May 30, 2018 Transcript

Transcription

1 May 30, 2018 Transcript Hello everybody, and welcome to The Bauman Letter Weekly. I had an interesting question from a reader this week about Her Royal Highness the Duchess of Sussex, also known as Meghan Markle. Because it relates to the taxation of U.S. citizens living abroad and to renouncing U.S. citizenship, I thought I would get over my natural aversion of talking about the British royal family and answer that question. Here s the question: My understanding is that Meghan Markel was born in the United States and is a U.S. citizen. Therefore, she must pay the IRS taxes and file for the rest of her life, unless she renounces her citizenship and pays an exit tax. If she doesn t do this, does the royal family owe us taxes for Harry s contribution to her finances? If she decides to end her U.S. citizenship in the future and then decides to return to the U.S., does she go to the back of the line to reapply for citizenship? Let me answer that question in parts. First, as an aside that may be interesting to you, Meghan s surname is going to change. Obviously, she won t be Meghan Markle anymore unless she decided to keep her surname, which is highly unlikely given British tradition. But her name is not going to be Windsor, which is the surname of the British royal family. Instead, it s going to be Mountbatten-Windsor. In 1917, the British royal family decided to call themselves Mountbatten-Windsor, rather than just Windsor, to distinguish the descendants of the king at the time. So, when Meghan applies for a U.K. driver s license, she s going to be called Rachel Meghan Mountbatten-Windsor. The second interesting thing is that the queen granted Prince Harry a dukedom when he married Meghan, just as she did with Prince William and Kate Middleton, who became the Duke and Duchess of Cambridge. So, Harry and Megan are now the Duke and Duchess of Sussex. (The only previous Duke of Sussex, way back a couple of hundred years ago, was married twice. But, both marriages were considered unlawful by his father King George the Third. Therefore, Meghan will be the first woman entitled to use the title of Her Royal Highness the Duchess of Sussex. I think

2 it s quite interesting. I had no idea that was true.) Now, let s get to the meat of the question. What about taxes? What about her citizenship? This applies to all of us, and the fact that she s a royal doesn t make any difference. First, the Duchess of Sussex is a citizen of the U.S. According to news reports, she is in the U.K. right now on a family visa. That means she was engaged to a U.K. citizen and could stay in the country until her marriage. After her marriage, she must apply for a continued family visa. In other words, the fact that she married Prince Harry doesn t give her the automatic right to live in the U.K. permanently. Instead, the Duchess of Sussex is going to have to apply to renew her visa every two and a half years. She won t be able to get permanent residence in the U.K. until she s lived there for five years. So, for the next five years she will be on a renewable visa. After five years, she can apply for U.K. citizenship and become a dual citizen of the U.S. and the U.K. Regardless of what she decides to do, Meghan will have to continue to file her U.S. taxes with the IRS on any income she makes. That s the case whether she is a on a family visa in the U.K., a permanent resident of the U.K. or a dual U.S./U.K. citizen. If she is a U.S. citizen, she is obligated to continue filing her taxes each year with the IRS. U.S. citizens are subject to tax by IRS regardless of where they live. And, you must pay taxes on all the income that you earn everywhere in the world, not just the income you earn in the United States. The U.S. is the only country other than Eritrea a tiny little country in Africa that does this. Every other country taxes their citizens on income that they make inside the country, but not on income they make outside the country. So, as a U.S. citizen, Meghan Markle is going to have to pay U.S. taxes on the income that she receives as a member of the royal family. Now, there s a thing called foreign earned income exclusion. That means that Meghan won t have to pay taxes on the first $104,100 that she earns in the U.K. Any U.S. citizen permanently living outside the United States is exempted from paying tax on the first $104,100 earned outside the United States. That applies to everybody. I took advantage of that when I lived in South Africa. Here s the tricky part: That exemption doesn t include income from investments, and investments are the main source of income for the British royal family. So, if Megan ends up getting her keep, if you like, from Harry and the British royal family s investments (they don t really earn money anywhere else), that means she s going to have to pay tax on her whole income.

3 Since age 21, Prince Harry and Prince William have been getting about $450,000 a year in investment profit from their late mother Princess Diana s estate. They pay taxes on that to the U.K. government. They also get an allowance from their father Prince Charles, which is used to cover things like clothing and travel in their royal duty. So, all the money to which Prince Harry and his wife the Duchess of Sussex have access to is going to be investment income. And it s all going to be taxable by the U.S. There is another loophole that that Meghan could take advantage of, but I don t think she s going to succeed. That loophole is called the foreign housing exclusion. This gives you an additional deduction for your living expenses when you re living abroad permanently. In addition to the $104,100 she could conceivably write off for U.S. taxes, she could also take this housing exclusion. The problem is that the housing exclusion doesn t include expenses that are lavish or extravagant under the circumstances. And, unfortunately for Meghan, Nottingham Cottage, which is the home that she and Harry are going to share on the grounds of Kensington Palace, is probably going to be considered lavish by IRS standards! So, Megan is not going to be able to escape any taxation from the IRS. There s an additional problem. If Meghan has more than $300,000 in assets at any point during the tax year which is quite likely given the fact that she was a successful actress and her husband is a prince of the royal family of Britain she s going to have to file a document called a Form 8938 under the terms of the Foreign Account Tax Compliance Act (FATCA). She must file that document with the IRS, which details her and her husband s financial assets. Not just her, but her and her husband, because he s part of her household. Therefore, any assets that he has are reportable to the IRS under FATCA on Form Here s the interesting part: Those financial assets almost certainly include foreign trusts and very complicated financial structures, which the U.K. Royal family uses to house their fortune (which is considered to be close to half a billion dollars). That means that while Meghan is a dual U.S./U.K. citizen, or a permanent resident in the U.K., she is going to have to report on her Form 8938 any financial interest that her husband Harry has in all these very complex royal family financial arrangements. Those include things like trusts in the Caribbean and other things, some of which were exposed in the Panama Papers issue a couple of years ago. This is something that the royal family is not going to want to see happen, because

4 once the IRS has the legal right to poke into their business, they may want to reconsider the notion of U.S. independence. Who knows, they could invade the U.S. to stop the IRS from poking into their money! Of course not... that s not going happen. The point is that even though Meghan is now the Duchess of Sussex, it won t change anything. If she has children with Harry, they would be U.S. citizens and would also be required to report their access to any of this royal family money as well. My guess is that the royal family is probably going to pressure her to renounce her U.S. citizenship, even if she d rather not do it. That s the simplest solution. But that can t happen for the next five years. So, for the next five years it s quite possible that the IRS is going to poke into Meghan s family s financial affairs, which are amongst the most secretive and complex in the world. Even if she does decide to expatriate, she would be subject to an exit tax in the United States. That exit tax is applied to her net worth at the time when she renounces her citizenship. In other words, even if she doesn t liquidate her assets, she will have to pay tax on the net worth of her estate at a certain rate on the day that she expatriates. This means that some of the money and wealth that she now has as a result of being a member of the British royal family would potentially be taxable by the IRS. Imagine how unhappy the queen is going to be about that. Never mind Prince Philip. I m sure he ll have lots to say! Of course, if she does renounce her citizenship, she d struggle to get it back. Yes, she would have to go to the end of the queue, as they say in Britain. She would not get any special treatment from the United States. Note that if Megan Mountbatten-Windsor does give up her U.S. citizenship, she won t be alone. Last year more than 7,000 people chose to give up their U.S. citizenship, which is a 26% increase over the previous year and an historic high. The reason for that is precisely because of the things I ve just described. It is not easy to be a U.S. citizen living outside the United States, particularly if you have your finances intertwined with your foreign family. All that stuff has to be reported to the IRS, even if your foreign husband or wife has nothing to do with the United States. This is something that has driven a lot of U.S. citizens crazy, many of whom are born in the U.S. to foreign parents and become citizens by virtue of birth, but would otherwise have nothing to do with the U.S. I would expect to see more headlines about this issue, about Meghan Mountbatten-

5 Windsor and her taxation situation. Things could get very interesting, and it could even lead to a change in these crazy laws we have in the United States. If it does, good on you Duchess of Sussex. You ve done a good deed for all of us. This is Ted Bauman signing off. I ll speak to you again next week.