The primary purpose of U.S. and California tax laws is to collect revenue for the government, but legislators are very familiar with the power of tax laws to influence taxpayer behavior. By imposing an additional cost on a transaction, tax laws alter the incentive structure of various decisions. The recent changes in tax reporting requirements for those who hold offshore bank accounts and other foreign assets, however, have provided some expatriate taxpayers with an unusual incentive: to renounce their U.S. citizenship.
In an effort to prevent overseas tax evasion, the U.S. government passed more rigorous financial reporting criteria under the Foreign Account Tax Compliance Act. Under that act--called FATCA for short--taxpayers have to file a new form that discloses offshore assets. Penalties for failing to comply with the act can be severe. Foreign banks also have responsibilities under the law.
But the banks are responding to the law by cutting ties with many of their American customers. Some have precluded Americans from opening accounts with them, and others have even closed active accounts held by U.S. citizens.
Americans living abroad with offshore accounts are therefore faced with a difficult decision. On the one hand, they can retain the benefits of U.S. citizenship, but comply with the FATCA requirements, pay taxes and possibly lose out on the ability to bank with some foreign institutions. On the other hand, they can eschew FATCA compliance and its associated costs while gaining access to those institutions, but at the cost of their citizenship.
According to the Federal Register, nearly 1,800 Americans living in foreign countries decided to no longer remain citizens of the United States in 2011. While this represents an increase from three years earlier, the number of renunciations is still a very small percentage of the overall population of U.S. citizens living abroad.
Many instances of renunciation took place in Switzerland, whose banks have been the primary target of Internal Revenue Service investigations into offshore tax evasion. Renunciations can have their own costs, however, including an "exit tax" that depends on a person's assets and taxes paid.
Source: Bloomberg, "Wealthy Americans Queue to Give Up Their Passports," Giles Broom, May 1, 2012.