August 21, 2013 - Phil Hodgen
We do a lot of expatriation work. I get asked all the time “Why do people want to give up their U.S. citizenship?” Most recently, a reporter asked me this question today. I want to expand on the blog about one of the comments I made to her.
One reason is estate tax. This is not the only reason, and not the dominant reason. But I predict that you will start to see a steady rise of expatriations in the Middle East particularly, and less so in Asia, for the reason I am about to describe.
In the Middle East it is common for very large (VERY large) enterprises to be family-owned. The patriarch starts the company, or maybe two brothers. They are successful, and pass the business down to the next generation.
At some point, one of two things happens. One of the men (and it is men who own and operate these companies) marries an American woman, and their children are U.S. citizens. Or — equally common — the pregnant wife will fly to the United States to give birth to the children. The children are then U.S. citizens.
Eventually, the current owner dies and the U.S. citizen children inherit his share of the company.
Here is what happens:
- The U.S. citizen children are now shareholders of a foreign corporation (or partners in a foreign partnership in the less-likely event that the business is treated as such). If they own enough of the business, they are looking at Controlled Foreign Corporation status for the business. This means possible leakage of financial information to the U.S. government on Form 5471. For a company whose affairs never have and never will touch the United States, this causes considerable disgruntlement among the other family members who are shareholders. (That’s an understatement, by the way).
- Most normal business enterprises have a variety of companies within the structure, and it is more than likely that one or two of these will be considered to be PFICs. Again, information leakage.
- The U.S. citizen children become officers and directors of the family business, along with their cousins and uncles. All of a sudden you have potential exposure to the various sanctions regimes (don’t do business with Iran, Sudan, etc. etc.), the Foreign Corrupt Practices Act, the anti-boycott stuff (see Form 5713), and other exciting accoutrements of U.S. foreign policy and domestic morality. The companies I see might do business anywhere from Nigeria to Khazakstan. Business operations become problematic. The U.S. shareholders, having newly inherited their shares, are quickly becoming toxic to the business operations.
- As officers and directors, these new U.S. citizen shareholders are probably signatories on the company’s bank accounts. FBAR disclosures. They must tell the U.S. government where the family business banks and how much money the business has in its accounts. Information leakage again.
- Our friend Mr. FATCA comes to visit. U.S. persons are involved in this company as officers, directors, and shareholders. Perhaps the company’s bank for the last 30 years becomes a little less enthralled with continuing the banking relationships, at least on the favorable terms that the family business has enjoyed.
- One of our U.S. citizen children, let’s say, heads up the division of the company that is doing business in Afghanistan. He flies in and out of Kabul regularly, and sometimes has close calls with destiny. He is paying 40% income tax on his salary and, dodging the occasional Taliban rocket, feels he deserves every penny of that salary. Meanwhile, his cousin — a noncitizen — is running operations in West Africa, and pulling the same salary. Things are not exactly a country club for him, either. But he’s not paying a penny in income tax. A certain personal disgruntlement arises in the U.S. citizen son who has inherited a piece of the family business. “I’m paying 40% for what? The black helicopters aren’t coming for me; quite the contrary.”
- Eventually, our U.S. citizen son dies, after a long and fruitful career. He inherited 1/3 of the family business from his father, and when he dies owns stock worth $500,000,000. His uncles and cousins — nonresident aliens all — own the rest of the company. Shari’a law tells everyone who inherits what. The U.S. government wants estate tax, though. How will his heirs find the $200,000,000 (I’m assuming a 40% estate tax rate) to pay the U.S. Treasury — wealth created outside the United States, none of which ever touched the United States or received any protection or services from the United States Government? The family business is blown apart. Our U.S. citizen’s heirs must sell their share of the business to the rest of the family in order to pay the U.S. estate tax.
It is for reasons like this that I travel so frequently to the Middle East. Expatriation is the only long term solution. The senior members of these families are pressuring the younger generation give up U.S. citizenship to protect against these problems. I have heard the ultimatum from the father to the son: “The business or your U.S. passport. You choose.”
I want to emphasize that I do not hear political rants from my clients, or from the other family members who must deal with having a U.S. citizen shareholder thrust upon them. Everyone I talk to is eager to travel to the United States, enjoys meeting Americans, and bears no ill will to anyone.
But faced with the prospect of destroying the family business or giving up the U.S. passport, it is no contest. The passport has to go.