US Taxation and Overseas Activity


US Taxation and Overseas Activity

The USA is more aggressive than almost all other nations with regard to taxing its citizens who live or do business overseas. This post will discuss two areas: the corporate tax and the rules for individuals living overseas (from personal experience).

Corporate Tax

The USA is unusual in two ways with regard to corporate taxes.

  1. The corporate tax rate (35%) if very high, among the highest in the world. When including state and local income taxes, the US might have the highest rate in the developed world. This encourages companies to locate their headquarters and development and manufacturing in other countries.
  2. The USA requires that US based corporations pay tax on income derived in foreign countries. In other words, if a US based company has a manufacturing plant in say, France, and sells in France, then the company is required to pay tax on what they earn on those operations. The US company only pays tax on such foreign income if they bring the money back to the US. This has a perverse incentive in that companies are encouraged to keep their foreign earnings in other nations to invest in new operations or buy other companies rather than bringing the money to the US to pay dividends to stockholders or invest in the US (thus creating jobs and more US taxes in the US).

    Even worse, this situation is creating a perverse incentive for US companies to move their headquarters to other countries so that they escape this situation.

Personal Tax

The US requires US citizens working in a foreign country to pay tax on their income in that country. However, for many nations with which the US has “tax treaties”, if the US citizen pays tax in the foreign country, then that serves as a credit against US taxes. Also, only income over $75,000 US dollars (last I knew, may have changed) is subject to US tax. This last provision is meant to simplify tax returns for modest income earners.

So how does this work in practice? Consider two very different cases.

  1. If an American citizen works in Australia, they pay Australian income tax. Since Australian income tax rates are generally higher than in the US (because their federal income tax, social security tax and state income tax are effectively all included in the federal income tax), their tax credit for paying the foreign tax is more than the computed tax to the US so they own nothing. The US citizen, must, however file a US tax return which can be quite complicated.
  2. If an American citizen works in Saudi Arabia, which has no income tax, then they will need to pay US income tax. While this makes a certain amount of sense, since as US citizens, they still enjoy the benefits of citizenship, it does put them at competitive disadvantage to citizens of nations which do not do this. What this means that if a company wants to hire someone to work in Saudi Arabia, they will find citizens of other nations much more eager to do so than Americans due to the tax advantages.

The strangest part of being a US citizen is that if one holds assets above a modest amount in a foreign nation, these must be reported. Prior to several years ago, the requirement was to file a strange form which was mailed to an address in Detroit, Michigan. It was not filed with one’s tax forms. Then the law changed to provide draconian penalties (thousands of dollars in fines and prison) if a US citizen failed to report foreign assets on a new tax form (1040 form 8938). The old form (sent to Detroit) did not go away; however, it has changed from a mailed in form to a website (called “fbar”). The two forms have essentially the exact same information.

With the new form 8938 came US efforts to strong arm foreign banks to report to the US government on any accounts held by US citizens. They did this by threatening to cut off a non-cooperating bank from US payment systems. This sort of imperialism was not popular in many foreign nations!

As a US citizen living in the US, if one has, for example, a simple savings account in a foreign bank, one must, of course, report the interest income on the normal form 1040 schedule B. This is in addition to the 8938 and “fbar” forms!

To be fair, I must note one unusual benefit of the US approach to citizens working in a foreign nation. If that citizen has children, then they are eligible for the so-called “kiddie tax” credit. This is a “fully refundable credit” (i.e. a welfare benefit – you get it whether you have tax to credit it against or not). Therefore, even if the US citizen does not have taxes against which to credit the “kiddie tax credit”, they get the amount as a payment. Therefore, for example, a US citizen living in a foreign nation whose income is below the threshold will receive a check for the full amount of the “kiddie tax credit” from the US government! This still requires a fairly complicated returns at times, but they do get money from the US government!

Summary

The USA seems to have a somewhat imperialistic approach to tax policy regarding its companies and citizens living and working overseas. For companies, US policy provides perverse incentives which can be destructive to the US economy. For most individuals, the effects are primarily an inconvenience (with the threat of big penalties if one makes a mistake).

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