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Nowhere to Hide, or Tax Dilemma for US Expats
Art Franczek
Artwork by Elena Krivovyaz

Ben Franklin once said “nothing in this world is certain but death and taxes”. He must have been thinking about the modern US tax system. Most countries in the world have an income tax that is levied on its tax residents. The general definition of a tax resident is someone who resides in the country for 183 days or more. If an expat works in Russia and resides here for 183 days within a 12 month period he/she is considered a tax resident and is taxed at a rate of 13% of income generated from services performed in Russia. If however he/she resides in Russia less than 183 days they are taxed at a rate of 30%.

There are few countries that levy income tax not only on residency but also on the basis of citizenship. One of these countries is the Belarus, another is North Korea and of course the United States. Under the Internal Revenue Code residency is based on the number of days an individual resides in the US over a 3 year period. US citizens or Green Card holders are subject to US income tax on their worldwide income regardless of how many days they reside in US. Section 911 of the Internal Revenue Code allows an exemption from US taxation of $91,400 of their foreign earned income if the individual meets the Bona Fide residence test for which there are a number of criteria. The other test that can be used to qualify for the $91,400 exclusion is the Physical Presence test which requires that the taxpayer live outside the United States for 330 days out of the previous 12 month period. There is some debate as to what constitutes a foreign country for purposes of a 911 exclusion. Recently the US Tax Court decided that Antarctica was not a foreign country so the taxpayer who worked there was denied a 911 exclusion. US citizens who qualify for the 911 exclusion can also exclude up to $90,900 from their taxable income for housing expenses. It must be noted that the $90,900 housing exclusion applies to those who reside in Moscow. The IRS stipulates a different housing exclusion for each country. Several years ago the IRS set a limit of $12,000 for the housing exemption. This created a great uproar among US expats living in Moscow because it meant that their US tax liability would increase by about $25,000. After a strong lobbying effort by the US business community and letters to the Secretary of Treasury the housing exclusion was increased to $90,900.

Let’s assume there are two expats living in Moscow for 330 days in 2009 and earning each $500,000. Ian is from the UK and Joe is from the US.

As we can see from this example the US expat pays an additional $70,000 in tax because he is subjected to income tax on his worldwide income even though he may have resided in the US for only 30 days during 2009. Ian as a citizen of the UK pays only Russian tax because he is a tax resident of Russia and not the UK.

  Ian (UK) Joe (US)
Income $500,000 $500,000
Russian tax 13% $65,000 $65,000
Additional US tax   $70,000(a)
Total income tax for 2009 $65,000 $135,000

(a) Additional US tax is computed as follows:

$500,000 - $90,000 (911 exclusion) –$90,000 (housing exclusion) x .35(US rate) = $112,000 (total US tax ) - $42,000(credit for Russian tax ) = $70,000

The previous example illustrates why many US expats renounce their US citizenship. For example a few years ago William Browder renounced his US citizenship to become a citizen of the UK, ostensibly because he felt more comfortable in the UK. I seriously doubt that was the main reason. I know US expats in Moscow who have also renounced their US citizenship, supposedly because they didn’t like the war in Iraq and again I have my doubts if this was the primary motivation. Thousands of US expats renounce their US citizenship each year. Most of these people are wealthy individuals who want to avoid taxes and live on the beaches of the Bahamas, or perhaps they purchase citizenship in St. Kitts. Prior to 2008 wealthy US expats who renounced their citizenship were required to file a US tax return for 10 years after the date they renounced their citizenship and they were not allowed to enter the US. In 2008 the rules for expats surrendering their citizenship with a net worth of $2,000,000 or more or a high income had to act as if they sold their worldwide assets at market value and to a tax on the gain. The new rules are described as an exit tax and provide a cleaner break from the US than the previous rules. Many younger US expats who are early in their careers use the new expat rules so they can avoid US taxes and they are not wealthy enough for the exit tax to be applied.

Wealthy people everywhere don’t like to pay taxes, certainly that is one of the reasons why they are wealthy. These people have bank accounts in Cayman Islands, Bermuda, Switzerland etc., where the local governments have very strong laws on bank secrecy and low or no taxes. The OECD estimates that 5-7 trillion dollars are deposited in tax haven bank accounts, hedge funds etc. In today’s crisis-ridden world the IRS and its European counterparts are looking for new sources of revenue. Recently, the IRS forced UBS, Switzerland’s largest bank to pay a fine of 780 million dollars and to release the names of 5000 US citizens who had bank accounts at UBS. The UBS case was the result of information turned over to the IRS by a whistle-blower that was paid by the IRS. In this case it was revealed that UBS bankers were recruiting rich American clients by attending yachting regattas, golf and tennis tournaments and “anywhere the rich hangout”. These UBS bankers explained exotic tax evasion schemes that UBS could facilitate. UBS bankers even served as couriers to avoid money transfers that might be detected by US surveillance. The IRS subpoenaed the names of UBS’s US clients. UBS vehemently protested claiming that the IRS subpoena violated Switzerland’s strict banking secrecy laws. UBS relented when the IRS threatened to revoke its right to do business in the US. The IRS currently requires that US citizens who have foreign bank accounts with balances in excess of $10,000 must file form 90-22, in addition the foreign banks are required to report on form 1099 the interest that is earned on these accounts. As we can see from the UBS case, the IRS is getting more serious and sophisticated in its enforcement procedures. The once invulnerable Swiss banking secrecy laws are giving way to governments desperately in search of new revenues.

The Europeans are also cracking down on banking secrecy and tax evasion, and the German authorities are considering purchasing a stolen database of German residents who have bank accounts in UBS. The G20 recently promised to stop the rich from salting away vast sums of money in offshore tax havens. The latest report of the G20 indicates that many new countries have relaxed their bank secrecy laws and established procedures for exchanging information. The trend against tax evasion is unstoppable and in the future those who wish to evade taxes either by expatriation or secret bank accounts will have no place to hide.

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