Trump’s Latest Tax Plan

Why do Americans pay US tax on income they earn while living abroad?

It’s a question many American expats ask. Now an American with a notably large audience is asking as well: Donald J. Trump.

According to a recent Wall Street Journal article, Trump is proposing to end taxation of foreign income earned by Americans who live outside the US.

It’s important to say that no other country of note does this. America taxes you because you are an American—no matter where you live in the world, or where you earn your income. (There are certain exemptions such as the Foreign Earned Income Exclusion—but you aren’t free of the need to file a US tax return.)

Most of the world operates differently.

Canadians, for example, will be taxed on their worldwide income (whatever the source) as long as they live in Canada. But, move abroad, and you no longer have that requirement.

Other countries (such as Panama) only tax you on what you earn in that country, and any income you earn from abroad (such as via remote work) is not taxed in that country.

So, if a Canadian lives in Panama and, let’s say, is working remotely for a company based in Ireland, he or she will owe no income tax anywhere. But an American living in Panama working remotely for an Irish company will still have to file a return with Uncle Sam, and could owe income taxes to the IRS.

The US operates the way it does because of our history…

During the Civil War, Congress levied an income tax on Americans’ global income, no matter where it was earned. The goal was to claim tax from Americans who’d fled the country to avoid military service. Even if they earned their living in, say, Britain, they’d have to file and pay taxes as if they were living at home. The Civil War is long over, but the system persists.

As I’ve said, no other country of note does this. (Writers in my field like to point out that the only ones that do are Eritrea and North Korea.) Instead, most countries exempt their expats’ foreign income from tax.

Note that this exemption doesn’t apply to tax earned inside one’s home country, such as on investments. That would presumably be the case under Trump’s proposal as well.

For example, if an American retiree moves to Costa Rica or Panama, countries that don’t tax foreign income, they’d still have to pay the IRS taxes on income from US investments, rentals, traditional IRA distributions, and so on.

The issue Trump’s raising, on the other hand, involves income from current work or business activity earned abroad by full-time expats.

Currently, under the Foreign Earned Income Exclusion (FEIE), nonresident Americans don’t have to pay tax on the first $126,500 of foreign-source income, or $253,000 for a couple. But if they earn anything above that, they must pay tax at current US tax rates.

But the issue isn’t just about money. The US global taxation policy creates other big problems for Americans abroad.

One is the complexity of tax filings. For example, this year I had to file a whopping fifteen separate forms with my 1040 return just to comply with IRS requirements for nonresident taxpayers. Many expats say they spend more on help with their tax filings than they would owe in tax.

The second problem is related to the US government’s attempts to enforce its tax laws on expats (and others).

Under the Foreign Account Tax Compliance Act (FATCA), any US taxpayer with a foreign financial account—including interest in trusts, partnerships, limited liability companies, and other structures—must report their cumulative balances to the IRS. No such requirement exists for US taxpayers living in the States.

FATCA relies on foreign bank cooperation for enforcement. For example, about 10 days ago I got an email from my local bank here in South Africa saying they were going to suspend my account unless I provided my US taxpayer information. If they didn’t send out emails like this, the US government could sanction the bank and cut them off from US dollar transactions.

The result is that many US expats can’t get banking services: they’re just not worth the hassle to the foreign bank. There are some horror stories of people who were “accidentally” born in the US, such as on a layover—and who therefore have tax filing obligations, even if they’re not aware of it—being refused banking services in their home countries.

Finally, the US global taxation system leads to many thousands of wealthy Americans voluntarily renouncing their citizenship to avoid the IRS. Called “expatriation,” it can lead to massive taxes on unrealized capital gains as the price of exit.

Organizations representing US expats have long complained about this situation and called for change. But these pleas are ignored in DC for a simple reason: US Federal legislators are elected at state and district level, and rarely have enough expat constituents to influence an election result.

Presidents don’t write the tax rules. Congress does. But presidential support for an issue can set the agenda, of course…

There are an estimated 6 to 9 million US citizens living abroad right now. And we’re eligible to vote in the upcoming election.

If enough of us vote one way or another in the presidential election—it could swing key states like Michigan or Pennsylvania…

In other words: The interest in expat taxes during this election cycle, is yet another reflection of how close the race is between Trump and Harris.