Knocked flat by “horizontal equity”

One of the most common justifications among DC tax professors and policy wonks for taxing US homelanders and US Persons abroad in the exact same way is “horizontal equity”: the idea that “similarly-situated” taxpayers should pay similar amounts to the US government. Naturally, these people see the current situation, in which U.S. Persons Abroad get all these “great tax breaks”, as horribly unfair. So here’s a handy table comparing the paperwork which U.S. homelanders and U.S. Persons Abroad must complete in order to conduct similarly-situated kinds of financial activities. All estimates are courtesy of the Paperwork Reduction Act.

Keeping an account at the bank situated down the street from your house, and earning a few dollars of interest on it:

  • Homelander: Form 1040. Put the interest income on Line 8a. No schedule B if the interest is under $1500.

  • U.S. Person Abroad: Form 8938 and FBAR. Go through all your bank & brokerage statements month by month and convert each number into USD at the then-current exchange rate to find the highest asset value. Figure out if it was greater than your applicable reporting threshold. Put the end of year value on the 8938. Put the highest value on the FBAR. Also file Form 1040 Schedule B and remember to check the box about foreign accounts. Allegedly this should take one hour for the 8938; no Paperwork Reduction Act notice is provided for the FBAR. Plus whatever reporting is demanded by the country where you actually live.

Does the one hour estimate for the duplicative Forms 8938 and FBAR accord with your personal experience? Well, let’s keep going. How about saving for retirement?

  • Homelander: Form 1040. Put the amount you contribute to your IRA on Line 25. You get a tax deduction for your contribution.

  • U.S. Person Abroad: Form 3520. 55 hours per year. You do not get a tax deduction for your contributions to a non-US retirement plan, because they are “gratuitous transfers to a foreign trust”. Plus whatever reporting is demanded by the country where you actually live.

  • Automation: Turbotax does not support Form 3520.

Situating yourself away from your normal tax home for a year to care for a dying relative, and then moving back to your usual residence and going on with your life:

  • Homelander: “Shut up and quit trying to scare me, there’s no tax form for this”.

  • U.S. Person Abroad: Form 2555. Explain why you have revoked the Foreign Earned Income Exclusion for a year but are now trying to claim it again. Possibly pay $2000 to get a Private Letter Ruling from the IRS. See 26 CFR 1.911-7(b) for details.

  • Automation: Turbotax supports Form 2555. It does not support automatic generation of requests for Private Letter Rulings. I’m sure they’ll get around to it any day now.

Buying an ETF on your local stock exchange:

  • Homelander: Form 1040. Keep track of your basis when you buy it. No paperwork while you hold it. Record the capital gain on Line 13 when you sell it.

  • U.S. Person Abroad: Form 8621. 46 hours per year. You have two options.
    1. Make a QEF election when you buy it. Pay tax every year on the mark-to-market gains regardless of whether you sell it.
    2. Keep track of appreciation in every year. When you sell it, divide the gain into one bucket for every day you held it. Look up the tax rate applicable to each year in question. Compute the interest between now and then, with daily compounding. Pay the whole amount. Go pay $2000 to get a Private Letter Ruling for a late QEF election so you never have to do that again.
    Plus whatever reporting is demanded by the country where you actually live.

  • Automation: Turbotax does not support Form 8621.

Forming an LLC with your neighbour to run a small business:

  • Homelander: Form 1065. 36 hours per year.

  • U.S. Person Abroad: Form 8865. 67 hours per year. Not counting the time you need to spend convincing your neighbour to let you report his personal details to the IRS. You also may need to file Form 8832 Entity Classification Election in the first year. Unless you live in a country whose local LLCs are considered per se corporations by the US. In which case, you can’t use Form 8865 at all and instead you get to file Form 5471 (83 hours per year) instead, plus Form 926 (44 hours) for any year in which you inject capital into your business. Plus whatever reporting is demanded by the country where you actually live.

  • Automation: Turbotax supports Form 1065. It does not support Forms 8865, 8832, nor 5471.

Fines for making unintentional errors:

  • Homelander: A number which is proportional to the tax involved. Interest up to 25% of the tax owed, and possibly an accuracy related penalty of 20% of the tax owed.

  • U.S. Person Abroad: $10,000 per year per form, regardless of tax owed.

Remember kids, an American in Peoria and an American in Poland are similarly-situated by virtue of their passports, so they should be taxed the same. Also, an American in Peoria and H1-B visa holder in Peoria are similarly situated by virtue of where they live, so they should be taxed the same. Finally, an H1-B visa holder in Peoria and an American in Poland are similarly-situated by virtue of … oh wait I guess this “horizontal equity” thing isn’t transitive. I’m just a dumb science major bringing up transitivity and logic and all those inapposite concepts. I’ll never be a tax professor.

So did everyone have fun with their similarly-situated paperwork? Let’s add up the numbers: that’s 170 hours of tax compliance burdens (presuming you are well-versed enough in tax law to do it yourself, and aren’t worried about racking up $50,000 in fines in a single year and getting your passport confiscated). Or you can pay an international tax accountant for 170 hours of his or her time. If you try to be cheap and use some discount internet tax preparer who charges $300, he will not file all the required forms, possibly for years running, and instead you will be paying for 170 days of a tax attorney’s time to undo the mess your discount clown made. But this situation is of course entirely fair: the law in its majestic equality imposes the exact same reporting requirements on you and on a tax evader in New York who forms a Panama foundation which settles a Belize trust which forms a BVI corporation which opens a Swiss bank account which sends him an anonymous credit card for use in the US. If you think this is unfair, why aren’t you using a patriotic bank and IRA like a normal American?

Horizontal equity for the win!


18 thoughts on “Knocked flat by “horizontal equity”

  1. “Horizontal equity” is a farce because it does not take into account the cost of living in the foreign country, other non-income taxes and fees, and the exchange rates which can push people into higher US tax brackets that do not correspond to their real situation abroad.

  2. Yes, the horizontal equity is a farce. I wound up having to pay a five figure sum in US capital gains taxes because I had invested in several UK mutual funds. What especially seemed unfair was that these were in tax free accounts so owed no UK capital gains taxes…it hurt even more that I was taxed via phantom gains, as I hadn’t sold the stuff.

    I’ve also had to pay thousands to a specialist accountant to sort out the huge mess I’d unitentionally created, so thus a further tax on tax.

    Thankfully, she felt I was innocent enough to use a quiet disclosure for the ended returns…had I been forced into OVDI, I would have wound up (after paying all the accuracy penalties, further PFIC taxes going all the way to 2003, 25% fine on my highest aggegregate, plus attorney fees) close to $180,000. And all for a completely unintentional mistake.

    But I’m still not out of the woods yet because I will still have to wait out the audit lottery at least till June 2016 because all my amended returns will have had six vs three year statutes of limitations due to the under-reported PFIC phantom capital gains.

  3. Why don’t we kid**p…oh I’m sorry “re-locate” Charles Grassley to Poland and chain him to a Polish chair for long enough to make him in the eyes of the IRS a host*ge oh sorry…”ex-pat” and have a 400 pound gorilla stand over him with a whip and make him fill in all the tax forms just like he expects an ex-pats to do.

    I sure his finances are sufficiently complicated the gorilla would be cracking that whip for days! And Chuck would be reduced to tears.

  4. I just wanted to add that these assets were completely built up over 16 years through my hard work and also help from my British husband so were entirely earned in the UK. It’s not as though it was inherited from a US relative.

    One reason he’s been generous over the years is because I only earn a small income and he wanted to protect me in case he ever suffers another serious stoke and winds up in a nursing home. If he ever has to go into care, the local authority would freeze his assets and accounts and thus use all his assets and income to pay the nursing home costs…they would only cover the rest if his assets dropped to below around $20,000. So he was merely trying to protect me in case the worst happened. But this was before we understood all the US double taxation problems.

    I had assumed I was protected by the tax treaty and hadn’t been aware of the savings clause that allows the US to double tax.

  5. Bureaucrats will come up with all kinds of bogus theories to justify their positions. Horizontal equity is just another one.

    It is better to renounce citizenship than argue with idiots with PhDs.

  6. @Tomas….that’s a good point. The Foreign Exclusion is not wholly exclusive. Your “beginning” US tax rate begins where the exclusion left you off in terms of tax bracket. For example if you were to figure out your income before the exclusion and it left you in the 33% tax bracket, all income after the exclusion is taxed at 33% not as if you start at dollar zero on your 1040. The exclusion is really a con, but again it Peoria and Poland again.

    In fact Poland is considering becoming a flat tax country. If you were to make a lot of money in Poland (like set up your own company and not be a Polish worker on Polish wages), and they brought in the flat tax like (Czech Republic, or Estonia for example) you would be danger in owing the US government money due to lack of foreign tax credits if you reported any of this to the IRS.

    I have known people who have worked in one European country and lived in another and moved around during the tax year. The Europeans have a hard an impossible time building up the “big picture” between themselves – how on earth is the IRS going to do it? The answer is they won’t. It’s like if you worked in California for 2 months worked as a IT worker, then moved to Iowa with another contract, and lastly to Virgina, but your “tax home” was New Hampshire and worked there the remainder of the year and all the four don’t talk to each other with no federal government and you kept the income from the other three in cash- how on earth is the IRS going to know? For IRS purposes pick you “tax home” as New Hampshire if you want to report to the IRS at all to satisfy the requirement.

    Overseas the reality does not match up what happens within US borders. in many cases the IRS is going have accept your version without launching a full scale audit lacking the knowledge where to look. The IRS is depending on data from tax authorities that themselves don’t have their act together – that’s why tax US citizens abroad is such a non-sense.

  7. The tax rate on income above the exclusion used to start at the lowest rate and move upwards progressively depending upon how much income one had in excess of the exclusion. This changed with (TIRPA?) in (2004?) about the same time that foreign housing exclusions and deductions were scaled back, correct me if I am wrong.

  8. As I understand it, many in higher tax countries would actually be better off just relying on 1116 and claiming foreign tax credits rather than using 2555 to claim the FEIE. In my case though, I’d still be better off with 2555 though because as a part-time worker, my personal exemption in UK is around $13,000 vs approx $9,750 for my US personal exemption of $3800 plus standand exemption of $5950. This means that if I earned $13,000 that I would owe US income tax on the $3250 difference which would be about $325. Not a lot, but still outrageous as a low earner.

    As a higher earner in the UK 40% bracket, I would have produced more than ample foreign tax credits to completely offset US taxation using form 1116 though.

  9. @Tomas….it’s not the IRS website but I’ve come across this a few times.

    “One final tax planning tip. Starting with the year 2006, taxpayers claiming the foreign earned income exclusion will pay tax at the tax rates that would have applied had they not claimed the exclusion. That means, instead of having their income taxed starting at the 10% rate, most expatriates will be taxed starting at the 25% tax bracket. ”

    Link –

    Sorry….ex-pats continue to be stitched up.

  10. Horizontal equity is a complete intellectual ruse there is no such thing. It takes citizenship and makes it the common denominator instead of residency. It is like trying to compare apples with oranges. Just another rabbit hole in Washington’s Wonderland.

  11. If you are an American in France you don´t pay US taxes on French pensions. If you are in Brazil, you do. Are Americans in France more or less Americans than Americans in Brazil?

  12. You can only be similarly situated if you are compared strictly to those who are in the same pond. As we know from biology all ecosystems are different.
    When it comes to the enviroment in which taxes are levied it is impossible to get a fair base of comparison because taxes are completely situational. Every country as different values and those values get reflected in the tax code.
    The Horizontal equity arguement to me seems more akin to a policeman who lacks sufficient evidence to demonstrate the guilt of an accused criminal so he/she goes about manufacturing evidence that supports his/her judgement that has already been made.
    It is one of those made up government categories like, U.S. person for tax purposes, that is just a way that the U.S. tries to lay claim to you. The reasoning defies all logic but it only has to matter to the government officals who populate the world of the true believers.

  13. I have come to the conclusion that it’s just something I’m going to have to learn to live with because I don’t see renouncing as an option for my own personal reasons. I share others’ hopes that things will eventually be reformed but in the meantime have become compliant and will have to budget for accounting fees and some double taxation.

  14. I am in the same boat as monalisa1776. I have been trying to comply since I learned about FBARs. I will not renounce for many reasons. It is a nightmare. I lived and wored 30 tears in the USA and I never felt the way I do today about this great Country. Is it possible that for some reason the USA wants us to renounce?…I have some evidence that they do. Someday I may share it with you all.

  15. @Mark, I appreciate your sympathy because I sometimes sense that some on here think I’d been dishonest due to having fairly large US tax bills. I can acknowledge that I’d been negligent but had up until last year no idea of the complexities or mess I’d created.

    I made my disclosure last July and so far so good, apart from minor adjustments and a hiccup where the IRS had lost track of my payment for 2010. But I still realise that they have up till July 2017 to assess FBAR fines and June 2016 for the amended returns. If I hadn’t had the damn mutual funds and thus PFIC taxation on phantom gains, would have not owed any US taxes and would have been through the SOLs by June 2013.

    I’d like to think that they’ll accept reasonable cause for the FBARs and will understand that I wouldn’t have invested in the mutual funds had I known about PFIC taxation but had foolishly been a DIY investor and filer. There was nothing in the instruction booklet about form 8621.

    In hindsight, I should have had an accountant from the start or perhaps just kept my life simple and stuck to straightforward savings accounts. But I went native and invested like a Brit as I’d assumed I could live by the law of the land, especially as I am permanently settled with British citizenship too.

    I resent that I am forced to rely on professionals for what is a straightforward situation for me with the British tax authorities. I can self-file an 8 page tax return here but will have approximately a 220 page US tax return for 2011…and even from next year, my US returns will be at least 50 pages long, which is ridiculous when I don’t live there nor even have any asssets there.

    My accountant has explained that she doubts I’ll be audited especially as I have no money or property in the US, but I still face several years of uncertainty.

  16. I suppose though that I shouldn’t fear an audit, actually, because I trust that my accountant computed my taxes correctly. It’s just that it would still be very stressful and expensive. I just feel that the situation is absurd. It’s as though the Us wants to artificially creat a feeling of fear because I had the gall to marry a foreigner and choose a life abroad…America still wants its cut, especially as it has no concept of emigration.

  17. Emigration / Expatriation lawyers are going to make a killing. Its gonna be a booming market.

  18. Horizontal Equity?

    What about Horizontal Representation and Horizontal Benefits?

    Just another brilliant Ivy League thank tank fallacy that amounts to nothing more than academic fraud.

    The academics who invented the concept were probably funded by a government grant.

Comments are closed.