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The Cost of Taxing Foreign Income

United States citizens must pay tax to the U.S. government on income earned anywhere in the world. This comes as a surprise to some U.S. taxpayers who are confused about how the U.S. could have the right to levy taxes and acquire so much information on money that, in some cases, has no connection to the U.S. other than the fact that it is earned by a U.S. taxpayer. These same taxpayers are equally surprised to learn that the U.S. laws concerning the reporting of their income in foreign countries are very strict and the related penalties, draconian.

While the various reporting requirements associated with offshore income and accounts is not new to U.S. tax law, what is new is the U.S. government's vigilant efforts to track down citizens who are not complying with these requirements and the increased criminal and civil penalties associated with a failure to comply. Since 2009, the IRS has offered three different voluntary disclosure programs that offer amnesty from criminal prosecution to U.S. taxpayers who choose to disclose previously unreported foreign income and pay the related taxes, but there is an additional civil penalty levied as part of these programs that makes some taxpayers balk.

The offshore voluntary disclosure programs, in concert with the Department of Justice's efforts to prosecute foreign financial institutions and foreign individuals that have helped U.S. taxpayers, have added over $6 billion in delinquent taxes to the government coffers, and experts predict that there is another $5 billion on its way. With a federal deficit in the trillions, efforts that bring that much money back into government hands may seem laudable, but the U.S. must start to consider what these billions of delinquent tax dollars may end up costing the country in the long run.

America Losing Citizens

The U.S. government's actions in this area have created several consequences that negatively impact U.S. citizens. For example, rather than comply with the onerous reporting requirements and risk the related penalties that come with doing business with U.S. taxpayers as a result of the FATCA legislation, many foreign financial institutions are now refusing to accept new U.S. clients, and many have closed all accounts that have any tie to the U.S. As such, many U.S. citizens have opted to renounce their U.S. citizenship and move abroad, removing themselves from the U.S. taxation system for the rest of their lives. This decision comes with its own set of complicated consequences for the taxpayer, so the growing number of citizenship renunciations in 2013 may be a bold statement by taxpayers that the burden of U.S. citizenship is beginning to outweigh the benefits. It's important to consider that at some point, tax dollars lost from taxpayers who choose to remove themselves from the U.S. taxation system may start to rival tax dollars gained from the government's aggressive taxation of foreign income earned by U.S. taxpayers.

U.S. Citizens Losing Business

The impact here is twofold: 1) Foreign entities may choose not to do business in the U.S. to avoid the long arm of U.S. taxation on income derived from the U.S., and; 2) U.S. citizens and companies, restricted by the U.S. government's high tax on foreign-earned income, may be put at a disadvantage in the international marketplace. Given the worldwide nature of modern commerce, these disadvantages should not be taken lightly.

Is There a Compromise?

Though it is easier than ever to point the finger at the IRS for these consequences, the bottom line is that the IRS is only enforcing laws created by Congress and doing their part to fulfill the legislative agenda. The current laws and resulting IRS programs, which focus on increasing the tax dollars coming in the door, seem to ignore the potential negative impact of the increasingly aggressive reporting requirements on foreign income.

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