FREQUENTLY ASKED QUESTIONS ABOUT CONVERSION TO RESIDENCY-BASED TAXATION
1. Is ACA’s RBT “Vanilla” Approach the definitive version of a residency-based proposal?
The “Vanilla” Approach is not an ACA “proposal", per se. It is intended as a starting point for examining how citizenship-based taxation (CBT) might be replaced with residency-based taxation (RBT) and what the new rules might look like. By working off a “Vanilla” Approach, it is easier to compare a variety of versions.
RBT works on the premise that Americans overseas should be taxed in essentially the same manner as Non-Resident Aliens (NRAs). US source dividends, interest, and royalties, and income effectively- connected with the US trade or business, would be taxed in the same way it is when earned by an NRA. Income sourced from outside the US would not be taxed.
The “Vanilla” Approach addresses all or most of the issues that we think should be considered.
2. What is scoring? Why does RBT need to be scored? What will scoring tell us, and why not have Congress do this work?
Major tax reform legislation probably will not be adopted without “scoring”, that is, development of revenue estimates, which tell Congress how much revenue will be lost or gained by enactment of the legislation. Advocating successfully for a proposal for this kind, ACA believes, cannot be done based on simple assertions such as: It is fairer, it is the right thing to do or, it is how all other industrialized nations tax their citizens.
A proposal describing the specific amendments to existing law necessary to transition from CBT to RBT, we think, can best be developed after putting on the table all the essential pieces and, very importantly, estimating the revenue costs. Many of the revenue costs will tie to particular parts, such as “grandfather” and “transition” rules. “Grandfather” rules, for example, make individuals who are living overseas, and have been living overseas for some specific period of time, automatically qualified for RBT treatment, without them having to do anything further. “Transition” rules might phase-in certain provisions.
It is only through the process of scoring a “Vanilla” Approach that we can determine which elements need to be included, excluded, refined, etc., and whether certain topics (e.g., estate and gift tax) should be addressed. The scoring is intended to help everyone determine what is the best RBT proposal for the diverse population of Americans overseas.
3. Why should organizations like ACA drive the tax reform process for Americans overseas?
Changes in the current approach for taxing Americans abroad will need to be made legislatively, by Congress. Treasury Department will play an important role in formulating policy. This work is happening in Washington, DC. ACA’s team is readily available to the offices involved in tax reform and is developing the information and working with decision-makers in Congress and elsewhere. A number of criteria relating to revenue costs and placement of provisions within the existing Internal Revenue Code will need to be dealt with. ACA is preparing to do just
As most Americans overseas know, there is no collective voice in Congress for this constituency. Americans overseas vote from the State and District in which they last lived. Identifying legislators with a thorough understanding of the community’s issues and a deep-seated interest in addressing them is not an easy matter. ACA believes that leaving legislation such as this up to individuals in Washington, DC who do not have an understanding of the needs of this community, would be counter-productive and, worse, might result in a proposal that creates more problems for Americans overseas that it solves.
ACA believes that our organization, along with others serving the overseas community, are best positioned to describe how an RBT system might be structured.
4. ACA’s approach seems complicated. If the policy intends to treat Americans overseas as NRAs, why not just say that?
RBT is a set of tax rules treating Americans residing abroad the essentially the same as nonresident aliens. We say this in various places. For example, in describing “Residency-Based Taxation ‘Vanilla’ Approach”, we say: “US citizens and resident aliens, including ‘green card’ holders, residing overseas, in general, would be removed from the category of individuals subject to US income tax and placed in the same category as nonresident aliens (foreign individuals). Various conforming changes would be made.”
The more detailed topics, or “complicated bits”, have to do with such things as defining who will qualify, saying what to do with "leftover luggage”, such as the foreign-earned income (section 911) exclusion, talking about estate and gift tax rules, filing requirements, effective dates, and so forth. In addition, there needs to be a defined path for how individuals bring themselves within RBT. If not, it leaves the proposal open to loopholes for tax evasion, which would cause the revenue estimates for enactment to skyrocket.
The basic underlining change to the existing tax code is to treat Americans abroad the same as nonresident aliens. ACA believes that it is best and simplest to work with the fabric that exists and to offer a proposal that does not require many "cuts" to the current tax code, as opposed to writing new and novel provisions from scratch, which would be complicated and difficult to draft and to explain. It also makes it easier to develop reliable revenue estimates.
5. Why should RBT be revenue neutral? Shouldn’t RBT be argued on fairness and the fact that it will help Americans to be more competitive?
There is no way to know with certainty how the Congress will address tax reform. Will Congress evaluate proposals based on static or dynamic scoring, the later taking into account changes in behavior? What assumptions will be made about future economic growth? Will Congress look at the larger picture or focus on particular elements of the Internal Revenue Code?
Some may argue that with greater tax reform in the works, there will be offsets in other areas of the Code that would increase revenue and, therefore, offset any revenue loss from the implementation of RBT. Due to the uncertainty about how Congress will address tax reform, ACA’s belief is that the best way forward is to provide Congress with a road map that is revenue neutral, neither increasing nor decreasing revenue. Also, if RBT is a “revenue loser”, then some – especially those who only reside in the US – might say that they should not, in effect, have to subsidize tax relief for Americans residing abroad.
There are arguments for “selling” RBT based solely on how RBT would increase competitiveness. Although not impossible, this argument is difficult to quantify. ACA believes that RBT will unleash Americans, giving them the freedom to be more mobile and to create more economic opportunity for America and Americans through greater engagement internationally. Although revenue estimates for this behavioral change can be made, Congress may rely more on what can concretely be proved.
How much revenue will flow out, and how much revenue will flow in based on the numbers? ACA believes it is better to use a model that can demonstrate how revenue flows would operate under RBT, rather than use modeling that is more subjective in nature.
Why fight uphill and have to defend a loss of revenue when you can present a proposal that is revenue neutral?
6. What about Accidental Americans and RBT? Won’t they pay a heavier price of entry into RBT?
ACA tries to avoid categorizing “Americans” in this way. ACA is seeking a way forward with tax reform that meets the needs of all Americans overseas. That said, our approach provides a path for those Americans residing abroad who were born in the United States and left as infants or young children (living primarily outside of the US and as a citizens of a foreign jurisdiction) and for those who have no real ties to the United States and may have obtained US citizenship from a parent/grandparent.
Most Americans who have resided long-term abroad will immediately qualify for RBT treatment. Moreover, if they have resided abroad for at least three years prior to date of enactment of RBT and if they are tax compliant, they will not be subject to a "Departure Tax" and will not be subject to a one- time User Fee – that is, they will be “grandfathered” under the rules. For those who are not tax compliant, they normally would be eligible to enter the Foreign Streamlined Compliance Program, which ACA recommended to the IRS and which was improved upon and finally adopted by the IRS. This should allow most individuals who were unaware of their filing requirements or non-willful in their failure to file, to become compliant without the application of penalties. That said, not everyone may qualify, and some electing RBT treatment may incur back-taxes and penalties. However, it does give the overwhelming majority of these individuals a path forward while trying to be fair to everyone seeking to opt into RBT.
7. Why not address FBAR in the “Vanilla” Approach and exclude Americans overseas from the obligation to file FBARs (FinCEN Report 114)?
FinCEN Report 114 (Report of Foreign Bank and Financial Accounts (FBAR)) filing is required under Title 31 as part of the Bank Secrecy Act and is not under any provisions of the Internal Revenue Code (i.e., it is not a tax-reporting form). FBAR reporting is more about national security and crime prevention than tax compliance.
The perception of many individuals is that FBAR is a tax-reporting tool, when, in fact, it is about prosecuting criminal behavior. If the Government can’t “get” criminals “in the act”, they will get them on a technicality: failure to file an FBAR. Individuals may have differing and strong views as to whether FBARs are an effective tool in combating terrorism, money laundering, and drug trafficking, but the reality is that the requirement was developed specifically to address these concerns.
There are two perfectly good schools of thought on the question of removing the requirement to file FBARs for Americans abroad who would qualify for RBT. It boils down to: Do you think the FBAR filing requirement, which many in Congress believe to be aiding national security, combating terrorism and crime prevention, is not necessary for all Americans living abroad (regardless whether they opt into RBT)? Or, would you drop the requirement with respect to Americans living abroad that bring themselves within RBT?
ACA believes that, given Congress’s heightened counter-terrorism efforts since 9/11, addressing FBAR in the context of RBT might create an obstacle to advancing RBT. Congress might have serious reservations about removing any tool in its arsenal that addresses criminal and, in particular, terrorism financing.
At this stage, ACA would prefer to not risk losing support for RBT in order to gain an exception from FBAR reporting. ACA believes it is better to push for the basic RBT proposal and possibly fold in an FBAR exception at a later time, after the Congress has embraced the concept of RBT. This should be possible, as FBAR is a separate subject which stands on its own.
8. Why include Same-Country Exemption (SCE) for FATCA reporting in RBT? Doesn’t it automatically “go away” if RBT is adopted?
There are narrow situations where an American residing abroad might not be “covered” by RBT. Or, for special reasons, an individual might opt out of RBT. Or parts of RBT might be phased in over time. It’s impossible to say at this stage whether a Same-Country Exemption might “come in handy”. By including SCE in RBT, it guarantees, without question, that it will be part of a residency-based approach to taxation. Moreover, ACA’s advocacy calling for the implementation of SCE is a very simple thing, so why not do this? ACA’s advocacy for SCE in no way diminishes our advocacy for RBT. We can and should ask for both. Finally, while the last Administration’s Treasury Department did not embrace SCE, interested parties on both sides of the political aisle supported it, and the Taxpayer Advocate supported it. It is a good solution to lockout of Americans abroad from foreign financial institutions, albeit not a 100% comprehensive solution. It does address the heart of the issue; as to overseas Americans electing same-country treatment, their local bank can treat them, in effect, as inoculated from the burdensome FATCA rules.
9. Departure Fees, proof of tax compliancy, residency requirements: why should there be these requirements to opt into RBT?
Probably the one element of RBT that Congress will pay closest attention to is how easily can individuals abuse RBT for tax evasion purposes. It is for this reason that ACA has included in the “Vanilla” Approach elements that set forth the requirements for how individuals can qualify for RBT. Simply stating that one lives overseas and providing a foreign address would create an enormous loophole that Congress, we believe, would not accept. Loopholes generally result in causing negative revenue estimates to skyrocket, and they work against getting the serious attention of the tax-writing offices, potentially putting these offices off the topic of residency-based proposals now and long into the future.
A Departure Tax has been posited to ensure that individuals cannot easily find ways to “game” the system, running up the revenue costs of enacting RBT. For example, it would be a mistake to create an opportunity for an individual who holds highly appreciated assets to move abroad and then “cash out” and not pay any US tax. One of the defenses against this is a form of Departure Tax and a requirement that he/she logs some time as a non-US resident. As a subset, there is a problem with people jumping out of the regular tax system and then back in again.
Some form of Departure Tax may or may not be needed. Only a scoring of revenue costs will tell us for sure and, for that matter, what the right mechanics are for eligibility for RBT.
10. Why use District Economics Group (DEG) for the revenue estimating of RBT?
Outside of the government agencies that “score” or develop revenue estimates for legislation, there are few independent economic consulting firms that specialize in this work. The Big Four accounting firms provide revenue estimating for legislation. However, ACA believes that it is best to use a firm that is not involved in tax compliance and is, therefore, less likely to have conflicts.
ACA has selected District Economics Group because they specialize in tax policy services to develop and improve legislative and regulatory proposals. DEG has over 30 years of experience providing tax policy analysis to the Congress and Executive branches. They provide ground level insight into the federal revenue, legislative and regulatory process. DEG’s client base includes a wide range of industries, including non-profits. For more information on DEG, see: http://districteconomics.com.
ACA believes that DEG is best placed for working with us on revenue estimating for RBT. They are well-respected, independent, understand our project and our audience, and, most importantly, understand how legislation needs to be developed to promote passage by Congress. In addition, they have excellent access to the widest range of databases.
11. What about individuals who chose to stay with CBT or who can’t access RBT due to short- term or contractual employment? If the foreign earned income exclusion (FEIE; claimed on Form 2555) is repealed, will these individuals be double taxed?
ACA’s “Vanilla” Approach summarizes how residency-based taxation might be implemented. For individuals placing themselves under RBT, there would be no need for the FEIE as they would no longer be subject to US taxation. Foreign tax credits (claimed on Form 1116) could still be taken; section 901 allowing a credit for foreign taxes is not affected.
For individuals who remain under CBT because of choice or due to short-term or contractual employment, several approaches are posited. The goal is to place these individuals in no worse a position than under existing CBT rules. Beginning any year including the year of enactment, individuals qualifying under existing residency rules (section 911(d)(1)) could elect section 911 treatment for up to 5 years, which period could not be extended. This is a one-time election and could not be revoked without the consent of the Secretary. Following this period, if individuals qualify for RBT treatment and wish to be taxed on a residency-basis, they could apply to the IRS for a Departure Certificate. This rule provides a transition rule.
12. What can be done to help individuals who for whatever reason are not able to or do not wish to elect RBT treatment?
A transition rule and special election are provided. Individuals can elect section 911 treatment to be applied to the taxable year of enactment plus three successive taxable years thereafter. These years reduce the number of years covered by the special one-time election for Short-Turn Overseas Employment (above). This gives individuals an opportunity to assess their situation and either place themselves under the RBT regime or not.
Last revised 10/4/2017