HR 7358, introduced on 20 December 2018, represents a watershed moment for American citizens residing OUTSIDE of the US. You can read a bit about the bill over at Citizenship Solutions – where a draft has also been posted. The official bill should be posted on congress.gov in a day or two.
This is a HUGE step forward! While the naysayers are already active on Facebook and Twitter complaining that this bill will never pass because there’s not enough time left in the current Congress, they fail to realise that any step forward is a victory. Enormous effort has gone into getting sufficient support in Congress to get this far. We need to acknowledge the significant time and effort that has been expended by people like Solomon Yue, Suzanne Herman, John Richardson, and Keith Redmond; and by organisations such as American Citizens Abroad, Republicans Overseas and Democrats Abroad. They have been working consistently over a period of years to get this far. Someone in Congress now recognises the problem – this is the first step in ultimately achieving a solution.
So, does the bill deliver what it promises?
I think the answer is mostly YES.
Essentially, any US citizen who qualifies for the foreign earned income exclusion (FEIE) and has filed all required US tax returns for the prior 3 years can elect to be treated as a qualified nonresident citizen. Qualified nonresident citizens can exclude not only foreign earned income, but also foreign-source unearned income. There is a small exception: only that portion of gains on personal property that accrued while the taxpayer was a qualified nonresident citizen can be excluded. So, if you bought shares in 1980 for $100, moved out of the US in 2019, and sold the shares for $1 million the day after you became a qualified nonresident citizen, the entire gain would still be taxable in the US.
As written, the bill applies only to US citizens residing outside the US. There is no relief for green card holders living outside the US who have not properly terminated permanent resident status. Furthermore, the 3 year compliance requirement will mean that any current expat who has avoided US compliance due to the devastating impact of PFIC, CFC, the US taxation of their foreign retirement savings, or other US tax rules, will have to weigh up whether three years of compliance is possible and whether the future benefit and peace of mind is worth the cost.
What’s the compliance burden?
Based on the plain language of the bill, most qualified nonresident citizens will have either no obligation to file Form 1040, or their taxes will be substantially simplified. The bill simply excludes foreign source income from gross income for US tax purposes. The Form 1040 filing thresholds are based off of gross income. So, add up all of your US source income (dividends from US mutual funds and US domiciled companies, rent on US real property, US trade or business income, etc.) and compare that to the threshold for your filing status.
Information returns are a bit trickier. The intent behind the bill was to avoid all US tax filing EXCEPT for taxes on US source income and an annual election to confirm eligibility for qualified nonresident citizen status. The bill’s proponents appear to be relying on the good will of the US Treasury to exempt qualified nonresident citizens from filing forms 5471, 8865, 3520, 3520A, 8621, and 8938. Perhaps it would be better to make that explicit.
And FATCA? FBAR?
The bill makes no changes to FFI reporting under FATCA or to FBAR requirements under the Bank Secrecy Act. These changes are left for a subsequent bill when, hopefully, Congress will realise that FFI and FBAR reporting of the foreign accounts of qualified nonresident citizens is superfluous as these accounts will not generate any US taxable income.
This bill is not a panacea. It does NOT establish residence based taxation – the US is still clinging on to emigrants and long-term nonresidents and insisting on an annual check-in. The Estate and Gift tax regime remains unchanged. Qualified nonresident citizen status will be denied to those who live in sanctioned countries. And three years of compliance is required to get out of the current system of worldwide taxation. As a result, there will be people who are not helped by this bill.
Another concern is what happens to the qualified nonresident citizen if they decide to become a US resident. While it appears that one portion of the bill is meant to exclude from US taxation those gains accrued while nonresident, I do not believe this section has been drafted effectively. An even bigger worry for the repatriating citizen, though, is how the US tax system will cope with all of those “foreign” assets that were acquired as a qualified nonresident. What happens to your “foreign” retirement account? Does it become a foreign trust filled with PFICs? Even if you can exclude the gain accrued prior to repatriation, you’re still stuck with reporting current gains and all of the associated information returns.
However, it is important not to throw the baby out with the bath water. HR7358 provides an important framework on which the 116th Congress can construct a bipartisan solution to the problems that have plagued US expats for decades; problems which were exacerbated by the passage of FATCA in 2010. The bill will clearly undergo some transformation before it is actually passed into law. Introduction of a bill is a HUGE step forward, but there’s still a long way to go.