person or company. The latter view is not uncommon among countries that emphasize source basis taxation.

Residence Basis Taxation: In contrast, pure residence basis taxation would assign the right to tax exclusively to the country of residence of the recipient. Residents would be subject to tax on their worldwide income; nonresidents would not be taxed. Source rules are important to avoid international double taxation of residents, but in addition, a definition of residence is essential. In practice, pure residence basis taxation is rarely if ever practices. Perhaps the closest example is the Soviet Union, although it taxes on the basis of citizenship rather than residence. The Soviet Union taxes the income of Soviet citizens, including those who work abroad, and is generally willing to exempt from tax on a reciprocal basis income derived within the Soviet Union by persons who are not Soviet citizens. Most countries use both residence and source basis taxation, taxing residents on their worldwide income, and also taxing non-residents on income having its source in that country.

Residence vs. Domicile vs. Citizenship: Few countries have a single precise definition of residence for tax purposes; generally a number of factors are relevant, such as the place of permanent residence or center or economic interests as well as the period of physical presence. A number of countries employ a broader concept of “domicile” to describe persons who retain ties of family or home ownership to the country or show an intent to return there even though they may spend prolonged periods abroad. The United States exercises a still broader jurisdiction in taxing nonresidents and non-domiciliaries who are U.S. citizens (and in special circumstances certain former citizens with U.S. income). It is common in such cases to provide special exemptions or deductions to residents, domiciliaries, or citizens who are employed abroad. These special rules are described in the next section.

Fairness and Competition: Fairness: One major goal of an income tax is equity, or fairness in the sense of equal treatment of persons with equal incomes and in equal circumstances. But the perception of equity depends on who is being compared.

Relevant Comparisons: For many countries, the relevant comparison is among residents. Such countries do not tax the foreign income of nonresidents. Thus, individuals residing in the same country face the same tax rules, regardless of their nationality or domicile. Canada and the United Kingdom follow the residence criterion; but both extend the meaning of residence to include certain persons living abroad who maintain significant ties to the home country, and Canada imposes a tax on departing residents.

For other countries, the relevant comparison is among domiciliaries, a somewhat broader concept than residence. Japan, France and Germany use this approach, although France and Germany exempt nonresident domiciliaries who are employed abroad in certain activities.

For the United States, the relevant comparison is among citizens. Thus, a U.S. citizen residing abroad is, like a U.S. resident, subject to U.S. income taxation on his worldwide income (with certain adjustments in the case of foreign earned income), rather than being taxed like a nonresident alien only on income from U.S. sources. Income taxes paid to foreign countries on foreign income may be credited against the U.S. tax on that income. As a result, a U.S. citizen whose foreign income tax liability is as high as or higher than the U.S. tax will nave no net U.S. tax liability and will be in the same position as other nationals in that country. But U.S. citizens whose foreign income tax is lower than the U.S. tax will have to pay an additional tax to the United States beyond the income tax liability of other nationals in that foreign country. For Americans living abroad who tend to compare their tax burden with that of their immediate neighbors and colleagues, this situation is not perceived as equitable.

Is it fair to ask Americans living abroad where the local income tax is less than the U.S. tax to pay more than other nationals living there? The defense of citizenship basis taxation rests on the belief that U.S. citizenship confers benefits independently of residence. It is not necessary that the amount of benefit received be reflected precisely in the amount of tax charged. Income tax liability is measured by the ability to pay, not, like a user charge, by the amount of services used during the tax year. But benefit is an important consideration in the scope of an income tax. Taxing the income of nonresident citizens is justifiable only if they derive significant benefit from their U.S. citizenship.

The infrequency with which U.S. citizenship is renounced suggests that it does have value even for permanent residents of other countries. At a minimum it assures the right to re-enter and remain in the United States. Many, probably most, Americans abroad are there temporarily; i.e., they retain a U.S. domicile. For them, the benefits of U.S. citizenship are more extensive. Typically, they grew up and attended school in the United States, their children may attend U.S. colleges, and they expect to return to the United States eventually. They derived benefits from U.S. Government expenditures while in the United States at the time when their income, and therefore their income tax, was generally relatively low, and they will derive benefits as residents again when they return. Moreover, even during the period of non-residence, there is no fixed pattern of distribution of benefits. For example, the benefits of government spending on education and police and fire protection, which are derived largely by residents, are financed largely by state and local governments, which tax on a residence basis and not on the basis of citizenship; while the principal Federal expenditures, for defense and social security programs, benefit nonresident citizens as well.

It may be worth noting that changing to residence basis taxation would not be an unmitigated blessing to Americans abroad. If the practice of other countries were followed in defining residence or domicile in terms of permanent home rather than present location, most Americans employed abroad would continue to be treated as residents or domiciliaries. Special rules would be needed to exempt their foreign income. Alternatively, if residence were defined more narrowly, for example, by treating Americans absent from the United States for 17 out of 18 months as nonresidents for tax purposes, their tax on U.S. income could increase. Nonresidents are subject to U.S. tax at 30 percent of the gross amount of certain U.S. source income such as dividends, interest, and royalties. Income tax treaties generally reduce this rate reciprocally, and are in effect with most industrial countries. But there would be cases where U.S. nonresident citizens, if taxed like nonresident aliens, would incur a heavier tax than at present on their U.S. investment income.

Competition: Income tax systems frequently depart from the equity objective in specific instances to achieve other desirable goals. An income tax that provides incentives to expatriate employees, relative to other expatriates and to residents, is generally justified on the grounds of export promotion.

Consequences: One consequence of taxing the foreign income of nonresident citizens is that, when those individuals live in a country where the income tax is lower than in the home country, they will have a higher tax burden than their neighbors, who are subject only to the lower host country income tax. Thus they will either be more costly to employ or less willing to work abroad. In either case, it is argued, exports will suffer. Firms that hire the more expensive employees will lose contracts to firms using the cheaper labor, which can, accordingly, submit lower bids. Firms which hire the cheaper foreign nationals will find themselves using more foreign materials as well, as their employees will turn to suppliers in their own countries with which they are more familiar. For these reasons, some take the position that the United States should give up citizenship basis taxation, at least in the case of Americans employed abroad, in the interests of promoting U.S. exports.

Other Consequences: Subsidiary reasons advanced for providing incentives to Americans to work abroad are that overseas employment increases the total volume of employment available to Americans and generates greater international understanding and good will. Sending Americans to work abroad expands the total employment of Americans only if there is a domestic surplus of the skills of those who go abroad to work so that they would otherwise be unemployed or would replace other domestic employees, making the latter unemployed. From time to time this may be the case in certain employments, teaching for example, but Americans working abroad have a variety of skills. Many Americans employed abroad by U.S. multinationals have supervisory skills that are not in excess supply at home. Employment of Americans abroad may or may not generate good will. It would be inaccurate to generalize. In some environments, the presence of Americans abroad has a favorable impact; in other environments, the impact may be negative. In any event, there is no evidence that American employees abroad have an advantage in this respect over Americans abroad in other capacities, as permanent residents, invited visitors, or travelers.

Export Promotion: Thus, the principal argument for tax exemption of Americans employed abroad is export promotion. Given that objective, exempting from tax the foreign earnings of Americans employed abroad is one possible policy tool, which should be evaluated and compared with other possible alternative measures.

Labor Intensive Industries: A case where the impact of present U.S. tax policy on exports could be significant is in labor intensive industries operating in low tax jurisdictions. One such example is the construction industry in Saudi Arabia (where foreign employees are not subject to any local income tax). In such cases, the added U.S. tax cost could increase the total cost of the project by an important margin. If equally competent foreign nationals can be hired without the added tax cost, they will tend to replace Americans in such situations. And if foreign suppliers can produce goods of equal quality at no higher price than U.S. firms, the employment of foreign nationals will reduce U.S. exports as the foreign nationals direct orders to the firms they know best.

Impact on Exports: But it is not clear how prevalent this type of situation is, or what its impact is in terms of overall exports (even assuming no offsetting changes such as exchange rate adjustments). Americans employed abroad engage in many activities, some of which may be entirely export related and others of which may have no connection with exports. For those in export activities, the added U.S. tax cost may cause a significant increase in the export price or it may have an insignificant effect. And the employment of foreign nationals rather than Americans will divert demand to foreign rather than U.S. suppliers (and conversely, the employment of Americans will result in orders t U.S. suppliers) only if the foreign and U.S. equipment are very good substitutes in terms of both quality and price. A competent engineer or purchasing agent will not write specifications or place orders for inferior supplies or be ignorant of differences in quality.

More Information Needed: One approach to evaluating tax exemption of some or all expatriate American employees as an export incentive would be to gather more information on the export impact of Americans employed abroad; for example: precisely how many Americans are employed Abroad; what they do; in which countries their local income tax is below their U.S. tax; how much the added U.S. tax increases the export price; and how much exports would be likely to increase if there were no U.S. tax. A related consideration is the significance of the non-tax costs of hiring Americans; how would the cost of hiring Americans compare to the cost of hiring third country nationals if there were no U.S. tax on foreign earnings? Other aspects to be considered include the effects of such other U.S. rules as the anti-boycott and anti-bribery regulations. Is the availability of credit and insurance a constraint on U.S. exports? How effective are the marketing efforts of the U.S. firms themselves? Gathering the necessary data and disentangling these various strands would be a complicated assignment.

Another Approach: A more limited approach would be to identify activities which can be shown to be export sensitive and to devise selective incentives for the targeted areas. As indicated earlier, construction appears to be the primary area of concern. Even in such cases, however, further tax relief should be compared with direct spending alternatives. (One obvious drawback to the use of tax relief is that it entrusts to the Internal Revenue Service decisions that are outside its area of expertise.

No Conclusive Judgments So Far: The studies done to date on the issue of Americans employed abroad do not permit conclusive policy judgments on what changes, if any, would be most effectively encourage exports.

THE PRESIDENT’S EXPORT COUNCIL’S TASK FORCE OF THE SUBCOMMITTEE ON EXPORT EXPANSION issues a report on December 5, 1979. It has three recommendations on the taxation of expatriate Americans:

Regulations and interpretations in force under the current tax law concerning Americans living in camps in hardship areas (Section 911) should be simplified and made less restrictive, in keeping with the intent of Congress.
The current tax law concerning allowances to employees for excess living costs incurred while working abroad (Section 913) should be interpreted in the least restrictive and simplest manner.
Work should begin immediately to encourage enactment of a new tax law to put Americans working overseas on the same tax footing as citizens from competing industrial nations.

The first and second recommendations are well taken and work is being carried out to make appropriate changes. The third recommendation that Americans working overseas be taxed more lightly, if at all, is expressed in general terms. It assumes that tax exemption would reduce U.S. export prices, prompting an increase in demand sufficient to make a significant increase in the value of U.S. exports. As noted above, the evidence to date does not support this assumption. Any such proposal should be compared with other tax or non-tax measures in terms of likely effectiveness and relative simplicity. Most U.S. export activity takes place in the United States, so measures to reduce domestic taxes or costs of production may be more effective and preferred by exporters. Non-tax measures have administrative advantages. Selective tax exemption for certain overseas earnings may be beneficial to exports if targeted to be cost effective, but the impact may not be large enough to appreciably improve the overall U.S. export position.

1981 CONGRESS REINTRODUCES A $75,000 FOREIGN EARNED INCOME EXCLUSION for "physical presence" and "bona fide" residents abroad (rising by $5,000 per year until $95,000 in 1986). There are additional deductions or exclusions for excess cost of foreign housing. No tax credit is given for taxes paid abroad on excluded income. There is no change in the full taxation of "unearned" income including retirement pensions earned abroad. (Economic Recovery Tax Act of 1981, PL 97-34, 95 Stat. 172 (1981)).

1982 THE TREASURY DEPARTMENT TELLS THE CONGRESS THAT IT NEEDS MORE ENFORCEMENT POWER overseas to stop the drug trade. Congress enacts legislation which defines all overseas Americans as resident in the District of Columbia for certain legal purposes, including requests for information and the serving of summons. Overseas Americans are also to be subjected to a new form of request for the provision of documents pertaining to their work abroad. Failure to provide such documents, even in the case where providing them is against the law of the country of foreign residence, will subject the overseas American to civil and eventually criminal penalties in the United States. (Tax Act of 1982 Sections 336, 337 and 342 of the Act and sec. 7701 and new section 982 of the Code). (For legislative background see H.R. 4961 as reported by the Senate Finance Committee, sec. 372, 373 and 374; S. Rep. No. 97-494 (Vol. 1) July 12, 1982, p. 298+; and H. Rep. No. 97-760 (August 17, 1982), pages 590+).

1983 IN “ROWE V. INTERNAL REVENUE SERVICE”, a taxpayer suit to have the Foreign Earned Income Act of 1978 declared unconstitutional is dismissed with prejudice on the basis of res judicata. The suit repeated claims of the taxpayer which previously had been litigated and dismissed on the merits by the Court of Claims. The taxpayer had failed in two earlier attempts (summarized at 4 U.S.E.T. 6, 105-106 and 125) to have the 1978 Act declared unconstitutional because it gives foreign citizens a competitive advantage over U.S. citizens in working abroad. In this present case, the Court noted that, while it had jurisdiction over a tax refund suit under Section 1346(a)(1), venue is improper. Venue for a refund action is restricted by Section 1402(a)(1) to the federal district court where the plaintiff resides whereas the plaintiff in this case resides in Honduras. However, in an evident desire to compel the plaintiff to desist from further litigation, the court went beyond the venue determination to dismiss the action with prejudice on the basis of res judicata. The general rule of res judicata is that parties to a suit and those in privity with them are bound not only as to every matter which was offered and received to sustain or defeat the claim in a prior action but also as to any other admissible matter which might have been offered for that purpose. (Rowe v. Internal Revenue Service, 83-1 U.S.T.C. 9238 (D.D.C. 1983))

THE INTERNAL REVENUE SERVICE, IN CONDUCTING AUDITS OVERSEAS, attempts to make the definition of a "bona fide" resident contingent on the overseas taxpayer actually paying an income tax to the foreign country of "bona fide" residence. This practice, if sustained, will place taxpayers in countries where there is no local income tax in a worse tax position than they have ever been in before.

NEW IRS RULES FOR TAXATION OF SOCIAL SECURITY RETIREMENT BENEFITS indicate that there will be a zero level of base income above which Social Security Benefits will be taxed (50% of the benefit will be taxable) for those who file as married filing separately. There is a dollar earnings base of about $20,000 for those filing a single return, and double this amount for married filing a joint return. This ruling will be especially harsh for overseas taxpayers married to aliens who have to file as married filing separately to exclude the non-resident alien spouse's income from taxation by the USA.

1986 CONGRESS PASSES THE “TAX REFORM BILL OF 1986” which introduces a number of significant changes affecting U.S. citizens resident abroad. The section 911 foreign earned income exclusion is reduced to $70,000. Separate foreign tax credit limitations are introduced for passive income, high withholding tax interest, etc. Source rules are introduced to treat income from sales of personal property as U.S. source income for U.S. persons if such income is not taxable in the country of residence. The U.S. dollar is deemed by statute to be the “functional currency” of U.S. citizens for transactions other than those of a “qualified business unit”. The new laws limit foreign tax credits for alternative minimum tax purposes to 90% of the alternative minimum tax before credits. This results in clear double taxation by legislative intent.

1988 CONGRESS PASSES THE “TECHNICAL AND MISCELLANEOUS REVENUE ACT OF 1988.” The Act eliminates the marital deduction for property passing from a U.S. citizen to a non U.U. citizen. An annual gift tax exclusion of $100,000 is introduced for gifts to non U.S. citizen spouses.

1989 CONGRESS PASSES THE “REVENUE RECONCILIATION ACT OF 1989” which creates a separate foreign tax credit category for lump sum distributions from foreign pension plans. The law also confirms the denial of marital deductions for property passing from U.S. citizen to non citizen spouse overrides existing treaty provisions for taxable years ending more than three years after enactment.

1990 CONGRESS PASSES THE “REVENUE RECONCILIATION ACT OF 1990” which raises the maximum marginal tax rates and introduces “phase outs” of itemized deductions for higher income taxpayers.

1992 CONGRESS PASSES THE “REVENUE BILL OF 1992” which recognizes that Sec 988 of the 1986 Act, which established the U.S. dollar as the “functional currency” for individuals, had created an impossible administrative burden. Under the 1986 Act, an individual must measure gain or loss on each foreign currency transaction. The 1992 law provides for non-recognition of exchange gains in personal transactions for gains not exceeding $200.

REVENUE RULING 90-79 PROVIDES THAT A LOSS ON A FOREIGN CURRENCY MORTGAGE CANNOT BE USED TO OFFSET TAXABLE GAIN ON THE SALE OF A HOUSE IN A FOREIGN COUNTRY. This was later upheld in court. In practice this works as follows: you borrow foreign currency to buy a house. You sell the house for less than you paid for it in the foreign currency. Yet, during the same time the dollar has appreciated so that the actual foreign currency loss looks like a dollar capital gain. You pay tax on the phantom income increase but cannot deduct the phantom loss. In reality you actually lost money, but you have to pay tax on a capital gain that never took place! Somehow this meets the cannons of tax fairness.

1993 CONGRESS PASSES “THE REVENUE RECONCILIATION BILL OF 1993” which raises the top regular tax rates from 31% by adding two new brackets of 36% and 39.6%. The act also raises the maximum alternative minimum tax rates from 26% to 28%. It increases the portion of social security benefits that are taxable from 50% to 85% for high income taxpayers (who are defined as those earning $34,000 as a single person an $44,000 for a couple). The act also increases the amount of income earned by controlled foreign corporations that is currently taxable to U.S. shareholders.

1996 CONGRESS PASSES THE “SMALL BUSINESS JOB PROTECTION ACT OF 1996” which significantly changes the taxation of foreign trusts with U.S. grantors and/or beneficiaries.

CONGRESS ALSO PASSES THE “HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996” which states that individuals who have assets of $500,000 or more or income of more than $100,000 and who lose their U.S. nationality are deemed to have expatriated themselves for income tax avoidance purposes. Non U.S. citizens who have been long-term U.S. residents have comparable treatment.

1997 CONGRESS PASSES THE “TAXPAYER RELIEF ACT OF 1997” which reduces taxes on long-term capital gains and estates. It also provides for a $500,000 exclusion of gain on the sale of a principal residence. The foreign earned income exclusion is increased by $2,000 per year (from 1998 to 2002) to a new maximum of $80,000 and indexes for cost of living increases after 2002.

2001CONGRESS PASSES THE “ECONOMIC GROWTH AND TAX RELIEF RECONCILIATION ACT OF 2001” which phases in certain deductions and benefits that have sunset provisions by 2011. Middle income taxpayers assume the burden for repealed estate tax provisions by now paying capital gains income tax on decedent’s built in gain.

THE IRS ESTABLISHES A QUALIFIED INTERMEDIARY PROGRAM (QI Program) to attract foreign investors to U.S. securities (more than 7000 foreign banks participate in the program). The IRS allows the banks to promise to identify clients, withhold any taxes due on U.S. securities in their account (typically 30%) and send the tax money owed to the IRS.

CONGRESS ADOPTS THE “USA PATRIOT ACT”, which stands for Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (Pub. L. 107-56).

The Act increases the ability of law enforcement agencies to search telephone, e-mail communications, medical, financial, and other records; eases restrictions on foreign intelligence gathering within the United States; expands the Secretary of the Treasury’s authority to regulate financial transactions, particularly those involving foreign individuals and entities; and enhances the discretion of law enforcement and immigration authorities in detaining and deporting immigrants suspected of terrorism-related acts. The act also expands the definition of terrorism to include domestic terrorism, thus enlarging the number of activities to which the USA PATRIOT Act’s expanded law enforcement powers can be applied.

Title III of the Act, titled "International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001," is intended to facilitate the prevention, detection and prosecution of international money laundering and the financing of terrorism. It primarily amends portions of the Money Laundering Control Act of 1986 (MLCA) and the Bank Secrecy Act of 1970 (BSA).

It is divided into three subtitles, with the first dealing primarily with strengthening banking rules specifically against money laundering, especially on the international stage. The second attempts to improve communication between law enforcement agencies and financial institutions. This subtitle also increases record keeping and reporting requirements. The third subtitle deals with currency smuggling and counterfeiting, including quadrupling the maximum penalty for counterfeiting foreign currency, such as the Hans Vierck case of 2001.

The first subtitle tightened the record keeping requirements for financial institutions, making them record the aggregate amounts of transactions processed from areas of the world where money laundering is a concern to the U.S. government. It also made institutions put into place reasonable steps to identify beneficial owners of bank accounts and those who are authorized to use or route funds through payable-through accounts. Anti-money laundering software from companies such as Lexis-Nexis, coupled to databases of high risk individuals and organizations developed by companies like World Compliance help financial institutions perform this due diligence. The U.S. Treasury was charged with formulating regulations designed to foster information sharing between financial institutions in order to prevent money-laundering.

Along with expanding record keeping requirements it put new regulations into place to make it easier for authorities to identify money laundering activities and to make it harder for money launderers to mask their identities. If money laundering was uncovered, the subtitle legislated for the forfeiture of assets of those suspected of doing the money laundering. In an effort to encourage institutions to do their bit to reduce money laundering, the Treasury was given authority to block mergers of bank holding companies and banks with other banks and bank holding companies that had a bad history of preventing money laundering. Similarly, mergers between insured depository institutions and non-insured depository institutions that have a bad track record in combating money-laundering could be blocked.

Restrictions were placed on accounts and foreign banks. Foreign shell banks that are not an affiliate of a bank that has a physical presence in the U.S. or that are not subject to supervision by a banking authority in a non-U.S. country were prohibited. The subtitle has several sections that prohibit or restrict the use of certain accounts held at financial institutions. Financial institutions must now undertake steps to identify the owners of any privately owned bank outside the U.S. who have a correspondent account with them, along with the interests of each of the owners in the bank. It is expected that additional scrutiny will be applied by the U.S. institution to such banks to make sure they are not engaging in money laundering. Bank must identify all the nominal and beneficial own