Is the Nation of Immigrants Punishing Its Emigrants: A Critical Review of the Expatriation Rules Revised by the American Jobs Creation Act of 2004

Abstract

The thesis of this article is that the revised U.S. tax expatriation provisions fail to correct the most important defects of the prior U.S. tax expatriation regimes. Under the new rules, expatriating U.S. citizens and resident aliens subject to the U.S. tax expatriation rules can still avoid U.S. tax on items properly taxable by the U.S. On the other hand, they remain subject to U.S. tax on income that should fall outside of U.S. tax jurisdiction.

During the last forty years, the U.S. has undertaken several attempts to capture what it sees as its rightful share of the income and gain of tax-motivated expatriates. In carrying out this policy, Congress developed a set of alternative U.S. tax rules applicable only to tax-motivated expatriates, subjecting them to an alternative method of U.S. taxation. From the perspective of the U.S., the necessity for an alternative method of taxation arises because of the bifurcated structure of the U.S. tax system, applying one set of rules to U.S. persons and another, generally more favorable set of rules to nonresident aliens. The U.S. imposes residence-based taxation on U.S. persons, subjecting them to U.S. income tax on their worldwide income, to U.S. estate tax on their worldwide estates, and to U.S. gift tax on their worldwide gifts. On the other hand, the U.S. imposes source-based and business-based taxation on nonresident aliens, subjecting them to U.S. income tax on U.S.-source passive and business income, and to U.S. estate and gift tax on U.S. situs property. In both situations, income is subject to U.S. tax only upon the occurrence of a recognition event. The divergence in the scope of the two tax regimes creates a situation in which the U.S. tax liability of an individual calculated under one tax regime could be markedly different from the individual's U.S. tax liability determined under the other tax regime, with nonresident alien status generally rendering the less "taxing" result. The financial benefits of nonresident alien tax status may encourage wealthy U.S. persons to expatriate and be taxed by the U.S. as nonresident aliens. The challenge posed by expatriation is especially acute because it involves moving from residence-based taxation to source- based taxation, potentially causing some unrealized gain to escape U.S. tax as certain gains are not subject to U.S. tax under source-based taxation.