The costs of U.S. tax and reporting compliance
I have written a number of posts on the problem of compliance with U.S. tax and reporting requirements . Most people want to be and remain in compliance. My previous posts have opined that: the IRS and lawyer fear mongering coupled with complexity have made compliance difficult. The simple fact is that most people don’t know what to do. Taxpayers do NOT trust the IRS. Furthermore, the “not knowing what to do” is having a terrible effect on people’s lives (to the extent that they still have one). These views are echoed by the Taxpayer Advocate Report to Congress.
Interestingly, I realize that none of my posts has focused on what may be the single biggest obstacle to compliance.
It’s the cost stupid!!
I was alerted to this rather obvious point in a blog comment by Calgary lawyer, Roy Berg. He commented that:
“Perhaps this is worthy of a separate entry on your blog, though it is apropos to the high cost (in terms of professional fees) to particiapte in the OVDI and to bring unfiled returns current:
The Taxpayer Advocate Service report to the US Congress (released on January 11, 2012) is critical of the complexity and punative nature of US tax law as it applies to US citizens residing abroad. Page 154 of the report compares the average cost to prepare returns for taxpayers residing in the US and those residing abroad.
For taxpayers residing abroad return preparation can cost $1,000 to $2,000 PER RETURN (the report cites two separate studies). For taxpayers residing in the US return preparation ranges from $173 and $373 per return.
This means that participants in the OVDI (which requires filings for 8 years) should expect to incur preparation fees of between $8,000 – $16,000 for INDIVIDUAL RETURNS ONLY. If the taxpayer has a TFSA, trust, private company, private partnership, etc. these require additonal returns, which would multiply the return preparation cost accordingly.”
At this point, given the complexity of U.S. tax filings, the IRS requirement that paid preparers must be registered with the IRS, and the shortage of people willing to take this on (one CA told me that he simply will no longer accept American clients), I suspect that this $1000 – $2000 will be for the most simple returns. (For those who are either an employee or unemployed.) If you are carrying on a business (particularly if it is a corporation) it will cost much more. What does this mean in terms of the costs of cleaning up past non-compliance? What will be the accounting and legal fees? The simple reality is that most U.S. citizens do not have the money to bring themselves into compliance. Do the arithmetic and see what the minimum cost will be. The IRS has recently reopened OVDI. There are many U.S. citizens who simply cannot afford the financial cost of entering this program. What are they to do? They will simply drop out of the system and never return to the U.S. They will never apply for a U.S. passport. Those who do not currently have another citizenship will become citizens of another country. In other words, they will vanish.
Furthermore, once you pay the costs of coming into compliance, these financial costs must be incurred on an ongoing basis. The fear of IRS terrorism and anxiety will continue for life. Let’s consider this cost on an annual basis. Assume an annual cost of $2000. Tax preparation fees are not deductible under Canadian law. This means that the $2000 must be paid with after tax funds. Income tax rates are high in Canada. Assuming a combined federal/provincial rate of 33% this would mean that $3000 of your annual income is required to fund your U.S. citizenship. What does this mean? It is the cost of a vacation. It could be the cost of your car insurance. It is money that can go into your child’s RESP. It is $3000 that most people simply don’t have. Where does the $3000 go? For the most part to fill out forms which demonstrate that you owe no tax. In addition to the $3000 there is the tremendous cost of LCUs (Life Credit Units) and the tremendous wear and tear of U.S. tax and IRS anxiety.
Can you afford the financial cost filling out forms for the U.S. government? Can you afford the cost of not being able to do proper retirement planning in your country of residence? Can you afford the emotional cost and worry? Can you afford the time it takes to complete U.S. tax forms? Are you prepared to deal with the possible effects of U.S. citizenship on your marriage (if you are married to a non-U.S. citizen)? Can you afford to be discriminated against in the employment market because you are a U.S. citizen? Can you afford to deal with U.S. taxes on unearned investment income?
Only the wealthy can afford this cost. That said, the wealthy probably see far greater risks to their wealth. For the wealthy the U.S. estate tax is a huge problem. It is quite understandable that more and more people are renouncing their U.S. citizenship. It is no longer an issue of patriotism and it may be patriotic to renounce U.S. citizenship. It is no longer an issue of having emotional ties to the U.S. It is an issue of protecting yourself. U.S. citizenship is a very serious and dangerous “life liability”.
And we haven’t even considered the effects of FATCA …
FATCA – the neutron bomb of the financial system – will turn U.S. citizens into “untouchables” outside of the United States. U.S. citizens will have trouble getting basic banking services. Non-U.S. citizens will not want U.S. citizens as business partners or shareholders. The cost of IRS compliance is too great and too risky. In other words, if you think things are bad now – just wait until January 1, 2013.
U.S. citizens are being driven to renounce U.S. citizenship.
But, even this comes at great cost.
The Possible Costs of Renouncing Your U.S. Citizenship
When it comes to renunciation: if you have a net worth of under $2,000,000 you can make the break cleanly (assuming your tax filings are up to date). If your net worth is more than two million you are subjected to the exit tax. Those of you who:
- have a net worth of less than two million dollars
- who are unwilling to continue paying the ongoing costs of U.S. citizenship (including the estate tax)
- do not want to inflict the problems of U.S. citizenship on a non-U.S. spouse
- do not want to inflict U.S. citizenship on your children
- who see no other offsetting value to U.S. citizenship
should consider renouncing at the earliest opportunity.
Remember that the effects of inflation will increase the value of your assets to the two million mark. In Toronto and Vancouver a nice but unspectacular house could cost two million dollars!
Renunciation is not for everyone – Who are the people who are unlikely to renounce?
Renunciation is a very personal decision. It is clear that the IRS is “hunting” U.S. citizens living outside the U.S.
Therefore, my guess is that:
- those who have little or nothing too lose and who don’t mind paying the future compliance costs will be less likely to renounce (those who are employees or are unemployed and few assets)
- those with something to lose (everybody else) will be putting a “renunciation plan” into effect while it is still possible
I recently solicited reasons to remain a U.S. citizen. Admittedly this question was posted on the blog of the Isaac Brock Society. That said, few people were able to articulate any clear benefits to U.S. citizenship. I predict that renouncing U.S. citizenship will be a growth industry
There are few benefits to U.S. citizenship.
There are substantial costs to U.S. citizenship.
This is all because of citizenship-based taxation
All of these problems are rooted in the fact that the U.S. has a system of citizenship-based taxation. Why? Nobody knows. Certainly the U.S. doesn’t know. In fact, citizenship-based taxation is harmful to the U.S. economy. Citizenship-based taxation is eroding U.S. capital. Citizenship based taxation hurts the economy of the United States of America.
My advice: Stop citizenship-based taxation and repeal FATCA.