Tax
A Right Royal Headache: Taxing Americans Abroad

When even a member of the British monarchy comes under the net of the US tax authority it reminds people of the American expats' plight. This article takes a trip over the terrain.
The plight of expat Americans and their difficulty in getting
financial services is a well-trodden story for this publication.
Sometimes expats must have felt that their predicament would
never become a front-page news item, but that appears to have
changed because of a new member of the UK Royal Family, American
actress Meghan Markle. No less than the wife of a prince has an
issue caused by the extra-territorial reach of the Internal
Revenue Service. The enactment of the US Foreign Account Taxation
Compliance Act – or “FATCA” – added to the pain. Organisations
such as American
Citizens Abroad have called for the US to switch to the
residency-based taxes employed by most countries around the
world. In the meantime, Americans have an issue.
Rachel Davison, a lawyer at Taylor Wessing, the
law firm, examines the area. The editors of this news service do
not necessarily endorse all views of guest contributors so
readers are welcome to respond. We are grateful to Taylor Wessing
for sharing such views on this topic. To contribute views, email
tom.burroughes@wealthbriefing.com
I'm still waiting for that wonderful moment during a pub quiz
when the question is asked: "Which two countries tax their
citizens on their worldwide income on the basis of citizenship
rather than residence?" The answer to this question, as any
self-respecting tax lawyer will know, being Eritrea and the US.
It is, perhaps, a reasonable assumption to make that Eritrea's
enthusiastic approach to taxing its citizens gives rise to fewer
headaches for individuals worldwide than the effects of the long
arm of the US Internal Revenue Service. The plight of American
citizens who are subject to US tax on their worldwide income and
gains, despite not being resident in the US, has been brought
into topical and sharp focus by the joyful nuptials between
Prince Harry (a UK resident and national) and Meghan Markle, now
the Duchess of Sussex (a US citizen and we may assume now a UK
resident).
Accidental Americans
For many people (perhaps not for the Duchess of Sussex, who will
no doubt have been carefully advised on her ongoing US tax
reporting obligations), the effect of the US's citizenship basis
of taxation can come as a horrible and expensive surprise. US
citizens and green card holders residing outside the US all fall
within the scope of US tax on worldwide income. While no accurate
estimates exist, it has been cited that there are more than three
million individuals living outside the US who are in default of
their US tax and reporting obligations. Some US citizens who move
away from the US do not realise that they must continue filing
returns and paying tax in the US.
However, a more commonly encountered situation is of those
individuals who are completely unaware of their US citizen status
and may, in fact, never have lived in the US. Take the example of
our fictitious Mr John Doe, born in the UK to a UK citizen father
and a dual US/UK citizen mother. John's mother left the US
in her mid-twenties, while John has never stepped foot in the US
and has never held a US passport. I have come across this
scenario enough times with UK resident clients to know that given
John Doe's fact-pattern, he may well be a US citizen.
Compliance headaches
What are some of the practical implications for the individual
living in the UK who finds out that they're a US citizen?
Staying with our friend, John Doe (who happens to be a very
wealthy man with assets held worldwide), who is advised that he
is indeed a US citizen, he discovers that, as a result of his US
citizen status, he has inadvertently defaulted on filing previous
years' US tax returns in which he should have been reporting his
worldwide income and gains.
Furthermore, John Doe may well have been defaulting on his US
reporting obligations under the Report of Foreign Bank and
Financial Accounts rules (returns made in compliance with these
rules referred to as FBARs). These rules require US persons
to report to the IRS in each tax year the values in bank,
brokerage or other financial accounts located outside the US in
which that person has a 'financial interest' or 'signature
authority', where the aggregate value of such accounts exceeds
$10,000 at any point in the previous tax year. For those married
couples (such as Prince Harry and Meghan) where only one of the
couple is a US person, this can mean that a joint interest in a
foreign bank account is fully reportable under the FBAR rules,
even if that account was entirely funded by the non-US person
spouse. The financial penalties for failing to submit FBAR
reports can be hefty, and in certain circumstances, may end up
being assessed as half of the maximum balance (during the year in
which no report was made) in the unreported financial
account.
John Doe's situation may become bleaker still if he has
reportable interests in any non-US incorporated companies that
fall within the US's rules for the taxation of Controlled Foreign
Corporations (CFCs) or Passive Foreign Investment Companies
(PFICs).
It is not just the IRS that can give those US citizens living in
the UK a headache. Many individuals are fully aware of their US
person status, and have taken professional US tax advice so that
they are fully compliant with all of their US reporting
obligations. Unfortunately, the interaction between the US and UK
tax systems can sometimes throw up unexpected (and again,
expensive) issues. An example of this is the US citizen who,
while living in the US, puts in place a comprehensive US estate
plan further to the advice of his US lawyers. Part of that estate
plan involves the substantive funding by the US individual of a
lifetime trust, of which he acts as sole trustee. This individual
subsequently moves to the UK without taking any UK tax advice
until after he has become a UK tax resident. When he finally does
take some UK tax advice, he is horrified to discover that his US
lifetime trust has become UK tax resident on account of his role
as trustee and his own UK tax residence status. A costly
bill from HM Revenue & Customs may follow.
Transparency initiatives mean nowhere to
hide
It is no exaggeration to state that the advent of worldwide
transparency initiatives (under which international tax
information exchange between certain jurisdictions is made
obligatory) means that it is now more unwise than ever to put
one's head in the sand regarding potential historic tax
issues.
For US persons living abroad, the Foreign Account Tax Compliance
Act requires financial institutions outside the US to provide the
IRS with information on financial accounts held by US nationals
and residents. Transparency initiatives such as this, combined
with a reluctance on the part of tax authorities to enter into
benign tax settlement agreements with taxpayers under amnesty
programmes (the US closed its Offshore Voluntary Disclosure
Programme on 28 September this year), mean that it is now more
imperative than ever that international individuals are fully
aware of their worldwide tax and reporting obligations, and take
advice accordingly.