An update on progress towards residence-based taxation

Last week, Tax Fairness for Americans Abroad organized a webinar with our principal government affairs adviser in Washington, Mark Warren, who has deep experience in Congress and with U.S. tax policy. Mark provided an update on the progress that has been made towards residence-based taxation over the past year—often out of public sight—and offered some thoughts on the prospects for Rep. Darin LaHood’s and Sen. Todd Young’s Residence-Based Taxation for Americans Abroad Act to be re-introduced in Congress this year.

Below is an edited transcript of Mark’s comments:

What (elective) residence-based taxation means

We've been working with the broad structure of a residence-based taxation proposal that would be an elective approach for Americans living abroad, where they could elect to be treated really as a non-resident citizen and that would in effect allow an electing individual to be taxed only on their US-connected income and gains. You'd really be able to then make the choice about what sort of tax citizenship status should be best for you and your family and your particular financial situation.

It also is, I think, fundamentally designed to avoid Americans having to make the ultimate choice of renouncing their US citizenship in order to be able to take advantage of what the rest of the world uses, a residence-based tax system. A huge portion of the benefit of this would also be relief from the US FATCA and FBAR reporting burdens.

Where we stand on the path to RBT

A lot of people say it's been a long 15 months. I won't disagree. I think it has been a long but very busy 15 months, and I think a lot of progress has been made. It just hasn't been as public facing. 

The goal has been to try to get the revenue effect down as close to neutral as possible. So, a lot of work has been put into trying to identify what some people would call loopholes. I call them planning opportunities: Ways that people could abuse the residence-based system to take advantage in ways that would benefit them but cost the government tax revenues. So, they've really spent an enormous amount of time, and, somewhat surprisingly for a project like this, the joint committee has given them a huge amount of time. I think there have been about a dozen staff-level meetings between the two offices and the joint committee working through a lot of very detailed structural issues with the bill. They've also been working with the professional drafters in Congress to make sure that the legislative language gets updated.

What we now have is an updated draft. They've asked the joint committee … to try and give some assessment of are we even close to that revenue-neutrality target. The initial feedback is no, we're not close, and that the current draft is more than a few billion dollars a year in loss. And Congress looks at things over a 10-year budget window.

Why the revenue impact matters 

The reason that that's so important is that a key goal here is to try and maintain bipartisan support so that when the bills are introduced, we have both a Republican and a Democrat lead in both the House and the Senate. We know from our outreach with the Democratic offices in Congress that they are very concerned about the revenue loss potential for this. So, we're a bit off right now. The focus is working to maintain the structure as much as possible as what was in the original bill but looking at options to kind of tighten the rules, especially in the areas of the departure tax and the pretty broad grandfathering provision for Americans currently living abroad…. I'm expecting we're going to have a bit more back and forth, more fits and starts, as the two offices keep working with the joint committee to see if they can identify ways to bring that revenue effect down.

I know from talking with the staff on a regular basis that they are frustrated that this is not moving fast. I think It's important and they've impressed on me that the joint committee and the two offices are looking at this as a very fundamental change to the US tax system for an important constituency that is living abroad. It's a big shift and there are a lot of moving pieces and I think that is a key reason why it's taking so long. They want to try to make sure that they can satisfy the estimators and the experts that we are addressing any types of openings for planning opportunities and abuse. It is just so important that we have the commitment of both offices and the staff are incredibly committed to trying to revise and get this to a place where again we can get the bipartisan introduction that everybody wants.

Is the plan still to have the RBT election apply equally to low- and high-tax jurisdictions ?

In a very rudimentary way, they look at a US taxpayer living in a country that today has no local tax, and the US is going to tax all of that American’s income in that country up to 37%. Under an RBT system, that 37% of revenue goes away [for the IRS]. It’s arguably the same thing with other countries that have higher tax rates, or some tax rate, but the US foreign tax credit system is designed to reduce or eliminate the double taxation there.

In the end the question is, are we going to try to be able to maintain a system that applies very generally to any American regardless of where they live abroad, or are they going to have to make some changes to refine it in a way that reduces the revenue effect, to address that aspect of the bill? It’s hard to say at this point. I have impressed on our two champions that we very would like to maintain a sort of neutral system across the board so that there isn't additional complexity or choices that have to be made based on where you decide that you're going to live.

What seems to be driving the negative revenue effect? 

The government would really only lose revenue where you are living in a jurisdiction and you don't have enough foreign tax credits to offset your US tax from foreign income or you're living in a jurisdiction that really has no or very low tax and in which case there would be little or no foreign tax credit offset and all of that revenue would no longer flow back to the US Treasury if it was residence-based only. They look at this over a 10-year window. So, there would be some estimate in minds how much growth there would be in terms of Americans living abroad.

The second piece is what is the effect of the grandfathering rule?  Is there going to be a bigger rush of people to make the election that would kind of maximize the revenue loss? Or with the departure tax, how many people would really take advantage of that and is there going to be too much of an opportunity for high net wealth individuals with mobile income to shift all of that offshore? That's the worry that certainly Mr. LaHood and Senator Young, but also our Democratic supporters have, that they don't want this to become really a tax shelter opportunity. And that's where I think trying to get the departure tax in a tight way, but a reasonable way, and the grandfather rule kind of coordinated. What's the behavioral effect? How many people are going to take advantage of this and what's the future loss because they do?

Is there still a chance of making solid progress this year?

The calendar in Congress this year is probably not our best friend.

Members don't generally put out press releases and make public statements until they're ready with a product that they know has got a shot at being enacted.

With Mr. Le Hood and Senator Young and their commitment, with their staff, to really getting this done, it's still nose to the grindstone to try to get a bill together with a good revenue target on it. And then to engage with our candidates for Democratic support so that we can actually get a bill introduced and if we do have an opportunity, we want to be ready. That's the plan. I wish we were further along. I think everybody would. We are hopeful that we can get this wrapped up and get a bill introduced relatively quickly.

This has moved much faster than I think any of us ever anticipated. There is still a chance [for the bill to be debated this year] but we really have no chance until we can get a bill introduced. So, I think that has to be the first priority and that certainly is where the commitment is. I hope you'll hang on and keep helping us try to advance the cause.

It's hard to say how the election is going to play out but right now the trend seems to be that the House could flip to Democratic control. You know, if you have a divided Congress, it really does force more bipartisan legislation that puts a lot more pressure on us to get a bipartisan bill in place. If we can do that and get it introduced with a Democrat and a Republican on both sides, then I think it really does help heighten the chances of that even in a divided Congress because they're going to be looking for things that they can get done that are supported on both sides.

Link to recording

If you’d like to listen to the whole webinar, you can access the recording here: https://evdr.co/rbtupdate26-rec (Register to watch the replay).