Fear of the Foreign Account Tax Compliance Act (FATCA) is forcing Americans around the world to reconsider what they tell the tax authorities about their financial affairs.
US taxpayers already have to file a Foreign Bank and Financial Accounts (FBAR) report and from July 2014, will have to consider what they need to tell the US Internal Revenue Service about their foreign holdings when FATCA comes into force.
The tightening grip of the IRS on the offshore finances of an estimated 6 million US expats in 160 countries is there to see in IRS official statistics.
In 2009, no more than 300,000 US expats filed an FBAR report.
In 2011, following publicity about FATCA across the world, the number of FBAR reports going to the IRS doubled to around 600,000.
Tax tools
FATCA and FBAR are important tools for the IRS because the USA and Somalia are the only two nations in the world to tax their expat citizens on their worldwide incomes and capital gains.
US expats in the UK need specific tax help to comply with FATCA and to manage their wealth as best they can – and they are reckoned to number around 160,000 individuals.
Because of intrinsic differences in US and British law, many tax effective devices in one country do not work in the other.
One specific problem for US expats with British pension rights has been transferring any funds into a tax-efficient US Qualifying Recognised Overseas Pension Scheme (QROPS) as the trust wrapper is not recognised under US law, which can lead to the taxing of fund growth.
Another problem is with UK investment funds, unit trusts and open-ended investment companies (OEICs), which have a different tax treatment in the US than in Britain.
Divided nations
In the US, they are considered Passive Foreign Investment Companies (PFICs). PFIC investments must be reported to the IRS and can attract income tax at 39.6%
The difference is tax treatment is complicated – but US tax is based on domicile, while UK tax is based on residence.
So, if anyone born or has become a US citizen, regardless of where they live in the world should make tax returns to the IRS and pay income and capital gains tax on their worldwide incomes.
However, only those passing the statutory residence test pay tax in the UK and foreign residents selling assets pay no capital gains tax.
Churchill once remarked that the USA and Britain were one nation divided by a common language – but perhaps he should added in the rift between the tax systems.
Minor correction: unless it has just changed, the other country that has citizenship-based taxation besides the United States is Eritrea, not Somalia. And actually I don’t think there are so many Eritrean expats that have to worry about filing tax returns, but unfortunately for us expats from America, there are a lot of us that have the burden of extra tax forms and additional payment to tax preparers even before we must pay a tax liability for income earned outside of the US (if it is over a certain level), with potential double taxation.