Residence Based Taxation? Interview with Bill Yates – Former Attorney, Office of Associate Chief Counsel (International), IRS
Today’s blog post is the second of a two-part interview that provides valuable insight from Willard (Bill) Yates, who recently retired from the Office of Associate Chief Counsel (International), Internal Revenue Service after 31 years of service. During his tenure as a Chief Counsel Attorney, Bill was the recipient of 10 awards, including the Albert Gallatin Award, Treasury’s highest career service award. The Gallatin is awarded only to select federal employees who served twenty or more years in the Department and whose record reflects fidelity to duty. Bill received the Gallatin award for his work throughout his IRS career, including his work on implementation of some of the compliance requirements of the Foreign Account Tax Compliance Act (FATCA).
Most of Bill’s career at IRS focused on offshore compliance, including his participation in a massive overhaul of outdated foreign trust reporting requirements Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts and Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner). Bill was the principal drafter of the regulations under section 679, Foreign trusts having one or more United States beneficiaries, Notice 2003-75, RRSP and RRIF Information Reporting and Notice 2009-85, Guidance for Expatriates Under Section 877A.
Our focus today will be on Bill’s comments on the American Citizens Abroad working paper titled, RBT, Residence Based Taxation: A Necessary and Urgent Tax Reform (RBT Proposal), which recently was submitted to the International Tax Reform Working Group of the House Ways and Means Committee. You can access it here:
In general, the RBT Proposal offers an alternative to citizen-based taxation (CBT).
Let’s Talk About US Tax: Bill, please give us your general impression of the RBT Proposal.
Yates: At the outset, from a compliance standpoint, it makes a lot of sense because RBT would be “enforced,” so to speak, here in the United States through withholding at source.
Americans living abroad would be taxed on the same basis as non-resident aliens, primarily through a system of withholding taxes on passive U.S. source income (dividends, rents, pensions, etc.) and capital gains taxes on U.S. real estate; income earned in the United States would require filing a 1040NR. Americans abroad would remain subject to U.S. estate taxes on U.S. situs assets, including real estate and securities. The RBT Proposal provides extensive and comprehensive anti-abuse measures together with a precise transition roadmap.
In addition, two of benefits of RBT listed in the RBT Proposal stand out.
- increase Treasury tax receipts by an estimated $30 billion over ten years, whether RBT is drafted as a voluntary program or the default tax system; . . .
- liberate overseas citizens from a legislative straightjacket caused by the toxic combination of citizenship-based taxation, FATCA and FBAR reporting requirements.
An increase in tax receipts of $30 billion over ten years, is very impressive, and more importantly, critical if RBT is to be “sold” to Congress. Obviously, Congress is very much focused on “show me the money,” these days.
The second benefit addresses a concern that many of us in the office shared. It was very common around April 15th of each year to hear attorneys complaining about having just filed their tax returns and how difficult the process had been. And, it wasn’t at all unusual to hear someone remark, “just imagine what people living overseas are going through. What a mess. It must cost people a fortune to have their taxes done.” I don’t think anyone ever assumed that a U.S. taxpayer living overseas could possibly figure out how to do his/her own return.
Let’s talk about US tax: The RBT Proposal also talks about FATCA’s onerous compliance requirement resulting in foreign banks either refusing US customers, dropping current account holder and even causing many Americans and green cardholders to expatriate. Did you know about that?
Yates: Oh, yes. We knew. We even received a letter from a U.S. taxpayer who’s foreign bank account had been closed without an explanation from the bank. The taxpayer wanted to know why. Eventually, a response went out to the effect that we simply didn’t know why the bank closed the individual’s account. Politically, that’s all we could say.
As for expatriations, I received lots of calls from practitioner friends of mine all over the world telling me that Americans are getting out. We even heard that the wait list to make an appointment to expatriate at some U.S. consulates was over one-year long.
Let’s talk about US tax: This may be a little premature, but what did you think about FATCA from a policy standpoint at that time?
Yates: I thought it was bad policy. We shouldn’t be pushing U.S. citizens towards expatriation. But, having said that, I was less sympathetic towards foreign banks.
Let’s talk about US tax: Why?
Yates: First, the National Office sent me out to San Francisco to listen to what the LGT informant had to say. What it turned out to be was a series of well organized presentations detailing how LGT operated. It was really disgusting. The informant told us that Liechtenstein bragged that it had the toughest money laundering laws in the EU. He told us that LGT always asked prospective clients where the money came from. For example, he told us that one individual explained that he had made $50 million raising rodeo bucking horses in Florida
Let’s talk about US tax: So?
Yates: Everyone in the room who knew me turned and looked at me. I’ve been involved in horses since I was five. Believe me, no one makes $50 million raising bucking horses. That is patently ridiculous. What it shows is that LGT would accept any explanation regarding the source of a prospective client’s funds or assets. Then, the UBS scandal broke. That’s when things really got ridiculous.
Let’s talk about US tax: How?
Yates: Well, we started seeing how European governments were shocked, I mean shocked, really, to find out that any of their banks could be involved in promoting and facilitating tax evasion. Give me a break. How could you live in the EU and not know about what was going on in Switzerland, Lichtenstein and the Caribbean tax havens, many of which by the way are British protectorates?
Let’s talk about US tax: So, are you saying that foreign banks had it coming to them? I mean FATCA.
Yates: In a way, I guess I am. It’s not like they didn’t know that we knew and didn’t like what was going on. Congress passed the Bank Secrecy Act in 1970. Eleven years later, the Gordon Report was submitted to the Commissioner of Internal Revenue, the Assistant Attorney General (Tax Division) and the Assistant Secretary of the Treasury (Tax Policy). The report provides a detailed analysis of tax evasion through the use of tax havens.
I was also very much involved in developing learning programs for the IRS regarding the use of asset protection trusts (APT). During the course of my involvement, we learned that a U.S. firm had helped an otherwise obscure island jurisdiction design its very own asset protection statute. It was a work of art, or a poke in the eye, depending on your point of view. In order to upset a transfer to an APT set up in this jurisdiction as fraudulent, it would have to be proved “beyond a reasonable doubt” that the transfer was intended to defraud the victim. Enough is enough.
Let’s talk about US tax: Let’s talk about some of the specifics of the RBT Proposal.
Yates: Sure. I’ll focus on some points in the RBT Proposal that got my attention.
Under RBT, Americans living abroad would not be subject to tax on foreign source income. They would be subject to U.S. tax through withholding on U.S. source income. This is fine, it’s clean and, therefore acceptable, assuming ACA’s revenue estimates for RBT are accurate.
In order to be subject to RBT, an American establishing residence abroad must file an application for the Departure Certificate with the IRS that provides proof of both foreign residence and residence in a foreign “tax home’ and pay any U.S. income taxes due up to the date of establishment of overseas residence, and pay a Departure Tax, if applicable. I assume that an American applying for a Departure Certificate would be subject to the same standards as are applicable for the section 911 exclusion. This sounds acceptable. The RBT Proposal provides that, “No renewal or further notification would be required, as long as the non-resident American remains in the same country; if the individual moves to another country, he or she would be required to inform the IRS of the new address overseas. From a compliance stand point, I am not comfortable with this. How would IRS find out if an American moves to a tax haven?
Let’s talk about US tax: Well, the RBT Proposal provides that the taxpayer would have to notify IRS about any change in tax home.
Yates: Uh, huh. Right.
Let’s talk about US tax: You sound like you’re still working at IRS.
Yates: No, I’m working for the American taxpayer. That was true when I was at IRS; I was working for the American taxpayer. Anyway, the whole Departure Certificate procedure is problematic. The RBT Proposal provides that filing a U.S. resident tax return when a U.S. citizen moves back to the U.S. automatically makes the Departure Certificate expire. What if the taxpayer does not file a U.S. tax return?
In general, the RBT Proposal provides, among other things, that “. . . Americans abroad who return to the United States to reside would again be automatically subject to the ordinary tax rules for U.S. residents; their Departure Certificate would automatically expire. However, the market value of all assets, except U.S. real estate, U.S. based pension funds and possibly U.S. based family company shares, held on the date of taking up U.S. residence would become the cost basis for future capital gains determination.”
How is IRS going to know that an American has returned to reside in the United States? This is going to require coordination between IRS and USCIS, which maybe easier said than done. IRS can’t send USCIS a list of taxpayers who have been issued Departure Certificates for purposes of some kind of USCIS “watch list.” This would not be legally possible. Is USCIS going to send IRS a list of names of all Americans who are coming back to the States? For what purpose; vacation, medical reasons, Christmas? This would also be administratively impossible.
Let’s talk about US tax: What about the Departure Tax part of the RBT Proposal? It is similar to US current tax law expatriation provisions found in Section 877A.
Yates: The RBT Proposal Departure Tax changes the current thresholds for application of the mark-to-market regime as follows:
The Departure Tax would apply if –
- • total assets exceed $5 million, excluding U.S. real estate, foreign residence and U.S-based and foreign-based pension funds and retirement savings accounts, or average income tax over the last five years exceeds $190,000, indexed to inflation, and
- • unrealized capital gains on foreign assets exceed $650,000, indexed to inflation.
I have two comments. First, I agree with raising the asset and income tax thresholds. We always thought they were too low. Second, regarding the unrealized capital gains test on foreign assets raises compliance concerns. How can IRS verify the basis and current market values of foreign assets? However, having said that, IRS faces the same problem regarding a taxpayer’s valuation of foreign assets for purposes of determining the application of section 877A expatriation provisions.
Third, the RBT Proposal provides that the Departure Tax “. . . should
be viewed as an anti-abuse measure aimed at wealthy individuals who might consider leaving the U.S. for tax reasons.” This would take IRS back to the private letter ruling (PLR) days under a previous version of section 877. The National Office was put in the position of being a fact-finding body regarding the intent of an individual contemplating expatriation. The PLR process was a disaster. The National Office is not a fact-finding body; fact-finding is for the Field. How is an attorney sitting in the National Office expected to be able to determine if one of the principal purposes of expatriation is the avoidance of U.S. taxes? So, in my opinion, that part of the RBT Proposal is a non-starter.
Let’s talk about US tax: Implementing the RBT begins on page 14 of the RBT Proposal. Do you have any comments on the implementation of the RBT Proposal?
Yates: I certainly do. ACA definitely has taken the high road as far as the part about bringing overseas taxpayers back into the system. The IRS OVDIs go a little bit overboard, euphemistically speaking, when it when it comes to encouraging people to come forward. In general, the OVDIs required filing both the original returns and amended returns for the prior 8 years that report all income and disclose the foreign accounts. In addition, all missing FBARs are required to be filed, accompanied by a signed agreement to extend the statutes of limitations, and pay a penalty of up to 27.5% of the accounts’ highest balance over the 8 year period. Finally, OVDI required the payment of a 20% accuracy penalty based on the total underpayment for the 8 years, as well as failure to pay penalties, and pay failure to file penalties.
Taxpayers did have the option of “opting out” of OVDI, but do so risked exposure to criminal prosecution and additional FBAR penalties.
Whatever, course of action taken by a taxpayer, the OVDI terrified and angered a great many people. I received calls from many practitioners who told me stories about “accidental citizens” who had RRSPs who came forward and eventually were handed a 20% penalty of an account which represented their entire savings. From what I was hearing, an RRSP with approximately $100,000 was pretty much the norm. So, IRS takes a $20,000 chunk out of it. Practitioners told me that many of their clients were in tears when they were informed of what was going to happen to their savings. This is unacceptable.
Here is a typical example: A is a Canadian citizen; only a Canadian citizen, he thinks. Unfortunately, A is wrong. A’s parents were both Canadian citizens, and only Canadian citizens. A’s parents lived in Canada. Unfortunately for A, when A was “on the way,” the closest hos pital was just across the border in the U.S. A was born in the U.S. hospital. Twenty years later, A, who has never lived or worked in the U.S., is at a barbecue where he learns through casual conversation that he is a dual citizen; Canada and U.S. He soon becomes aware of his filing obligations and also, to his horror, the IRS OVDI. Just like everyone who has ever worked in Canada, whether Canadian or U.S., A has an RRSP. A has only $15,000 in his RRSP. He has never filed an FBAR. He is a truck driver.
There is really no need to continue. Suffice it to say that A is the last person the IRS OVDI should be hitting. The RBT Proposal states, “Many of the inconsistencies and inefficiencies inherent in FATCA legislation and IRS policies since 2009 can be traced to the unjustified bundling of Americans abroad and rich tax evaders, domestically resident but with assets hidden abroad, into a single amalgam. In reality, these are two very different subject groups.”
The RBT Proposal sets forth a far more palatable solution:
“An equitable and acceptable compliance program for Americans abroad:
• would require just three years of back tax reporting;
• would eliminate the requirement to file the FBAR which is superfluous since it is not a tax form; Form 8938 (submitted as an attachment of Form 1040) provides a much more comprehensive report on overseas assets;
• must eliminate all non-filing penalties for FBAR and Form 8938;
• must eliminate any threat or risk of criminal prosecution;
• must be open to all non-residents, with no ceiling threshold for the amount of taxes due;
• must be limited to payment of only back taxes, interest and late filing penalties related to unpaid taxes associated with the three years of back-filing.”
I had no part in OVDI, although I was part of a group that reviewed the OVDI FAQs.
Let’s talk about US tax: What was that like?
Yates: In the law dictionary where it lists “arbitrary and capricious,” the definition says, “See IRS OVDI FAQs.”
Let’s talk about US tax: Do you think the IRS will modify future OVDI programs as suggested by the RBT Proposal?
Yates: I doubt it. Apparently, the program has been successful in bringing in approximately $5 billion in back taxes and penalties. And, believe me no one at the IRS Field level is going to speak up about the inconsistencies inherent in OVDI as far as “accidental citizens” are concerned. I have good friends in the Field that didn’t agree at all with what their managers were telling them to do. They had no choice, other than to do what they were told. These are really talented, fair-minded people who are being marginalized. They aren’t out to “get” Joe Blow taxpayer. They want to get the big guys, the guys with the money who are cheating Joe Blow taxpayer through tax evasion.
You have to wonder how much more could be brought in if future OVDIs were less draconian. Earlier, I said that the OVDI had made a lot of taxpayers angry. At least, that’s what I heard. Apparently, a lot of taxpayers living overseas decided that the IRS OVDIs were totally unfair and way too risky. So, they decided to take their chances and not come forward at all.
Let’s talk about US tax: In the final analysis, do you think that RBT has a chance?
Yates: Not really. The Treasury and IRS have too much invested in FATCA to turn back now. It’s really too bad, but something had to happen. UBS and LGT broke the dam, resulting in the flood of compliance measures manifested by IRS OVDIs and FATCA. The OVDIs caught up a whole lot of people who were totally unaware of their U.S. filing requirements. How could they have been? And, FATCA is hitting U.S. taxpayers living overseas with unforeseen consequences, such as having their foreign bank account(s) closed.
Let’s talk about US tax: So, you think FATCA is a mistake?
Yates: It doesn’t matter what I think, now. FATCA is inevitable. However, Jacqueline Bugnion, Tax Team Director of ACA, explains that the RBT proposal could pass even if FATCA remains. But, she concludes that if citizen-based taxation remains, FATCA must go:
Citizen-based taxation (CBT) and RBT are two separate issues. What Congress has to realize is that the current citizenship-based taxation creates a serious competitive disadvantage for the United States and that if FATCA remains, CBT for Americans living and working abroad has to go. Otherwise, having a US passport overseas is simply too much of a liability to keep. Over 80% of Americans abroad are long-term overseas residents, married to foreigners, working abroad. Many have dual nationality – some even born with it. Why should they have to continue to double file, double pay when all of their governmental services come from the country where they reside? CBT does great harm to the US because it prevents US corporations from sending Americans abroad to represent US interests. More freedom of movement of US citizens would enhance US competitiveness around the World.
Let’s talk about US tax: Do you think Jackie is right when she says that FATCA must go if CBT for American citizens living and working overseas remains?
Yates: To me, it’s really a question of whether FATCA will go if CBT remains. But, I’ll tell you one thing. I’ll never forget what someone said after one of our many, endless Form 8938 drafting sessions.
Let’s talk about US tax: What was that?
Yates: “Boy, I sure wouldn’t want to have to fill out this form.”
Bill can be contacted directly by phone at 703-585-1786 or by email at [email protected]. For a more complete profile, see his LinkedIn posting.
Follow me on Twitter: @VLJeker