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Accidental Americans: The US Citizenship Conundrum

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About The Author

Keir Baker (Regular Writer)

Keir is currently in his second year of studying law at Selwyn College, Cambridge University. Outside the realm of law, Keir is the goalkeeper for Selwyn College’s football, hockey and water polo teams and a keen actor and pianist. He is also a long-suffering supporter of Middlesbrough FC.

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Image © Boston Harborfest on Flickr

You can always count on the Americans to do the right thing – after they’ve tried everything else

Winston Churchill

It is a largely unknown fact that a person born in the US becomes subject to its jurisdiction, no matter the associations they keep with the country throughout the rest of the life. As Eric Foner explains, ‘birthright citizenship does make the United States (along with Canada) unique in the developed world. No European nation recognizes the principle.

Birthright citizenship has many implications. For example, it can lead to the imposition of the typical duties and obligations of citizens onto individuals who have never lived or worked in the United States and do not hold a US passport; their only link with the country is that it is their birthplace.

And there is one such obligation that recently has led to serious repercussions being felt around the world: taxation.

The United States of America is one of the only countries on Earth which imposes citizenship-based taxation (CBT), rather than residential-based taxation (RBT). In the UK for example, the RBT system does not require its citizens who are not residing in the country to pay tax.

In contrast, the American CBT system requires that all American citizens – no matter where they live – pay income tax. As a result, all US citizens are obliged to make annual declarations to the Internal Revenue Service (IRS), with financial penalties theoretically applicable to those who failed to comply.  However, before 2010, it was estimated that only around 6% of the seven million Americans who lived overseas were making such declarations.

In response to such figures, as well as the public outcry over the 2009 UBS tax fraud and evasion case (which involved US resident tax payers hiding funds offshore), the US Congress enacted the Foreign Account Tax Compliance Act 2010 (FATCA) with the aim of targeting tax avoidance by American citizens using foreign bank accounts. This new law has extraterritorial effects, and requires financial institutions across the whole world to identify potential US citizens and report them to the IRS. If they fail to comply - even overlooking just one US citizen - the institutions themselves will be subject to a ruinous 30% tax on payments made to them by US payers. This tax, if and when applied, is intended to exclude companies who fail to comply with FATCA from access to critical U.S. financial markets, by preventing these financial institutions from transacting in US dollars.

Essentially, America has outsourced its tax policing to overseas companies by using disproportionate penal fines. Regrettably, this has proved effective. In 2014, more than 77,000 financial institutions agreed to pass information to the IRS. This was problematic for many American citizens living abroad who were not fully aware of their US citizenship statutes or the change in the tax law, when their banking institutions identified them as Americans and imposed on them the resulting tax obligations. The reality is for them issues of data protection, invasions of privacy and potential financial ruin have suddenly - out of the blue - entered their lives.

The US State department has failed to recognise these people as citizens and, in some instances, issued them with tourist visas to the US for decades. Yet in the eyes of IRS, their American citizenship is now valid, and they are liable to pay tax. Unaware, unsuspecting and unprepared, these unfortunate people are trying to avoid financial ruin caused by obligations that they could have never anticipated: they are the ‘Accidental Americans.’

As financial institutions in Europe and other regions deny ‘Accidental Americans’ access to certain financial services for fear of activating the 30% tax penalty, US citizens are - in effect - being actively discriminated against. Some banks have chosen to kick out their Americans clients rather than comply. This has caused severe harm to the financial security of those who were unaware about their status as American citizen.

This article aims to examine (and publicise) their plight, and examine the serious issues with America’s draconian attempt to clamp down on tax evasion.

Data Protection Issues

The implications of FATCA in requiring foreign financial institutions to identify potential US citizens and hand over financial and other information to the IRS based on certain criteria – birthplace, US address, US phone number – is significant breach customer confidentiality. By disclosing private information to a foreign authority, this raises complex issues under data protection laws across the world, alongside the potential breaching of the human right to privacy enshrined in European law. In theory, ‘Accidental Americans’ should be safe in the knowledge that the data protection laws of their country would protect their confidential information from being handed over to third parties but this is not the case.

Because of the devastating potential of the 30% tax, the governments of more than 80 countries have reluctantly agreed to collate the data from their local entities and pass it on to the US tax authorities, thereby allowing their financial institutions to comply with FACTA. Many governments - including the UK’s - have signed up, either without considering the rights of the individuals affected, or following what essentially amounts to coercion. Even the Chinese and Russians have signed; the latter exemplifying the ‘carrot and stick’ approach the US has used to secure worldwide implementation. In March 2014, the US and Russia were negotiating a FATCA deal but Russia’s annexation of Crimea caused the US to suspend talks, meaning Russian financial institutions faced being frozen out of US markets. Russia took last minute action to allow Russian banks to send American taxpayer data to the US and maintain an open banking relationship between the two countries.

All these special side-agreements between the US and signed up countries are not only devastating for individuals caught in the situation, but also have bigger implications in terms of human right principles; all of which have slipped under the radar of the press; there has been surprisingly little publicity bringing attention to this breach of privacy. Importantly, FACTA provides no guarantees as to how that very confidential information (names, addresses, relationships, income, and bank account numbers) will be safeguarded in the US, and it is unclear how the IRS will process all this information about millions of people. Identity theft, if collected data is not handled with the upmost security, could potentially be a significant issue, compounded by the fact that the IRS has suffered severe breaches of its data stores in recent months.

Worryingly too, in Schrems v Data Protection Commissioner [2015], whilst the European Court of Justice condemned the US practices and deemed it an unsafe for European digital data, the tax information compiled under FATCA was excluded from the ruling.

For ‘Accidental Americans’ the scale of the breach of privacy is huge and wholly disproportionate to the circumstance of being born on US soil, with two issues in particular in need of consideration. Firstly, they are required to provide documentary evidence of the life lived outside the US, which can involve passing over details including phone numbers and addresses. Secondly, there are compliance rules known as FBARs (Report of Foreign Bank and Financial Accounts) to be negotiated. These disclosure rules apply to any US person with $10,000 held outside the US, requiring the disclosure of all accounts, investments and insurances. This hits ‘Accidental Americans’ hard - all their assets are outside the US and they are required to potentially forfeit their right to privacy, by disclosing the location and value of their life's savings to the US. This is all worsened by a potential fine of $10,000 per account hanging over the process.

Financial Security Issues

The effects of FATCA on the financial security of many ‘Accidental Americans’ is significant. The consequences (which are listed below) of being treated as a US citizen are not only life-changing, but life-threatening.

  1. Closure of Bank Accounts: European banks do not want to have the complex reporting requirements imposed by FATCA for US citizens so they ask those clients to close their accounts.  ‘Accidental Americans’ are therefore not only unable to use banking services, but insurance and mortgage services too. Joint accounts held with non-US spouses are equally affected.
  2. Inability to Open Bank New Accounts: Many foreign financial institutions are refusing to allow US citizens to open replacement bank accounts for identical reasons to that of the bank account closures. Indeed, until the European Payment Accounts Directive comes into force in late 2016, there is no right to a bank account in European law, whilst for non-European ‘Accidental Americans’, this right may never come into existence. Others have had their inheritance blocked as banks have refused to open the necessary probate accounts.
  3. Narrowing Employment Opportunities: Due to FBAR disclosure requirements, US citizens must disclose all accounts over which they have signing rights. As a result, many corporations and companies do not want US citizens in responsible positions where they have signing power for corporate funds because this would entail full disclosure of the company's accounts. FATCA is adding further burdens to US citizens working abroad.
  4. Blocking of Investments: Under Dodd Frank and other investment rules, US citizens are not permitted to make certain kind of investments, meaning that the ‘Accidental American’ is thrown out of pension funds and other investment saving plans available to other European citizens.
  5. Double Taxation: FATCA does not change tax law but it has enabled the US to conduct a tax census on a global scale. The lack of respect shown by the US for other countries' tax breaks and retirement saving schemes will destroy the retirement plans of individuals working and resident outside the US. While the US will tax many non-US retirement pensions as though they were a corrupt pension fund, the US will not provide any benefits in compensation as these ‘Accidental Americans’ have not contributed to the US social security system.
  6. Advisor Costs: This situation is so complex – compounded by the fact that many ‘Accidental Americans’ do not speak English - that some professional help is often always needed to navigate the tax and compliance rules. The costs for this can often be substantial.

The negative financial effects are not just restricted to the ‘Accidental Americans.’ Their countries also suffer, as FATCA represents a raid on resources which European states have encouraged their citizens to save so as to be able to be financially independent in old age. The double tax treaties do not recognize European tax breaks, so the financial support which European governments give their citizens will now be transferred to the US coffers. The burden of filling things such as pension gaps will fall to the European states in which these people are resident and to which they have contributed. Commonwealth countries are also being adversely affected in a similar way, among them Canada and Australia.

Meanwhile, as was written in an editorial for The Economist,

the drug dealers and sophisticated tax evaders who inspired all this will switch into non-financial assets, such as art and property, or hide behind shell companies and trusts. The latter would be easier to penetrate if reliable ownership information were collected, but often it is not—and America is one of the worst laggards (see Delaware, Nevada and all the other money-laundering paradises within its borders).

Giving up US Citizenship

At first sight, there seems naturally to be an obvious solution for ‘Accidental Americans’: they can renounce their citizenship and free themselves from all these obligations. Indeed, more than 3,000 people have done so in 2015. Granted, the paperwork is probably irritating and it may take a while to process, but it would be assumed that it would not be too straining, mentally or financially. However, to exit the social contract with the US, you must renounce citizenship formally, via a process for which the description ‘complicated and expensive’ is an understatement.  

Apart from a series of reportedly confrontational interviews to justify the desire to renounce citizenship, there is a high fee (which stands at $2350, a rise that came into place in September 2014 – until 2010 this service was free, but it is now the highest renunciation fee in the world).

But to have complied with these filing requirements, a social security number is also required. Most ‘Accidental Americans’ therefore have to get further into the system before they can get out. According to PWC's website, the cost of hiring a tax adviser to help prepare a simple annual tax return with no tax owing will be around $10,000 per filing. It follows therefrom that the cost of a tax adviser to help negotiate the renunciation process is a significantly heavier burden, even where there is unlikely to be any actual income tax to pay. The US can also blacklist renouncers. 

As a result of all these issues, for many the renunciation of an accidentally-acquired US citizenship is not a viable option. The vast majority do not have either the expertise or finance available; the only solution available for them is the US Government, or the governments of their own countries, entering the debate.

A Solution

As far as solutions go, there have been some proposed but all are complex and unlikely to transpire – particularly given the lack of publicity and public outcry on the issue. Respite seemed to be on the cards in February 2015 when President Obama proposed a narrow – but nonetheless helpful – amnesty for ‘Accidental Americans’ in his 2016 budget proposal. Disappointingly however, he failed to enact it.

Individual governments could negotiate with the US Government for an amnesty for their ‘Accidental Americans’ who are suffering from this imposed citizenship and the penalties of tax compliance, and could also help enable those innocent accidental citizens caught in FATCA's net to renounce citizenship in a simple way on a “no fee, no taxation” basis. This could be done via an international treaty - equivalent to that the US has with Canada - whether it be bilateral or on a wider scale; after all, this is not an issue affecting the citizens of just one country alone and so co-ordination between states to address the combined effects of FATCA and US tax law would surely influence the US to correct its position.

It is a solution with precedent given that there are already treaties in existence between the US and some countries which regulate taxation. For example, articles 24 and 26 of the current tax treaty between Canada and the United States clearly gives the competent authorities latitude to solve double-taxation problems like those that have arisen under FACTA by stating that the competent authorities ‘may consult together for the elimination of double taxation in cases not provided for in the Convention.’

A further solution could be that the US changes its tax laws from a CBT-based system to an RBT-based system, which would make FATCA rules apply only to US residents, and also exempt ‘Accidental Americans’ who might have a very tenuous historic connection to the US, but have never sought to exercise it. This would bring the US’s tax laws in line with the rest of the world, and would solve the current financial and tax burden because only those who live in the US would need to pay US tax and comply with FATCA if they have overseas investments.

The final possibility would be to simplify the renunciation process. If the regulatory burdens on non-resident US citizens make it effectively impossible to live with that status, then it follows therefrom that those citizens have the right to an easy and harmless (financially and mentally) way to remove that status. Whilst the time and administrative fees may be a necessary by-product of such a process, the $2,350 renunciation fee is nothing more than a violation of the right to change one's nationality - a right not only enshrined in US law, but also a basic and fundamental tenet of human rights and freedoms.

Conclusion

Ultimately, it is worth stressing that this is a very human issue, causing distress and worry to thousands of people across the world. A page on Facebook is devoted to shedding light on people’s stories, and in many cases makes for a distressing read. The ‘Accidental Americans’ never applied for a US passport, never exercised any vote in the US, never taken any step as adults that could be regarded as exercising a right of US citizenship but have been caught up in a legal net which was not designed to catch them and the implications are far-reaching. Their only connection to the US is the event of birth. They are tax compliant in the countries they do live in and work in. And through no fault of their own, they face crippling financial ruin, and the distress and worry that comes with it.

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Tagged: International Law, Tax Law

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