U.S. Puts Americans in Japan in Taxing Situation

Question: Where do U.S. expatriates pay the heaviest taxes and have the toughest time getting along financially?

Answer: Without a doubt it’s Japan--and it’s not just the notoriously high prices here.

There are at least two problems that make it very difficult for Americans to compete in Japan--far more difficult than for Japanese citizens working in the U.S.

One problem is American, the other Japanese.

Everyone knows that Japanese prices are among of the highest in the world. What few people know is that Japan’s marginal income tax rates can go as high as 65%. Whereas these high tax rates hurt the Japanese economy by discouraging individual risk taking and innovation, they also discourage foreign companies from entering Japan by increasing the cost of doing business relative to other markets. In order to persuade American employees to move to Japan, for example, U.S. companies have to pay truly exorbitant salaries to compensate for both the higher prices and tax rates.

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However, because these rates are applied to Japanese as well as foreigners, they alone do not put Americans at a disadvantage.

What makes the situation worse for Americans is the fact that the Internal Revenue Service also taxes them on the income earned in Japan. The tool the IRS uses is the alternative minimum tax, or AMT, which was originally designed to deal with those people in the U.S. who use all sorts of tax breaks to reduce their liabilities. Although the regular (non-AMT) tax code avoids double taxation by allowing U.S. citizens abroad to offset their U.S. tax liability with foreign tax credit, the AMT doesn’t allow the full use of this credit. As a result, Americans have to pay AMT on top of exorbitant Japanese taxes and, as a result, end up paying one of the highest tax rates in the world.

Moreover, because companies abroad do not withhold U.S. taxes from their American workers’ pay, the IRS demands that the workers themselves pay the so-called estimated tax. The concept of estimated tax, which was designed for self-employed people within the U.S., becomes a nightmare for American taxpayers employed abroad.

An American worker in Japan, for example, must estimate dollar amounts of U.S. taxes based on yen-denominated income he or she receives. During 1995-96, the yen-dollar exchange rate moved from 79.75 yen to 111.2 yen--or more than 39%. Furthermore, it was not too long ago that former Treasury Secretary Lloyd Bentsen was openly taking down the dollar, and today, Treasury Secretary Robert Rubin is openly taking up the dollar. Asking taxpayers abroad to estimate U.S. taxes with this kind of unpredictability is effectively forcing them to speculate in the foreign exchange market.

These worries and concerns drain Americans working abroad in no small way. Just asking an accountant to calculate and file U.S. taxes from Japan, a rather involved procedure, costs $2,000 in Japan. The point is that Americans abroad are unduly penalized by payment rules (estimated tax) and taxes (AMT), both of which were designed with other goals in mind.

The Japanese tax authorities have not been asleep, either. After five years in Japan, all foreigners are taxed on their global income. In other words, if an American has a savings account in the U.S., the interest will be taxed by both U.S. and Japanese authorities. As a result of this provision, most foreigners sent to Japan leave the country in five years, just when they become useful in a place where long-term relationships are everything.

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In contrast to Americans facing double taxation in Japan, Japanese working in the U.S. have no Japanese tax liabilities. They do not even have to file a Japanese tax return. This is true with many other nationals. As a result, they can compete fully in the U.S. market vis-a-vis the local Americans.

For the U.S. to be competitive with Japan and elsewhere in the global economy, individual Americans must also be competitive. But the current U.S. tax structure places Americans at a severe disadvantage compared with other foreign nationals working abroad.

These kinds of self-inflicted disadvantages mean that U.S. companies have a tougher time penetrating the Japanese market and keeping qualified people in Japan. And that’s certainly not good for the U.S. economy in the long run.

The U.S. government needs to move to level the playing field. The AMT should be applied to those who are not paying taxes, not to those who are already paying one of the highest tax rates in the world. The U.S. should also negotiate with foreign governments to see whether double taxation, such as those contained in Japan’s five-year rule, can be relaxed to allow Americans to better compete abroad.