Update: These were my opinions as of October 2017. The final Trump tax reform signed in December 2017 looks very different from what was being discussed just two months earlier. To read about the unforeseen consequences for Nomads of the deal that was actually signed into law, read here.
Dateline: Madrid, Spain
Love him or hate him, there has been plenty of talk and many predictions of how a President Donald Trump would shake up the system in the United States.
I usually avoid discussing politics because “go where you’re treated best” transcends politics. Why fight to “change the system” when you can go somewhere that gives you want you want: more freedom, a better culture, more of your own money.
However, there is one area that a President Trump could impact that would have an outsized effect on Nomad Capitalists holding US citizenship.
It’s not health care reform or social policy.
It’s tax reform.
As you know, the United States is effectively the only country on planet earth to tax its citizens no matter where they live.
You can spend six days physically in the United States in almost four years – as I have – and you are still required to file a US tax return, report your “foreign” offshore bank accounts to the penny, document your offshore companies, and comply with all sorts of foreign regulations that disadvantage US businesses.
Oh, and if you’re an employee with a salary in excess of the Foreign Earned Income Exclusion, you’re going to pay tax… even if that salary is earned in tax-free Dubai.
We’ve covered the citizenship-based taxation policies of the IRS and how they affect US citizens on everything from filing taxes to renouncing US citizenship, so feel free to read our other articles for more background.
However, there is now a rumor going around: that the Trump administration’s tax reform will include a transition away from citizenship-based taxation.
The question is “to what?”
Trump Tax Reform for Nomad Capitalists
Part of the reason I so dislike politics is that so many ideas get floated and never acted on. The same applies here.
In one sense, the Trump budget team wants to change the IRS code to a residential tax system that mirrors European and other developed countries. What that means is that if you live in the United States, you pay; if you live elsewhere, you don’t.
In another sense, some proposals call for a switch to a territorial system that taxes only income earned in the United States. That would likely impact businesses more than people, because US citizens living and doing business overseas would have the “source” of their income outside of the United States.
There is also vague talk of restructuring the Foreign Earned Income Exclusion to allow for greater deductions.
Now, I am not confident this type of tax reform can pass. Furthermore, I am not confident that any changes to expats and nomads would actually make it into the final version of any such tax reform.
Donald Trump won on a highly nationalistic agenda of “America First”, and his biggest proponents decry the rise of globalism as a punch in the gut to the once-vibrant US economy.
(They apparently never got the memo that there is this thing called “change”.)
I am highly suspicious that Trump’s closest allies care one whit about Americans living overseas. While they may understand that US citizens working overseas is somehow good for American interests, they would surely much prefer that productive types like you and I be back on US soil building businesses and creating wealth for them…
…not in another country.
That’s why the biggest part of their tax reform plans – and the parts more likely to pass – are cuts to major tax rates, especially to business tax rates.
Basically, the pitch to expats and Nomad Capitalists would be: “come back and we’ll stop taxing you so heavily”.
Of course, that’s tough considering that the United States is not a cheap place to live, and even 15% is a lot more than 0% when you’re a six- or seven-figure entrepreneur.
Why Low Taxes Don’t Work in the US
Of course, even if some parallel universe of 15% corporate tax rates on single-taxed, pass-through income became a reality, the United States is still broke.
Unlike Singapore or Dubai or Hong Kong, it can not afford to cut tax rates by half. The United States has wars and Medicare prescription benefits to pay for, and they are not very efficient at paying for them.
And unlike a Singapore that BECAME a developed country on the backs of an extraordinarily free market policy and low taxes, politicians in the United States will likely go back to high taxes in a matter of years in order to pay for the next round of payoffs to middle-class voters.
Of course, there is also the issue that many of don’t want to live in the United States. Just flying through that place is an exercise in patience.
While I am hardly a Washington insider, I am skeptical of a total tax code overhaul in the near-time. More importantly, I have been on the record for years saying that while elimination of citizenship-based taxation of US persons is possible, it is unlikely.
I won’t go as far as some ‘Americans abroad’-type groups who say it is “99.99% never happening”, but I’m not far off.
As we often discuss, culture dictates economic policy. In all of the places I’ve visited, I’ve seen a correlation between open cultures and open economies. The United States may be open, but it is closed-minded. Many Americans believe in “American exceptionalism” and that their country is “the best country God ever smiled on” in the last 1,000 years.
It doesn’t exactly sound like the country that will craft policy to allow its citizens to leave and pay nothing.
That said, I did make a list of several potential scenarios offshore businesses should look out for if a Trump tax reform is enabled.
1. Business: Territorial Taxation of US LLCs
LLCs are pass-through entities, meaning they are taxed to the shareholder and may not necessarily be subject to tax in the United States.
Services like Stripe Atlas offer non-US citizens the ability to use US LLCs to operate their online businesses; a practice I call a “naked LLC” and that I believe is fraught with potential challenges, especially as few people using naked LLCs understand how to actually avoid US tax and end up paying a fortune.
However, if territorial business taxation were applied, it would allow US citizens – who currently can not use naked LLCs – to the same tax treatment as foreigners. Again, use of an LLC would still require proper planning, but at least it would give US citizens the opportunity to use lightweight structures for their business.
However, this potential benefit could also come with a big problem…
2. Business: Increased Taxation of E-Commerce Sellers
Some companies that sell physical goods into the United States – think Amazon FBA sellers or Shopify sellers – rely on US LLCs to allow them to receive money. If structured correctly, this can be done tax-free.
However, if territorial taxation of businesses were implemented, selling physical products could be reclassified as a “tax nexus”, and e-commerce business owners with no presence in the United States could suddenly see their tax bill and filing requirements increase.
3. Business: Other Tax “Nexus” Requirement Changes
Currently, banking in the United States does not create a “tax nexus”. For example, US citizens may maintain their US bank accounts – if used properly – while living overseas, a privilege that many other developed world expats do not enjoy.
Likewise, foreign businesses may use US bank accounts without necessarily creating a tax obligation in the United States. US banks generally don’t accept foreign corporations unless you have an extremely large deposit, but it’s possible.
I worked with one gentleman whose long history with JP Morgan overseas allowed him to open an account for his Hong Kong company with Chase in the United States, provided he deposited at least $10 million. It’s possible that tax policy surrounding banking in the United States could change under tax reform.
4. Personal: US Citizens Need Tax Non-Residency
Currently, it is possible to exempt just over $100,000 in income each year as a US citizen so long as you:
1) spend all but about one month in other countries, or
2) maintain substantial ties in a foreign country and spend less than about four months in the United States.
If you’re an employee, this policy sucks because you have no way to control your income: you get a salary, and you pay tax. If you earn more than the $100,000 exemption, you pay at progressive income tax rates. One friend of mine pays over $300,000 in US income taxes each year from his job overseas… despite never visiting.
If you’re a business owner, things are a bit more flexible if you establish the proper offshore strategy.
That means that while business owners suffer a lot of restrictions on their business income, and everyone suffers a high tax bill on investment and trading income, it is possible for US citizen entrepreneurs to pay zero tax.
My personal 1040 shows income tax due of $0 last year.
However, the US actually has relatively easy rules to qualify for these tax exemptions if you’re willing to be out of the country. While Canadians or Australians or Brits can spend more time in their countries each year, they have to prove that they left in order to be deemed “non-resident for tax purposes”.
This can lead them to fall into the “Nomad Tax Trap” if they don’t create the right strategy.
If personal income tax became collected on the basis of residency rather than citizenship, Americans would need to PROVE that they were no longer resident in the United States to qualify for the tax breaks.
For someone like me who has little desire to return to the United States, that would make the burden higher. I and others like me would possibly suddenly need to prove where our “tax home” was, close our US bank accounts, and cut ties with the United States from miles-earning credit cards to that empty condo that could be considered your “home”.
Now, all of these are merely potential ideas. The Trump administration has suggested that businesses should not be able to manufacture goods in Mexico or China and then sell them into the United States tax-free.
In the case of tariffs, that may mean a level playing field where consumers merely pay more for imported products and consumption goes down. (Obviously, not a great outcome.)
However, it could also impact those doing business directly in the United States, which makes businesses like mine that are entirely operated and delivered overseas potentially more attractive.
All I’m saying is that “tax reform” is most likely a boon to the US-based companies and workers that Donald Trump was elected to represent. We’ll keep you updated as the situation develops.