This article originally appeared in the January 24, 2022, issue of Tax Notes Federal.
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Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University in New York.
In this article, Zelinsky examines the Tax Simplification for Americans Abroad Act (H.R. 6057) and argues that the tax compliance burden for U.S. citizens living abroad can and should be reduced.
The Tax Simplification for Americans Abroad Act (H.R. 6057), introduced by Rep. Donald S. Beyer Jr., D-Va.,1 would amend the Internal Revenue Code to require the IRS to simplify the income tax reporting requirements for many American citizens living outside the borders of the United States. The policy reflected in H.R. 6057 is compelling: The tax compliance burden for U.S. citizens living abroad can and should be reduced.
However, amending the code is not necessary to achieve this simplification. The IRS can itself accomplish the simplification sought by H.R. 6057. Hopefully, the introduction of this legislation will spur the IRS, on its own initiative, to streamline the income tax reporting requirements for U.S. citizens who reside abroad. A side benefit of that effort would be tax reporting simplification for U.S. citizens living at home.
Taxing U.S. Expatriates Worldwide
The United States taxes the worldwide incomes of all its citizens, including those living outside the country.2 The global income taxation of U.S. expatriates has both its defenders3 and its often outspoken opponents.4 Among other arguments, those supporting the worldwide income taxation of U.S. citizens residing abroad cite the perceived benefits of U.S. citizenship enjoyed by citizens while they live overseas, as well as the administrability of citizenship-based taxation. When a person’s residence or domicile is the basis for income taxation, the taxpayer and the tax collector can be enmeshed in fact-specific inquiries about the taxpayer’s lifestyle and intent. In contrast to residence or domicile, citizenship provides a more predictable basis for the assertion of income tax jurisdiction because there is typically little doubt about an individual’s citizenship.
On the other side of the ledger, critics of the United States’ worldwide income taxation of expatriated citizens assert that it is unfair for the United States to tax its citizens while they reside abroad. These critics also contend that citizenship-based income taxation violates international tax norms and practices, under which an individual’s income is taxed based on her residence, not her citizenship.
A particularly telling argument advanced by critics of citizenship-based taxation is that for many expatriates, compliance with U.S. income tax law is too complex and expensive. This critique carries particular force for expatriates of modest means.
A review of the forms the IRS has promulgated confirms the validity of this critique. Those (such as me) who support the current law’s worldwide income taxation of U.S. citizens residing abroad should support efforts to facilitate compliance with that taxation by simplifying the income tax reporting required of expatriates.
Forms 2555, 5471, 1116, and 1040
Consider first Form 2555, “Foreign Earned Income.” Section 9115 permits a U.S. citizen residing outside the borders of the United States to annually exclude from gross income up to $108,7006 of compensation earned abroad, such as “wages, salaries (and) professional fees.”7 Section 911 also permits the exclusion from gross income of housing allowances received by U.S. expatriates.8 Form 2255 implements these exclusions.
The detailed data entries of Form 2555 are designed to ensure that a U.S. citizen claiming section 911’s exclusion for foreign earned income is a bona fide foreign resident entitled to that exclusion. But the result is a form of often inordinate complexity, particularly for individuals of relatively modest means.
The burden imposed by Form 2555 could be reduced. For example, the IRS could require U.S. citizens residing abroad to file Form 2555 periodically, perhaps every five years. In between, a U.S. citizen with modest income claiming the section 911 exclusion could file a simple annual statement confirming that neither her foreign residence status nor her level of foreign earnings has materially changed since Form 2555 was last filed.
A useful model in this context is the annual Form 990-N (e-Postcard) return that small nonprofit organizations can use instead of filing a complete Form 990, “Return of Organization Exempt From Income Tax.”9 Just as this yearly e-Postcard return reduces tax compliance costs for small nonprofits, the IRS could permit U.S. citizens who live abroad and have limited incomes to file annual e-Postcard returns affirming for section 911 purposes that neither their foreign residence status nor their income levels have changed.
Besides requiring simplified reporting forms, H.R. 6057 would also expand the definition of the income excludable under section 911.10 Insofar as that legislation would permit U.S. citizens living abroad to exclude from U.S. income taxation pension, retirement distributions, and disability and unemployment payments, that expansion sensibly implements the policy now reflected in section 911 — to permit U.S. citizens residing abroad to avoid U.S. tax on a basic amount of labor-based income earned abroad. Pension and retirement distributions are deferred wages, while disability and unemployment payments are wage substitutes. These forms of income fall comfortably within the ambit of section 911’s exclusion of earned income.
H.R. 6057 would also extend the exclusion of section 911 to investment income, particularly to capital gains, dividends, and interest.11 This change goes beyond tax reporting simplification and would fundamentally alter the substance of section 911, turning it from an exclusion for labor-based income earned abroad to an exclusion for capital-based income as well. That change may (or may not) be appropriate, but it should be addressed separately from the question of streamlining income tax compliance for U.S. expatriates.
Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations,” is another daunting income tax form, filed by many U.S. citizens living abroad as well as by citizens who live at home. Form 5471 requires detailed disclosure about foreign corporations and the stockholdings of U.S. persons in foreign corporations.12
A foreign corporation is a legal person beyond the jurisdiction of the United States. Thus, a U.S. citizen could avoid U.S. taxation by transferring income-producing assets to that foreign corporation and letting the corporation accumulate income abroad beyond the reach of the IRS.13 Today, an important way the code combats this kind of tax avoidance is through the concept of a controlled foreign corporation.14 A CFC is a foreign corporation more than 50 percent owned by U.S. shareholders.15 Form 5471 implements the concept of a CFC by requiring U.S. shareholders to disclose their interests in foreign corporations.
A possible simplification in this context might be the same as my recommendation for streamlining Form 2555: Taxpayers of modest incomes would initially file detailed disclosures on Form 5471 but could thereafter file a simple e-Postcard every year, affirming that they have no material change to report.
Alternatively, the IRS could take a hard look at the many entries on Form 5471 and significantly reduce the information to be reported by U.S. citizens who have limited incomes. Perhaps this simplified Form 5471 would merely require U.S. citizens to list the foreign corporations in which they or family members hold stock. Perhaps the IRS could adopt both approaches, creating a simplified Form 5471 for qualified taxpayers and then permitting annual e-Postcard affirmations that nothing has changed.
Form 1116, “Foreign Tax Credit (Individual, Estate, or Trust),” pertains to the credit against U.S. taxes for foreign income taxes paid by U.S. citizens.16 It is also a daunting document. Form 1116 must be filed by U.S. citizens who reside abroad and take a credit against their U.S. tax liability for the foreign taxes they pay. It must also be filed by U.S. citizens who live at home, pay foreign income taxes on foreign-source income, and claim a credit against their U.S. tax liability for those foreign taxes.
In this context, a somewhat different approach to simplification may be in order. In particular, if in any year a U.S. citizen claims a relatively small credit — for example, $5,000 or less — that citizen should be able to make that claim on a simplified form. Because U.S. citizens who reside at home also file forms 5471 and 1116, simplified reporting should extend to them as well.
Consider finally the workhorse form of the federal income tax system, Form 1040, “U.S. Individual Income Tax Return.” Given the expanded standard deductions established by the Tax Cuts and Jobs Act,17 as well as the section 911 exclusion of foreign earned income and the FTC, many U.S. citizens living abroad owe no net U.S. income tax. For some of these expatriates, a simplified Form 1040 would be appropriate. I suggest a simple Form 1040 for a U.S. resident living abroad who has an annual gross income of less than $50,000 if that resident can certify that, between the section 911 exclusion, the FTC, and the standard deduction, no U.S. income tax is owed. For expatriates of modest incomes, this simplified Form 1040 should be the only tax return they need to file.
Conclusion
Simplifying the tax reporting obligations of U.S. expatriates will not reconcile many opponents of citizenship-based taxation to that policy. Simpler reporting forms will not placate those who believe, on tax policy grounds, that it is wrong for the United States to tax any income earned abroad by expatriated citizens. Nor will that compliance simplification appease U.S. citizens whose foreign earned income exceeds the limits of the section 911 exclusion or who receive significant income that is subject to U.S. taxation because they pay little or no foreign taxes on this income. For these opponents of the United States’ worldwide taxation of all citizens’ incomes, the issue is not compliance costs but the net contribution they are required to make to the federal fisc.
Still, simplifying the tax compliance obligations for many U.S. citizens living abroad is the right thing to do and can be accomplished by the IRS acting on its own initiative. H.R. 6057 highlights the problem but is not necessary to the solution. If the IRS streamlines forms for U.S. citizens living abroad, particularly those of modest incomes, a side benefit will be reporting simplification for U.S. citizens residing at home as well.
FOOTNOTES
1 H.R. 6057 (117th Cong., 1st Sess.); cosponsors are Reps. Dina Titus, D-Nev.; Carolyn B. Maloney, D-N.Y.; and Maria Elvira Salazar, R-Fla.
2 Reg. section 1.1-1(b) (A U.S. citizen “wherever resident” pays tax on income “from sources within or without the United States.”). The seminal decision sustaining the United States’ worldwide taxation of its citizens living abroad is Cook v. Tait, 265 U.S. 47 (1924).
3 See, e.g., Edward A. Zelinsky, “Defining Residence for Income Tax Purposes: Domicile as Gap-Filler, Citizenship as Proxy and Gap-Filler,” 38 Mich. J. Int’l L. 271 (2017); Zelinsky, “Citizenship and Worldwide Taxation: Citizenship as an Administrable Proxy for Domicile,” 96 Iowa L. Rev. 1289 (2011); Young Ran Kim, “Considering ‘Citizenship Taxation’: In Defense of FATCA,” 20 Fla. Tax Rev. 335 (2017); Michael S. Kirsch, “Revisiting the Tax Treatment of Citizens Abroad: Reconciling Principle and Practice,” 16 Fla. Tax Rev. 117 (2014).
4 See, e.g., Ruth Mason, “Citizenship Taxation,” 89 S. Cal. L. Rev. 169 (2016); Reuven S. Avi-Yonah, “The Case Against Taxing Citizens,” Tax Notes, May 10, 2010, p. 680; Laura Snyder, Karen Alpert, and John Richardson, “Should Overseas Americans Be Required to Buy Their Freedom?” Tax Notes Federal, July 12, 2021, p. 223. For a spirited debate on citizenship-based taxation between Richardson and me, see TaxConnections Inc., “Citizenship and Worldwide Taxation: Is It Morally Justified or Unjustified?” YouTube, May 17, 2019. These discussions sensitized me to the need to simplify tax compliance for expatriates.
6 Rev. Proc. 2020-45, 2020-46 IRB 1016, section 3.39 (adjusting the section 911 exclusion for foreign earned income for the cost of living).
7 Reg. section 1.911-3(b)(1).
8 Section 911(a)(2); see Notice 2021-18, 2021-18 IRB 911 (establishing section 911’s housing allowance for specific foreign countries).
9 IRS, “Annual Electronic Filing Requirement for Small Exempt Organizations — Form 990-N (e-Postcard).”
10 H.R. 6057, section 3 (amending section 911).
11 Id.
12 IRS, “Instructions for Form 5471,” at 3-5 (“Who Must File”).
13 See Alvord v. Commissioner, 277 F.2d 713, 718-719 (4th Cir. 1960) (discussing the history of and reasons for the code’s foreign personal holding company rules).
15 Id.
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