America's Punishing Worldwide Tax Scheme
You know who's really thrilled about American actress Meghan Markle's engagement to Britain's Prince Harry? Uncle Sam. Although Markle will live in the U.K., Washington will get a cut of her income, because Americans owe taxes on money earned abroad.
Even if Markle becomes a British citizen, she will be required to file a tax return in the States unless she also renounces her U.S. citizenship. Depending on her levels of assets, she may have to share very private information about her holdings.
There are some advantages to matrimony with a prince. If she were marrying a regular Jack, she would also find it hard to open a bank account in the United Kingdom: The Foreign Account Tax Compliance Act (FATCA), which was enacted under Obama, deputizes overseas financial institutions to snoop on and collect taxes from Americans, making banks reluctant to take on U.S. clients. But she will still suffer under a tax regime that is all but unique to the United States.
Until recently, only five of the 33 countries belonging to the Organization for Economic Cooperation and Development (OECD) had a worldwide tax system for corporations. Just one other country, Eritrea, has a citizen-based individual tax scheme. America's policy is a legacy of the Revenue Act of 1862, which implemented the collection of taxes from Americans regardless of where they reside to discourage draft dodgers from fleeing to Canada during the Civil War.
This is how it works: If you're an American living and working abroad, you report your income in that country and pay taxes to that government. You must then pay U.S. taxes on the same income. Yes, there is an exclusion for foreign earnings of about $100,000. And yes, you get a tax credit for the foreign taxes paid. If you're lucky, filing the U.S. return is simply a time-consuming hassle. But depending on your income level and location, the tax credit may be too small to let you avoid paying extra taxes to the IRS. And if your assets are above $300,000, there are additional forms to file and taxes to pay.
FATCA is best described as the ugly love child of Uncle Sam and Big Brother. Passed in 2010, it requires law-abiding Americans with legitimate bank accounts outside the country and foreigners working in the United States to turn over information about overseas holdings above $50,000. The far-reaching law forces a variety of institutions to hand over private bank data about depositors, without a warrant and independent of any suspicion that a tax crime has been committed.
I don't expect Markle to be exempted from this violation of privacy, since foreign banks face steep penalties for not complying with the law. And if she's found to be non-FATCA-compliant, she could be hit with a 30 percent withholding tax on her U.S. earnings.
If the actress gives up her American citizenship, of course, the punishing tax treatment goes away. Some 5,411 people did that in 2016. Although this is understandable, it remains a costly move that involves relinquishing part of your identity. As much as I despise the French government, I was grateful not to be forced to renounce the citizenship of my birth when I became an American.
If you aren't rich or royal, you may also find the $2,350 it will cost to return your passport hard to stomach. According to State Department data, that fee is $2,236 more than the average imposed by other high-income countries.
Get ready as well to prove five years of IRS compliance—a potentially expensive project—before being freed from the American taxman's grasp. And if your net worth is greater than $2 million, you may even be hit with an exit tax.
The good news is that the recently passed Republican tax reform package partially shifted the country to a territorial tax system. The bad news is that it only benefits companies; lawmakers have expressed no intention of fixing the individual side of the code. But wouldn't that make a nice royal wedding gift from Uncle Sam?
This article originally appeared in print under the headline "America's Punishing Worldwide Tax Scheme."
