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.
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.
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!
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.
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:
- 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.
- 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?