Revenue Code 891: Doubling Taxes on Foreign Citizens

Internal Revenue Code Section 891 is a provision within U.S. tax law that grants the President the authority to double the U.S. tax rates on the citizens and corporations of a foreign country. This measure is designed as a tool to address situations where a foreign government imposes taxes on U.S. citizens or corporations that are considered discriminatory or extraterritorial.

The purpose of this statute, enacted in 1934, is to deter foreign governments from enacting tax laws that unfairly target American individuals and business interests. It serves as a negotiating instrument for the U.S. government, providing a response to what it perceives as inequitable tax treatment abroad. The authority rests with the President to determine when such conditions exist and to implement the tax increase through a formal declaration.

Conditions for Invocation

The activation of Internal Revenue Code Section 891 is contingent upon a formal process. The primary condition is the existence of a foreign law that subjects U.S. citizens or corporations to what are termed “discriminatory or extraterritorial taxes.” The statute does not provide a precise definition for these terms, leaving their interpretation to the context of international tax norms and the discretion of the executive branch.

A discriminatory tax, for instance, could be a law that imposes a higher corporate income tax rate on a subsidiary of a U.S. parent company than it does on a locally owned competitor. An extraterritorial tax could involve a foreign government attempting to tax income earned by a U.S. corporation entirely outside of that foreign country’s borders. Recent discussions have highlighted certain digital services taxes as potentially discriminatory, as they may disproportionately affect U.S. technology companies.

The second condition is a formal finding by the U.S. President that such discriminatory or extraterritorial taxes are being imposed by a specific foreign country. This finding is formalized through a Presidential Proclamation, which officially identifies the foreign country and triggers the doubling of tax rates for its citizens and corporations.

This proclamation marks the official start of the punitive tax measure, applying for the taxable year in which it is made and all subsequent years it remains in effect. The President also holds the power to revoke it. If the foreign country modifies its laws to remove the offending taxes, the President can issue another proclamation to that effect, ceasing the application of the doubled tax rates for taxable years beginning after the new proclamation is made.

Scope of Application

Once the President issues a proclamation under Section 891, the doubled tax rates are directed exclusively at the citizens and corporations of the specific foreign country named in the proclamation. This means that U.S. citizens, U.S. permanent residents who are not citizens of the targeted country, and U.S. corporations are not subject to this tax increase.

For individuals, the impact is centered on their national citizenship. A person who is a citizen of the designated foreign country would face the doubled U.S. tax rates on their applicable U.S. income, even if they are a resident of the United States for tax purposes. This could affect employees on certain visas working in the U.S. or individuals who have U.S.-source investment income.

For entities, the focus is on the country of incorporation. A corporation organized under the laws of the foreign country identified in the proclamation would be subject to the doubled tax rates on its U.S. earnings. This applies to income that is effectively connected with a U.S. trade or business, as well as certain types of U.S.-source income not connected to a business, such as dividends and interest. The legal status as a corporation of the targeted foreign country is the defining factor.

Tax Implications of Invocation

Invoking Section 891 mandates a doubling of the tax rates imposed by the Internal Revenue Code. This increase applies to the income, estate, and gift taxes of the affected foreign citizens and corporations. The tax at the doubled rate is then treated as the tax imposed under the original, underlying Code sections.

For an individual citizen of the targeted nation, the U.S. income tax rates on their earnings would be multiplied by two. For example, if their U.S.-source income falls into a tax bracket with a 22% rate, that rate would become 44%. This doubling applies to taxes on income connected with a U.S. business as well as the flat withholding tax rates on U.S.-source income like dividends, which could be doubled to 60%.

The provision’s reach extends beyond income tax to wealth transfer taxes. For a citizen of the designated country, the U.S. estate tax, which applies to their assets located within the United States, would also be doubled. Similarly, the U.S. gift tax on transfers of U.S.-sited property would be subject to the doubled rates.

However, the law includes a limitation to prevent confiscatory levels of taxation. Section 891 states that the total tax imposed cannot exceed 80% of the taxpayer’s taxable income for the year. For instance, if doubling the applicable tax rates resulted in a calculated tax liability of 85% of taxable income, this cap would reduce the final tax owed to 80% of that income.

Interaction with Tax Treaties

Tax treaties are international agreements designed to prevent double taxation and provide fiscal certainty for individuals and businesses. These treaties often contain provisions that set maximum tax rates on certain types of income, which could directly conflict with the doubling of rates mandated by Section 891.

A governing principle in U.S. law for resolving conflicts between statutes and treaties is the “later-in-time” rule. This principle holds that whichever instrument—the domestic law or the international treaty—was enacted or ratified more recently will prevail. Since most U.S. tax treaties were established after Section 891 was enacted, they would typically override the statute’s provisions.

For Section 891 to supersede a later-in-time treaty, a Presidential proclamation alone may not be sufficient. To override the treaty, Congress might need to pass new legislation that affirms the President’s proclamation. This new statute would then be the “later-in-time” authority, giving Section 891 the legal power to override the treaty’s conflicting terms.

This creates a scenario where, even if the conditions for invoking Section 891 are met, its application to citizens of a country with a tax treaty with the U.S. may be limited. Overcoming a treaty’s protections would involve careful consideration of broader diplomatic and economic consequences.