The U.S. is one of the only countries left in the world that still taxes its citizens and residents on their worldwide income, regardless of where it is earned. In order to understand the debate, some background information about the different forms of worldwide taxation is necessary.
There are two ways in which a nation may exercise jurisdiction to tax: (1) source and (2) political allegiance. Under the first category, a nation taxes income or assets located (“sourced”) within its borders regardless of where the owner of such income or assets lives. This type of taxation is often referred to as a “territorial tax system.”
Under a territorial tax system, taxation is limited to taxation of income from sources within a country’s borders, no matter who derives it – a citizen, resident, or anyone else. Territorial tax systems accommodate other tax systems in the simplest way possible – by not extending their own.
The second tax system is based on “political allegiance.” Citizenship and Worldwide Taxation: Citizenship as an Administrable Proxy for Domicile, Edward Zelinski, Iowa Law Review, 2011, p. 1294. It is premised not on the source of income or assets but upon the political allegiance of the taxpayer who owns such income or assets. How a country defines the phrase, “political allegiance” leads to two different types of worldwide taxation: “citizenship-based” and “residence-based.” Id. The poster-child for the former is none other than the United States. And for the latter, the United States’ northern neighbor: Canada.
Let’s begin with citizenship-based taxation. Taking a unique position, the U.S. defines “political allegiance” as an ‘individual’s citizenship, regardless of his residence.” Citizenship and Worldwide Taxation: Citizenship as an Administrable Proxy for Domicile, Edward Zelinski, Iowa Law Review, 2011, p. 1295. Very succinctly, Treas. Reg. 1.1-1(b) states that all U.S. citizens, regardless of whether they live in the U.S. or not, must pay U.S. tax on their worldwide income. This is a very rigid and strict interpretation of the phrase, not unlike the uncompromising parent that demands that his teenager be home by a certain hour, or be grounded.
Other nations define “political allegiance” for tax purposes on the “basis of residence.” Citizenship and Worldwide Taxation: Citizenship as an Administrable Proxy for Domicile, Edward Zelinski, Iowa Law Review, 2011, p. 1294. In so doing, they tax an individual’s global income and holdings only if the individual resides in that nation. As the poster-child of residence-based taxation, Canada imposes worldwide taxation on all of its residents without regard to Canadian citizenship.
If you are curious about the chief difference between the U.S. system of citizenship-based taxation and the Canadian system of residence-based taxation, look no farther. It’s relatively simple: a non-resident Canadian citizen pays Canadian income tax only on his Canadian-source income, whereas a non-resident U.S. citizen is liable for U.S. taxes on his worldwide income. Citizenship and Worldwide Taxation: Citizenship as an Administrable Proxy for Domicile, Edward Zelinski, Iowa Law Review, 2011, p. 1325.
No other topic generates more debate than the U.S. policy of taxing its citizens and residents on their worldwide income. Have you ever stopped to think about what the justification is for the U.S.’s system of worldwide taxation? Does it make sense?
This article will reveal exactly what that justification is and evaluate whether it makes sense from the perspective of a U.S. citizen who lives abroad.
What gives the United States the right to tax its citizens on a worldwide basis in the first place? As may come as a shock, it is not found in the Internal Revenue Code. Nor is it found in any piece of legislation passed by Congress. Nonetheless, it has long been established that the U.S. Constitution permits the federal government’s worldwide taxation of nonresident U.S. citizens. Who do we have to thank for that? None other than the U.S. Supreme Court, in a little-known case by the name of, Cook v. Tait, 265 U.S. 47 (1924). In an opinion that has been widely criticized as obscure and unintelligible, the Court upheld the federal income tax assessed by the IRS on a non-resident citizen’s Mexican-source income. In so doing, it interpreted the U.S. Constitution to allow worldwide taxation of nonresident U.S. citizens.
What rationale lies at the heart of the Court’s justification for worldwide taxation? Nothing less than the “public benefits” stemming from U.S. citizenship.[i] Specifically, the Court reasoned that a citizen who lives abroad and whose property is located outside the U.S. receives benefits from the federal government.[ii]
Precisely what “benefits” was the Court referring to? According to T. H. Marshall, author of “Citizenship and Social Class,” the Court viewed benefits as consisting of three distinct rights: “civil, political, and social rights.”[iii]
By civil rights, Marshall was referring to “the rights necessary for individual freedom – liberty of the person, freedom of speech, thought and faith, the right to own property and to conclude valid contracts, and the right to justice.”[iv]
By political rights, Marshall was referring to “the right to participate in the exercise of political power, as a member of a body invested with political authority or as an elector of the members of such a body.”[v]
And by social rights, Marshall was referring to those that were the most significant, namely “the educational system and the social services” available to members of a society.[vi]
Against this framework, how did Mr. Cook stand? He fell woefully short of enjoying most, if any, of these rights. With respect to political rights, Mr. Cook lacked the most fundamental one: the right to vote. Why? Because back in 1924 when Cook was decided, a U.S. citizen living abroad did not have the right to vote.[vii] That’s because such a person “did not live in any state and thus had nowhere to cast a ballot.”[viii]
However, that has long since changed. Since 1986,[ix] a nonresident U.S. citizen, like Mr. Cook, has the right to cast an absentee ballot in a federal election in the state where he “was domiciled before leaving the United States.”[x] That does not mean that every nonresident U.S. citizen can automatically vote. On the contrary, a nonresident U.S. citizen who has not established residence in a particular state will not be able to vote in a U.S. election.[xi] Very simply, he is a nomad when it comes to having a “home” from which he can cast a ballot.
In terms of civil rights, Mr. Cook, not unlike any contemporary U.S. citizen living abroad, could “have called on the U.S. for formal diplomatic protection, including representation in international negotiations or arbitration.”[xii] Mr. Cook could have also requested “less formal assistance” from the American Consulate in Mexico or, at the extreme, “military protection, including evacuation” by the U.S. military.[xiii]
The problem of course, is that there is no telling whether the U.S. would have granted these requests. In other words, Mr. Cook “merely had the right to ask.”[xiv] Beyond that, because Mr. Cook was a Mexican resident, his civil rights were guaranteed not by U.S. law, but by Mexican law.[xv] This is true today of any U.S. citizen living abroad: it’s the foreign government’s responsibility.[xvi]
Perhaps the only remnant of U.S. civil rights that Mr. Cook retained was the ability to return to the U.S. at anytime. In terms of this right, Mr. Cook had a “leg up” on a permanent resident. Very simply, permanent residents can be stripped of the right to permanent and continuous presence in the U.S. if they commit any one of a number of certain types of crimes, aptly referred to as “aggravated felonies.”
Consider a permanent resident who is arrested and charged with aggravated assault, a crime that has been designated as an “aggravated felony.” If convicted, the person would be deported. While a U.S. citizen who commits a crime faces punishment, he or she does not face the same draconian result as a permanent resident – outright “expulsion” through deportation.[xvii]
Therefore, a permanent resident does not have the same ironclad guarantee of permanent and continuous presence in the U.S. as a nonresident U.S. citizen does.
And let’s not forget something even more fundamental when it comes to distinguishing between nonresident U.S. citizens and permanent residents: freedom to travel and to move from place to place. While U.S. citizens, resident and nonresident, have the absolute right to live outside of the U.S. for however long they wish, the same is not true of permanent residents.
Unlike a U.S. citizen, a permanent resident cannot live outside the U.S. for a continuous period in excess of 180 days. Such a person must “return to the U.S. after spending 180 days abroad.”[xviii] As a U.S. citizen, Mr. Cook “faced no such requirement.”[xix] In other words, Mr. Cook could have spent 181 days or 181 years in Mexico. If he then decided to return to the U.S., he would not have encountered any barriers to re-entry. On a primitive level, while a permanent resident’s ability to remain outside of the U.S. might be restricted, one cannot overlook the fact that he still has the right to live in the U.S. just like a U.S. citizen does.
With respect to social rights, there are few U.S. social benefits that the “contemporary Mr. Cook” would be entitled to while living in Mexico. For starters, unemployment insurance and Medicaid are state-run programs to which Mr. Cook would not be entitled to today since he has no state of residence.[xx]
On the other hand, if the contemporary Mr. Cook was self-employed or worked for a U.S. employer, he would be eligible for U.S. social security benefits, since there is no totalization agreement between the U.S. and Mexico.[xxi]
If, however, Mr. Cook had lived in one of the twenty-four nations with which the U.S. had a totalization agreement, then he would not be eligible for U.S. benefits. Why? Under a totalization agreement, U.S. citizens living abroad are exempted from paying U.S. social security taxes.[xxii] And because they are exempted from making payments, they get absolutely nothing in return.[xxiii]
However, that does not mean that Mr. Cook would be deprived of social insurance benefits altogether. On the contrary, to the extent that he paid into the social security system of the country in which he resided, he would be eligible for retirement benefits from that country later in life. Such would be the case if Mr. Cook lived in Canada, Japan, Australia, South Korea, or Chile, a few of the countries in which the U.S. has a totalization agreement.[xxiv]
In order to see how paltry a nonresident U.S. citizen’s rights actually are, it is helpful to compare the U.S. legal rights of such a citizen with the U.S. legal rights of a resident alien. If you thought that a nonresident U.S. citizen enjoyed more rights than a resident alien, you’d be sorely disappointed.
A nonresident U.S. citizen possesses more rights than a resident alien in just one respect: the right to vote. Very simply, resident aliens are not permitted to vote in U.S. elections.[xxv]
Outside of the right to vote, the resident alien possesses substantially more rights than the nonresident U.S. citizen. How so, you ask? By the mere fact that he lives on U.S. soil.
Let’s take civil rights for example. While a nonresident citizen “has the right to ask the U.S. government for assistance” during a time of crisis, there is no guarantee that the government will “answer the call.”[xxvi] In stark contrast, a resident alien receives a plethora of civil rights, from “the protection of his person and property” by the U.S. government to “the guarantees embodied in the Bill of Rights.”[xxvii]
The civil rights of a nonresident U.S. citizen, on the other hand, are provided by the nation in which he resides, and not from the U.S.[xxviii]
With respect to social rights, a nonresident U.S. citizen derives few, if any, from the U.S. government.[xxix] Because social security benefits tend to be one of the most cherished social rights of U.S. citizenship, let’s look at how a nonresident U.S. citizen’s claim for social security benefits would be viewed by the Social Security Administration.
Such a claim would be denied, unless the nonresident U.S. citizen satisfies the following conditions:
(1) There is no totalization agreement between the U.S. and the nation in which he lives;[xxx]
(2) He works for a U.S. or other employer covered by the U.S. social security system (as a general rule, U.S. citizens or residents employed outside the U.S. by “an American employer” pay FICA taxes on their salaries);[xxxi]
(3) If he is self-employed, he pays federal self-employment tax on his foreign-source earned income.[xxxii]
On the other hand, a resident alien is entitled to a plethora of social services provided by the federal government and the states, from “public education for his children” to “welfare benefits such as unemployment compensation and income assistance.”[xxxiii]
In summary, the citizenship-based benefits enjoyed by Mr. Cook and other U.S. citizens residing abroad are minimal. These trifling benefits fall woefully short of justifying worldwide taxation of a U.S. citizen’s assets and income under a benefits theory.
While Cook might provide Constitutional validation for the U.S. to tax its citizens and residents on a global basis, the benefits rationale that it relies upon as justification for that authority is unconvincing.
What do you think?
[i] Citizenship and Worldwide Taxation: Citizenship as an Administrable Proxy for Domicile, Edward Zelinsky, Iowa Law Review, 2011.
[ii] Cook v. Tait, 265 U.S. at 56 (“government by its very nature benefits the citizen and his property wherever found”).
[iii] T.H. Marshall & Tom Bottomore, Citizenship And Social Class 8 (1992).
[vii] Id, supra, Note (i), at p. 1308.
[ix] In 1986, the President signed the Uniformed and Overseas Citizens Absentee Voting Act, Pub. L. No. 99-410, 100 Stat. 924 (codified as amended at 42 U.S.C. Sections 1973ff to -6 (2006)).
[x] Id. Section 1973ff-6(5)(C).
[xi] Id., supra, Note (i), at p. 1308.
[xv] Id., supra, Note (i), pp. 1308-09.
[xvi] Id. at 1309.
[xviii] Id. at 1309, citing 8 U.S.C. Section 1101(a)(13)(C) (listing conditions under which a permanent resident alien shall be “regarded as seeking an admission into the United States for purposes of the immigration laws,” including “absen[ce] from the United States for a continuous period in excess of 180 days”).
[xxi] Id. (citing U.S. International Social Security Agreements).
[xxiv] U.S. International Social Security Agreements.
[xxv] Id., supra, Note (i), p. 1315.
[xxvi] Id. at 1315-16.
[xxvii] Id. at 1316.