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The Ridiculous Story of a Pilot and his Taxes

This entry is part 17 of 23 in the series US citizenship

I received a message recently from an American airline pilot living and working out of Hong Kong for a major airline. He told me the story of how America’s citizenship-based taxation affects him and I felt I had to write about it.

sunset as a pilot and passengers might see it from a plane

sunset from a plane

Ridiculous

I already thought the way overseas Americans are taxed by the US is ridiculous—citizenship-based taxation, while the rest of the world uses residence-based taxation, a much more sensible system. You can read more about it here, but the upshot of it is:

  • Overseas Americans have to file extensive, over-complicated forms.
  • Overseas Americans have to report account information that homeland Americans don’t have to report—an invasion of privacy.
  • “Foreign” banks (our local banks) have been strong-armed by the US government into sending our private account information to the US Financial Crimes Enforcement Network.
  • Some overseas Americans end up unfairly double-taxed.
  • We receive no services from the US in exchange for our tax dollars.

The purpose of all of this is to prove we aren’t tax cheats. Notice that we’re assumed to be criminals until we prove otherwise.

US citizens living overseas qualify for a Foreign Earned Income Exclusion (FEIE) of about $100,000. That means that up to that limit, we pay income taxes where we live but not to the US. If we earn more than the exemption, we might end up paying double taxes: once where we live and once to the US.

Many—perhaps most—of us don’t earn that much, so we go through all that paperwork and expense (accountant fees!) just to prove we aren’t cheating on our taxes.

More ridiculous

But let’s get back to Ben, our pilot. His story makes mine seem relatively simple.

Ben is not his real name. I’m calling him Ben after Benjamin Franklin, who also traveled across the ocean. He went to Europe both before the American Revolution, to represent individual colonies (states) in England, and after independence, to represent the US in France.

Based in Hong Kong, Ben, as an American citizen, has to file taxes in the US, and go through the same procedure as all overseas Americans to prove that he is not, in fact, a tax cheat.

However, as a pilot, it gets more complicated. Whenever he flies a plane over international waters, the US government considers this as working on US soil because it is not “within a foreign country.”

Think about what this means. Doesn’t this imply that the US claims the oceans as its own? What hubris!

a view of the Italian Alps. The flight time that our pilot spends here would not count as US-earned.

a view of the Italian Alps. The flight time that our pilot spends here would be foreign-earned.

But never mind the basic philosophy of that policy. Let’s look at its effects on Ben.

The FEIE only applies to “foreign-earned income.” So Ben’s income that he earns over international waters is not considered “foreign earned.” It’s considered earned in the US, so Ben has to pay US taxes on it.

To comply with this rule, Ben has to keep track of all of his flight hours each year and how many of them were spent over international waters. Then he pays taxes to the US on the amount he earned flying over the ocean. This means that, in effect, he’s taking a significant pay cut compared to his co-workers with any other nationality in the world, where taxation is residence-based. If they live in Hong Kong, they pay taxes in Hong Kong, not in their country of origin.

Ben’s average tax rate in Hong Kong is 18%. His US tax rate is about 30%. That means that for whatever time he spends over international waters, he has to pay 12% to the US. If you live in the US, that might sound fair, since you may be paying 30% as well. However, keep in mind that Ben is a pilot living in Hong Kong. He gets absolutely nothing for those tax dollars except a reduction in his take-home pay in comparison to his colleagues from other countries.

If Ben flies “home” to the US, 75% of that flight is over international waters. “I am being penalized,” he writes, “for going back to my own country! Whereas, if I wasn’t an American citizen, I could fly home as much as I like tax free.”

Even more ridiculous

It gets worse. Since the US does not recognize Ben’s retirement fund in Hong Kong as being a retirement fund, he has to pay taxes on it as income. While his co-workers accumulate a pension, Ben has to cash out his contributions each month to be taxed in the US. Since it is considered unearned income, it does not fall under the FEIE either.

These rules apply to anyone working in or over international waters: cruise ship crew, flight attendants, cargo ship workers and so on. Depending on where they live and that country’s tax laws, this situation could mean a substantial tax penalty on top of the complicated paperwork. Depending on the country’s tax treaty with the US, some people end up with no pension, or pay US capital gains taxes on property that has already been taxed where they live.

parked planes at Schiphol airport in the Netherlands

parked planes at Schiphol airport in the Netherlands

Many overseas Americans suspect that the purpose of these unfair laws is a conscious effort to keep Americans at home: to stop us from taking jobs overseas. I’ve always dismissed this as conspiracy theory paranoia, preferring to believe that these laws, meant to catch rich people hiding money overseas, just had some unintended consequences for overseas Americans. When I look at Ben’s situation, though, the conspiracy theory begins to look more plausible.

As far as I can tell, there are two ways that a pilot like Ben can deal with this situation:

  1. The first is to request overland routes as much as possible (obviously not an option for a cruise ship’s crew). If Ben flies from Hong Kong to the Netherlands, for example, all of his earnings fall under the FEIE since the whole flight is above land. He would still have to cope with the ridiculous paperwork and invasion of privacy, though.
  2. The other possibility is to renounce his US citizenship, as I have done. Like me, Ben doesn’t want to do this. In any case, it can’t be done unless you have another citizenship as well, and that’s not always easy to get.

What would you do?

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33 Comments

    • Rachel

      March 25, 2016 at 11:10 pm

      Isn’t that usually the same thing? Ben is paid in Hong Kong, but still is required to file US tax forms too, as are all overseas Americans and green card holders.

      Reply
        • Rachel

          April 26, 2016 at 8:49 pm

          It doesn’t matter where you earn or how much you earn; you still have to file the forms with the IRS every year. You generally don’t have to pay any taxes if you earn under the exemption of about $100,000.

          Reply
          • Randy Uthe

            July 18, 2016 at 9:52 pm

            $100,000 is a huge income. I filed, but stated my income was $0 because I made the equivalent of $12,000 USD at the time. So, $0 owed, $0 paid, $0 earned.

          • Rachel

            July 19, 2016 at 8:53 am

            I don’t understand what the advantage would be of saying your income was $0. If you’d declared the $12,000, you also wouldn’t have had to pay US taxes because of the $100,000 exemption. Why write $0?

          • Randy Uthe

            November 8, 2016 at 10:54 pm

            Like I said, $100,000 is a HUGE income says 80% of the world, or more. This whole argument seems pretty petty to me considering its greater context.

  • Heather Court

    March 26, 2016 at 8:52 am

    What is so frustrating is that it is still happening. There are enough US citizens being screwed by this law. Is there no way we can ban together and fight this? I cannot be okay to violate people’s privacy this way. And punish them for leaving the US.

    Reply
  • Viv

    March 26, 2016 at 2:41 pm

    Clocking the time in and out of International Airspace is outrageous, this is like logging the time one spent in and out of the office bathroom and then calculating a workdesk-vs-bathroom ratio at the end of the year to file and pay taxes!

    Reply
  • John Richardson

    March 26, 2016 at 7:10 pm

    Rachel:

    This is a very interesting post that illustrates a number of the absurdities inflicted on Americans abroad.

    First, your post demonstrates how Americans abroad are taxed differently depending on which country they live in. You make reference to the problems that the pilot has the with the Hong Kong pension. You note correctly that under U.S. tax law the pension is NOT considered to be a pension at all. As such it is taxable under U.S. law. The U.S. has NO tax treaty with Hong Kong (unless it is included in the China treaty – which I have not investigated) that would mitigate this problem. But, what is interesting is that if the pilot lived in Canada then he would have the benefit of the Canada U.S. tax treaty which would mitigate the pension problem. Americans abroad are taxed incredibly punitively. But the degree of punitivenness depends on he country where the American resides. Obviously Americans in Canada are taxed less punitively than Americans living in Hong Kong (or other countries where the U.S. has a tax treaty).

    Second, you have identified a very serious problem with the the FEIE (Internal Revenue Code S. 911) works. Income subject to the FEIE must be FOREIGN. It’s not where you live. It’s where the income was earned.

    You can see the IRS explanation of this principle by searching: “U.S. Citizens Performing Services in Foreign and International Airspace” – there is an actual IRS page on this.

    Third, it would be interesting to investigate whether (assuming that the pilot must pay taxes to Hong Kong on his full income) whether the Hong Kong taxes apportioned to the flight time over International Waters would be allowable as a Foreign Tax Credit against U.S. taxes. (See S. 901 of the Internal Revenue Code). Perhaps someone else could comment on this particular issue. Because Hong Kong has lower taxes than the U.S., the best case scenario (I think) would be that the pilot would end up paying a lower percentage (after taking a possible foreign tax credit) of tax directly to the USA.

    Fourth, the problems for U.S. pilots in Hong Kong may be even worse. A June 2, 2014 post by Virgina La Torre Jeker includes:

    “Starting in June, we understand that Cathay Pacific Airlines will commence withholding 30 per cent of its American pilots’ salary every month. The withholding will be for US taxes and will be passed on to the US Internal Revenue Service (IRS). In addition, Cathay will remit the pilots’ personal information to the IRS so that the proper records will be maintained and tax credit given to the taxpayer-pilot. It has been reported that the move will affect about 18% of the cockpit crew. …

    US Tax Shock

    It may come as a shock to foreign (non-US) companies and other foreign businesses to learn that they may have US tax withholding obligations with respect to their US employees, even if the foreign business is not in any way involved in US activity. Pursuant to the US Internal Revenue Code, an employer is required to withhold federal income and social security taxes from the wages of its US employees. Every quarter, the employer must file a Form 941, the Employer’s Quarterly Tax Return, reporting the amount of income and social security tax withheld during the period. A Federal Tax Deposit Form must be filed with the remittance of the withholding taxes the month following the close of each quarter.

    Foreign Employers Supposed to Withhold US Tax on Wages Paid to US Employees

    With certain exceptions, every employer making payment of “wages” to US employees is required to deduct and withhold upon those wages an income tax determined in accordance with IRS procedures.

    For income tax withholding purposes, “wages” is defined, with certain exceptions, as all remuneration for services performed by an employee for his employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash. The term “wages” includes remuneration for services performed by a citizen or resident of the United States as an employee of a nonresident alien individual, foreign partnership, or foreign corporation whether or not such alien individual or foreign entity is engaged in a trade or business within the United States. Thus, for example, a foreign corporation without any US activities is responsible for income tax withholding on wages paid to its US person employees.

    There are two possible exceptions to income tax withholding that may apply to US citizen employees. Generally, these are for amounts paid to US citizens (note, not to green card holders) when the amounts are covered by the foreign earned income / housing exclusions of Code section 911. There is also an exception for amounts on which the employer is required to withhold income tax by the laws of any foreign country or United States possession.”

    Finally, it is increasingly clear to me that unless one intends to return to the United States the only real option (as you know) is to renounce U.S. citizenship. The U.S. government is well aware of these problems and has chosen to not act. This means that either the abuse of Americans abroad is deliberate (which is quite possible) or the result of indifference (a form of extreme abuse).

    It’s simple either renounce U.S. citizenship or move back to the United States.

    Reply
    • Rachel

      March 26, 2016 at 9:06 pm

      Thank you for this thorough response, John! It’s such a shame that our government is treating us this way so that law-abiding citizens feel forced to renounce.

      Reply
  • JD

    March 27, 2016 at 7:15 am

    I’d say the ONLY true option is, as John has stated, renunciation. Given that our local, “foreign” banks are starting to close US person’s accounts (or disallowing the opening of), there literally is no way to live overseas. I don’t know about you all but, in AU, every wage is paid directly into a bank account. If you have no access to banking, you have no access to living.

    The US gov’t is simply running out of money after giving it all to the top-tier, richie-riches. They are now grabbing it from ANYwhere they can, including from people for whom they offer no representation nor services. With FATCA, the US is waging “law-fare” (as Assange calls it) against the entire world & is using threat of extortion as punishment. USA now = United Sopranos of Amerika.

    Relinquishing/renouncing is no longer a “choice”. Now, the only choice is: pay to have a CLN in-hand, living where you want to abroad as a truly free, global-citizen, or return to the US gulag like the good little slave the US gov’t considers you. Harsh, but true.

    Reply
    • Rachel

      March 27, 2016 at 9:41 am

      That is indeed harsh! But some people can’t renounce. They don’t have another citizenship, for example. Or they’re not willing or able to cut off the option of living in the US again. That’s a huge thing for a person who grew up in the US like me: renouncing means deciding I will never reside in the US ever again.

      Reply
      • JD

        March 27, 2016 at 1:34 pm

        “But some people can’t renounce. They don’t have another citizenship, for example. Or they’re not willing or able to cut off the option of living in the US again.”

        Then, they stay forever locked inside the USA- which, imho, is far worse than getting out & not going back. I’m not sure who I feel worse for: the ones who renounce & rue, or the ones who want out & have no easy way to do so.

        Sometimes the truth IS harsh, but better to face it head-on than to look for a fantasy reason behind this agreement- like FATCA & it’s fallout might not have been deliberately, cunningly, & sneakily planned & implemented on the part of the USA. Of course it was. And when you look at the figures of cost (to all of the other countries of the world) to benefit, you don’t even see any benefit.

        So, why do it? To gain control over the autonomy of other countries via the extortion-posing-as-tax-cheat agreement. I am incredulous that every country turned over their sovereignty just like that? This, is just mind-blowing to me! And what’s to say that the US gov’t doesn’t decide to up that ante the way they upped the renunciation fees? It’s nuts!

        Additionally, the US gov’t now has unfettered access to a whole lot more data– it’s massive value is difficult to put a price tag on. This, again imho, is the true reason behind FATCA.

        Citizens of the USA are NOT free, not by a long-shot, and their own gov’t is actively working to poison them to the world. THAT, to me, is the harshest truth of all.

        Reply
        • Rachel

          March 27, 2016 at 3:26 pm

          It amazed me too, that so many countries just agreed so easily to handing over the data. There seems to be some push-back happening in Canada, though. If the situation changes there, maybe it will embolden other countries to stand up to the US… but I’m not holding my breath!

          Reply
  • Anita @ No Particular Place To Go

    March 27, 2016 at 5:48 pm

    Ridiculous sums up the whole FATCA situation and the scenarios you’ve written about here! I love Viv’s comment above which seems to sum up neatly one aspect of a complicated situation. As retirees living outside the US we’ve continued to file our taxes annually without any undue hardship but it will be interesting to see how the future unfolds now that we have residency visas. And, in another tax twist, we need to file paperwork in Portugal demonstrating that we pay taxes in the US so that we can be exempt from paying taxes in Portugal. It’s all so complicated to be law abiding citizens, isn’t it?

    Reply
    • Rachel

      March 27, 2016 at 11:37 pm

      And it’s ridiculous –there’s that word again– that the law-abiding citizens are getting treated like suspected criminals! Portugal must have a very different tax treaty with the US. Here in Holland we pay Dutch taxes first, then pay US taxes only after the FEIE exemption. I don’t know if we’d get to deduct US taxes from Dutch taxes if we made more than the FEIE cutoff; I’ve never earned anywhere near that much!

      Reply
  • John Richardson

    March 27, 2016 at 6:39 pm

    @JD and @Rachel

    I certainly agree that the question of:

    “To renounce or not to renounce, whether tis better …”

    is a difficult question.

    There is NO answer to this that will not cause pain, hurt, resentment, anger, and long term pain.

    When I consider various categories of Americans abroad, I think it is useful to distinguish between those who have been filing their U.S. taxes and those who have not.

    First, Those who have been and are U.S. tax compliant …

    Those who have been filing U.S. taxes (and are in the tax system) are in the worst of all possible situations. By entering the U.S. tax system, they have voluntarily entered a “fiscal prison” that means that they will always be disadvantaged relative to others in their country of residence. Those who have been filing U.S. taxes can be further divided into:

    A. Covered expatriates – Subject to the S. 877A Exit Tax

    You will be a “covered expatriate” if you:

    – have too much income

    – too many assets

    – not tax compliant for five years

    Those who are “covered expatriates” (particularly those who have pensions in their country of residence) are in an incredibly difficult situation. To put it simply, they are likely to have to pay a huge portion of their life savings to be free of the United States. This is because of the effects of the S. 877A Exit Tax (Google this). As a rule of thumb, those Americans abroad with assets that exceed two million USD (easy to do if you own a house in Toronto, London, Vancouver, etc) will be very damaged if they “choose to be free”, by leaving the “land of the free”. I find that most Americans abroad are unaware of this or they think “that there must be some mistake – this couldn’t possibly be true”. Make no mistake. The U.S. S.877A Exit tax is designed to impose confiscatory taxation on (1) assets that exist outside the United States and (2) that were acquired after the person moved from the United States.

    B. Non-covered expatriates – not subject to the S. 877A Exit Tax

    If you check my site at “citizenshipsolutions dot ca” you will see this defined and discussed. My message for those of you who are non-covered expatriates is to get out now! Sooner or later you will be “covered”.

    It’s interesting that those who were “dual citizens from birth” (and meet other criteria) may be able to escape being a “covered expatriate”. This is interesting because it means that those who are punished the most by the S. 877A Exit Tax rules are those who were born ONLY U.S. citizens. You can’t make this up!

    Those who have not been and are not U.S. tax compliant …

    All of the evidence suggests that Americans abroad who are “U.S. Tax Compliant” are in a minority. Because of FATCA and fear mongering they are under pressure to become U.S. tax compliant. Many of them are coming into U.S. tax compliance. In fact many of them are coming into U.S. tax compliance for the sole purpose of being able to (1) avoid being a “covered expatriate” and (2) renounce U.S. citizenship.

    If you want to see what it means to live as a “U.S. tax compliant” citizen abroad, and why it is a “fiscal prison”, I invite you to read the following blog post (if Rachel will allow the link):

    https://www.taxconnections.com/taxblog/how-to-live-outside-the-united-states-in-an-fbar-and-fatca-world/

    There is NO “pain free” answer to the problem of attempting to live as a U.S. citizen outside the United States!

    Reply
    • Rachel

      March 27, 2016 at 11:30 pm

      Of course I’ll allow the links, John! You have been an invaluable help to lots of overseas Americans facing this situation! I was one of those who was non-compliant for years. When I first moved overseas, I filed taxes dutifully each year, but stopped after several years because it seemed so pointless to keep filing when I didn’t ever owe anything. Then I didn’t file for many years until I learned about FATCA and fell victim to the fear-mongering. I started the process to renounce, which involved paying thousands to an accountant to become compliant (our finances and the regulations had become much more complicated and I just couldn’t do them myself with any degree of confidence.) Fortunately I’m non-covered, and 2015 will be my last US tax year.

      Reply
  • Deckard1138

    March 27, 2016 at 9:17 pm

    More hypocritical nonsense from the Land if the Fee and the Home of the Depraved.

    The U.S. system of citizenship-based taxation is the moral equivalent of slavery – period. It is completely indefensible and has no place in the modern world.

    Reply
  • Kim Bergstrom

    March 29, 2016 at 1:46 am

    Interesting post about how one pays taxes when living outside of the US. The process definitely doesn’t encourage living outside of the US. Hm … while I love to travel, and Vacation is my middle name, I was thinking of living outside the US part time. Now I’m really going to have to investigate this!

    Reply
    • Rachel

      March 29, 2016 at 11:13 am

      You should really consult with a international tax specialist before you make any decision! It gets much more complicated at tax time if you’re a US citizen and live abroad.

      Reply
  • Hung Thai

    March 29, 2016 at 7:42 am

    Good lord… reading stuff like this makes me so mad. I don’t understand why our government lack such common sense that it’s absolutely absurd. If I were Ben, I would definitely denounce my citizenship – taxation without representation! I wonder what would happen if he just refused to report his taxes? Would they throw him in jail the moment he lands on US soil? Common sense… not in America.

    Reply
    • Rachel

      March 29, 2016 at 11:09 am

      There are literally millions of US citizens abroad who are not reporting their income to the IRS. It’s not clear what can happen to them. Since the banks, under FATCA, have to send the account information about US citizens to the US, they’ll presumably be liable to fines, etc. from the IRS if they have a lot of money in the bank that they haven’t reported. Presumably they could just refuse to pay up, but then it would not be a good idea to visit the US ever again, because, yes, in theory they could be arrested. Most of them, though, don’t have enough to owe any taxes to the US because of the FEIE, so it’s hard to believe the IRS would bother to come after them.

      As for Ben, I don’t know if he has another citizenship; I forgot to ask! He works for a big international airline, so it seems to me that not reporting his taxes isn’t really an option.

      Reply
    • Rachel

      April 1, 2016 at 3:55 pm

      I do think that eventually the push-back will be too much as countries realize how much it’s costing them: in expenses to banks and employers, in lost expertise of Americans going back to the US, and in money flowing out of the country because of the taxation of people earning within the country. I think it just takes a lot for them to stand up to the big bad US.

      Reply
  • Mike

    November 5, 2016 at 2:27 pm

    An American here in Belgium will net less of his salary than any other nationality. This is before the USA has stuck out it’s grubby paw for a slice. The reason is that a bonus payment is frequently paid via a SICAV. That’s basically an open ended investment trust. The reason for this is that it can be withdrawn at an advantageous tax rate compared to if it was paid via payroll. Yes you guessed it. The SICAV, being a complex financial product is closed to “US persons”, and so the American gets hit with confiscatory payroll taxes on bonuses.
    What the USA has done and is doing with it’s tax code and FATCA is the greatest scandal this planet has seen in a very long time, and one the general public are blissfully unaware of.

    Reply

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