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Trading U.S. Citizenship for Lower Taxes

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Most expats probably will not be trading their U.S. citizenship for Mexico lower taxes, but that seems to be a growing trend.

According to U.S. government data analyzed by CNNMoney earlier this year, over 4,300 Americans gave up their U.S. citizenship in 2015, a 20 percent increase over 2014 and an eighteen-fold jump since 2008.

CNNMoney said, “Many of those severing links are Americans living overseas who are tired of dealing with complicated tax paperwork, a headache that has worsened since new regulations came into effect.”

One of the key reasons for this increase can be traced back to current U.S. taxation policy. In an editorial last year, Bloomberg View – the editorial division of Bloomberg News – spoke out for a change in U.S. tax law that taxes American expats no matter where they live in the world.

Only two countries in the world do that, the U.S. and the tiny African nation of Eritrea. All other countries base their taxation of citizens on residence.

Bloomberg View pointed out that taxing Americans abroad began during the U.S. Civil War to deter draft dodgers who were fleeing to other countries. Today, few of the more than seven millions Americans living abroad are motivated to move to another country just to avoid taxes.

Under the Foreign Account Tax Compliance Act (FATCA), which was passed in 2010 and implemented in 2013, taxation of expats has raised only 0.2 percent of all federal tax revenue, according to Bloomberg View, but the law significantly complicates tax filing for Americans abroad.

Primarily designed to require more disclosure of American-owned accounts by non-U.S. banks to the IRS, FATCA’s main goal is to track down Americans who try to dodge U.S. taxes by setting-up secret offshore accounts.

Bloomberg View believes it is time for new reporting rules because American expats are getting “caught in the crosshairs.” Expats have to report on their local bank accounts or face penalties and, because foreign banks do not want the U.S. reporting liabilities, some expats experience problems opening an account.

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FATCA requires non-U.S. banks, investment funds and other financial institutions to report to the IRS on accounts held by Americans that have balances of more than US$50,000. For American expat taxpayers, FATCA requires a report on accounts with more than US$200,000. Foreign financial Institutions that do not comply with FATCA reporting rules could have a 30 percent tax imposed on all their U.S.-based transactions and also those of their U.S. clients.

To understand the impact of FATCA and current tax laws on American expats in Mexico, we spoke with Marylouise Serrato, the executive director of American Citizens Abroad (ACA), a non-profit volunteer association headquartered in Washington, D.C. that represents the interests of Americans living abroad.

“Some banks continue to turn away U.S. citizen clients,” she told us, “but ACA is seeing that more foreign banks are becoming familiar with the reporting requirements of FATCA and are requesting that U.S. clients provide them with tax compliancy documentation, such as a W-9 form, in order to maintain them as clients.”

Serrato said that to alleviate the lockout that still exists by many foreign financial institutions, ACA has proposed a “Same Country Exemption,” which would remove FATCA reporting for financial accounts located in the country where the U.S. citizen is a legal resident, for both financial institutions and individuals. The ACA proposal has been reviewed with key staff at the IRS and the U.S. Treasury department and, so far, has been well received, according to Serrato.

Foreign financial institutions have had their fair share of difficulties with FATCA since the requirement to report on U.S. accounts was implemented. Those that are fully compliant with FATCA, like the Hong Kong and Shanghai Banking Corporation (HSBC), are required by the law to collect personal and financial information from their U.S. clients and report it to the local tax authority or the U.S. Internal Revenue Service on an annual basis. The type of information they collect and report to the IRS depends on each client’s FATCA classification number and can vary between each foreign financial institution.

Adding to the problem, the IRS also has stepped up its enforcement of The Report of Foreign Bank and Financial Accounts (FBAR), which has been on the books since the 1970s, but has only recently been vigorously enforced. Smaller account holders must complete an FBAR form each year if they own or have signature authority on a foreign account that exceeds a cumulative total of U.S.$10,000 at any time during the calendar year.

“The threshold for FBAR reporting is US$10,000 cumulative, which means that accounts with smaller values need to be reported to FBAR if, combined, they exceed U.S.$10,000,” said Serrato. “FBAR also may require reporting of other financial accounts. Many U.S. citizens living in Mexico or other countries who have foreign tax-free or tax-deferred pension plans should be reporting those on an FBAR form, because the pension may not be recognized as a qualified pension under U.S. law and therefore is considered a bank or investment account.”

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Bloomberg View pointed out that the current treatment of American expat foreign pension contributions, which the IRS does not recognize in most countries, results in many Americans paying tax on their contributions, something they would not have to do in the U.S.

Penalties for undeclared accounts are US$10,000 per account and can increase if the oversight is deemed willful. ACA recommends that American expats in Mexico consult with a qualified professional about their U.S. tax filing requirements. ACA provides, free of charge, a worldwide http://www.acareturnpreparerdirectory.com/Tax Preparer Directory.

Both Bloomberg View and ACA agree that it is time for the U.S. government to change a law that penalizes America’s own citizens for making the decision to live abroad, and perhaps is forcing some to renounce their citizenship.

You can contact American Citizens Abroad (ACA) and the Association of Americans Resident Overseas (AARO) for more information and to support legislative change.