Why was ADCT formed?
The Alliance for the Defeat of Citizenship Taxation (ADCT) was formed due to the (lack of) response of the Senate Finance Committee to the well-documented harm that CBT with it’s vicious tentacles has done to “U.S. Persons” abroad. It is undeniably clear, that U.S. citizenship-based taxation is fueling the largest number of renunciations in U.S. history. Ironically, the government is not permitted to take actions which cause Americans to lose their citizenship:
In Afroyim v. Rusk, a divided Court extended the force of this first sentence beyond prior holdings, ruling that it withdrew [p.1567] from the Government of the United States the power to expatriate United States citizens against their will for any reason. “[T]he Amendment can most reasonably be read as defining a citizenship which a citizen keeps unless he voluntarily relinquishes it. Once acquired, this Fourteenth Amendment citizenship was not to be shifted, canceled, or diluted at the will of the Federal Government, the States, or any other government unit.
Short History of CBT
Citizenship-based taxation has been an issue throughout the 150-year history of the U.S. income tax. Interestingly, the United States started with a residence-based tax system. The first income tax enacted by Congress, passed in 1861 to help fund Civil War efforts, Rep. Justin Morrill, proponent of Revenue Act of 1861 only taxed citizens abroad on their income from U.S. investments; overseas income was specifically excluded. In 1864, Congress moved to citizenship-based taxation and passed a new law which taxed non-resident citizens on their non-U.S. income as well. The tax, both for residents and non-residents, was only in effect until 1872. Congress introduced an income tax law in 1894 which included taxation on all income of non-resident citizens. The law was ruled unconstitutional by the Supreme Court the following year (for reasons unrelated to non-resident taxation). Fourteen years later, the 16th Amendment to the Constitution was passed to overturn this Supreme Court decision, and the modern federal income tax was begun. The new income tax regime forming the basis of the modern system of U.S. taxation, created in 1913 and revised in 1916, applied to “every citizen of the United States, whether residing at home or abroad.” The provision of the new law taxing non-resident citizens on their global income was immediately controversial. Already by 1914, U.S. citizens in London had begun to renounce citizenship in order to escape double taxation, and American Abroad groups challenged the legality of the new provision. The challenges reached their climax in 1924 when the Supreme Court ruled in a case brought by a U.S. citizen living in Mexico that taxing non-resident citizens on their global income was indeed constitutional.
Cook v Tait
In 1924, the Supreme Court of the United States, per Justice McKenna ruled in Cook v. Tait that U.S. “citizenship taxation” was constitutional. Since that time Cook v. Tait has been cited to justify the constitutionality, although not necessarily the propriety, of “citizenship taxation”. Note that “citizenship taxation” contains both the words “citizenship” and “taxation”. As a result, Justice McKenna’s decision along with the relevant statutes, may tell us a great deal about what “taxation” and “citizenship” meant in 1924.
Cook v. Tait was argued on April 15, 1924 and decided on May 5, 1924. The taxpayer plaintiff “Cook” was described by Justice McKenna as:
a native citizen of the United States, and was such when he took up his residence and became domiciled in the city of Mexico
Note that there is no evidence that Cook had become a naturalized citizen of Mexico or that he had taken an oath of allegiance to Mexico.
In holding that Cook was a taxable U.S. citizen, Justice McKenna ruled:
The contention was rejected that a citizen’s property without the limits of the United States derives no benefit from the United States. The contention, it was said, came from the confusion of thought in ‘mistaking the scope and extent of the sovereign power of the United States as a nation and its relations to its citizens and their relation to it.’ And that power in its scope and extent, it was decided, is based on the presumption that government by its very nature benefits the citizen and his property wherever found, and that opposition to it holds on to citizenship while it ‘belittles and destroys its advantages and blessings by denying the possession by government of an essential power required to make citizenship completely beneficial.’ In other words, 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, it being in or out of the United States, nor 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 is now almost 100 years old. The case was decided in the context of the world as it was in 1924. The world has changed and changed a great deal. The concepts of both “taxation” and “citizenship” have evolved.
Effects of CBT on Americans abroad – A Form of Life Control
The U.S. practice of citizenship-based taxation is not about tax. Its origins in the Civil War demonstrate it was initially intended as a way to prevent people from leaving the country. Clearly the back-and-forth actions of the courts and Congress from 1861 up until Cook v Tait in 1924, attest to the fact that there are serious flaws in its conception and application. The world today is not the world of 1924.
An American citizen is deemed to be a tax resident of the United States and (it is claimed) taxed in exactly the same way as a Homelander. The manner in which this is done cannot possibly amount to “equal” (and it is certainly not “fair”). The reason for this would seem obvious. First of all, the entire world practices residence-based taxation. One pays tax where one resides and uses services. The U.S. practices residence-based taxation. Those who live in the U.S. fall under only one tax system; the one where they live. However, U.S. citizens outside the country fall under two jurisdictions and in spite of tax treaties, living under disparate tax systems has an incredibly negative effect. (In addition to the treaties, there is the Foreign Earned Income Exemption (FEIE) and the Foreign Tax Credit (FTC) which supposedly prevent double taxation).
It is a fact that the U.S. never enforced CBT. People living outside the U.S. for decades had virtually never heard of it, almost NO ONE had ever heard of the information reporting forms (which is where the horrific penalties come into play). Second, the tax law of the U.S. is built upon the perspective that anything foreign and/or involves tax deferral is to be treated punitively. This is the first component of how the U.S. succeeds in controlling the lives of those living outside its borders. It even manages to tax those who are not American, living in foreign countries.
In addition to filing basic income tax (reported on 1040s, with schedules a,b,c,d etc), some of the other basics those outside the country have to file reports on:
- all of their “foreign” bank accounts if the aggregate balance is $10k or more
- certain assets on the FATCA form 3893 with thresholds based upon marital status & highest balances or end of year balance
- whether they have an incorporated business on Form 5471
- whether they have foreign “trusts” on Forms 3520A and 3520
- whether they have Mutual Funds on Form 8621
All of these forms are incredibly complicated; standard penalty for not filing is $10k per form; accuracy related penalties are 20 – 40%. Having a cross-border tax professional file these forms are incredibly expensive. In Canada for example, a simple 1040 can be $900-$1000. Each additional information return can be $500. Trusts and Mutual Funds are filed as one account per form. Imagine the failure to file penalty for say, 3 foreign trusts and 10 mutual funds. Total = $130k. It is not difficult to see why middle-class people simply cannot afford to file U.S. taxes. Particularly when the majority do not owe any income tax . A similarly-situated Homelander most certainly does not pay an average of $2000 a year to file tax returns. . Another complication is that the U.S. requires one to report/pay on undistributed amounts earned in tax-deferred accounts (for which one cannot claim a foreign tax-credit). This is especially perverse in accounts where the foreign governments, as an incentive to encourage people to save, match amounts contributed by the owners of the accounts. Many of these accounts are for education and to provide for disabled persons. What the U.S. achieves by doing this is to directly tax the citizens of the other country, as it is their money used by the government to match funds.
Many expats have “alien” spouses, so for U.S. tax forms they file “Married Filing Separately” (MFS). This results in tax kicking in at lower thresholds for things such as the Alternative Minimum Tax (AMT – Form 6251) and the Net Investment Income Tax (aka Obamacare Surtax)(NIIT – Form 8960). There is, of course, no FTC for the NIIT.
So at this point, how does all this amount to being a form of “life-control” on those residing outside the country?
- a disproportionate amount of disposable income is wasted on paying the compliance industry to prove one owes no tax
- one is truly unable to make use of incentives available to them to save, since the U.S. can tax them on all tax-deferred accounts
- professionals who incorporate in order to allocate their income in a tax-wise way are requiredto pay on income not received at the highest marginal rate
- non-U.S. mutual funds, if the appropriate election is not made when opened results in distributions not received and tax exceeding the amount of the fund when sold
- other often-used retirement vehicles such as sale of a long-owned principle residence are taxed if the capital gain exceeds $250k though the same treatment Homelanders receive-ability to deduct the interest paid – is not available to the expat.
This is a simplified description which does not take into account gifting and attribution nor estate tax issues. This becomes important later on.
How much income one is able to retain/save on money earned completely outside the U.S. and usually not from U.S. sources is totally determined by the United States of American. Simply because one was born there.