Month: April 2014
The above statement may sound quite provocative, until one explores in more detail some of the basic principles identified by the U.S. Supreme Court.
IRS Notice 2009-85 is the guidance issued by the IRS after Section 877A was adopted in 2008 and attempts to address a number of issues regarding the mark to market rules. This IRS Notice is a type of so-called “IRB” guidance (Internal Revenue Bulletin). Other IRS guidance that falls into this “IRB” guidance category includes revenue rulings and revenue procedures.
Two key Supreme Court cases, Mayo Clinic and Home Concrete and the 3rd Circuit Cohen decision, among many others, help articulate when such IRS authority is valid, and when it can be successfully challenged by taxpayers. A thoughtful law review article by Kristin Hickman, Unpacking the Force of Law, articulates in much detail the law in this regard and when IRS guidance, specifically including IRS Notices are subject to other U.S. laws, including the Administrative Procedures Act (“APA”).
Below is a list of some of the provisions of IRS Notice 2009-85 that seem to fall outside the language of the statute:
- A covered expatriate who is required to file Form 8854 for such taxable year will be considered to have timely filed Form 8854 if it is filed by the due date of the original Form 1040NR or Form 1040 (including extensions) for such taxable year. Covered expatriates who are U.S. citizens or long-term residents for only part of the taxable year that includes the day before the expatriation date must file a dual-status return.
D. Interaction with treaties
Section 877A(f)(4)(B) provides that a covered expatriate shall be treated as having waived any right to claim any reduction under any treaty with the United States in withholding on any distribution to which section 877A(f)(1)(A) applies unless the covered expatriate agrees to such other treatment as the Secretary determines appropriate.
What are the consequences if a former USC or LPR does not comply with one or more of the above requirements that are only set forth in a Notice and not the statute?
Can the IRS make a determination that the taxpayer is a “covered expatriate”, even if they otherwise do not meet the asset or tax liability thresholds?
There is no “timely filed” requirement in the statute or even an inference in it, as to the time and effective nature of notifying the IRS?
Can the IRS successfully argue that the certification requirement of Section 877(a)(2)(C) has not been satisfied and the individual is a “covered expatriate” if IRS Form 8854 is not “timely filed” as defined by the IRS in the Notice?
Must a taxpayer necessarily agree to “such other treatment as the Secretary determines” appropriate, even if such determination is contrary to the terms of an applicable income tax treaty? Can the Secretary unilaterally override the terms of an income tax treaty negotiated between two countries?
These and other questions remain as a result of IRS Notice 2009-85.
The difference between news and advertisement/self-promotion can sometimes be confusing. In this sense, I am not sure the report in the WSJ is very helpful, thoughtful or accurate. It consists largely of a survey conducted by H&R Block, which has its own bias and looks more like an advertisement.
Nevertheless, the following tidbit of information from this H&R Block survey may be of interest:
- The survey found that a majority of expats seek assistance. And when they do, more than three-quarters of the time — 78 percent — they seek the help of a U.S.-based tax preparer. The survey also found that more than 4 out of 10 expats file in March or April — a full two to three months before the filing deadline of June 15.
I question whether the majority of citizens residing overseas do seek assistance? I also doubt whether the vast majority of those, 78%, actually seek a U.S. based tax return preparer?
Filing U.S. income tax returns (along with the tax returns in the country of residence) is one of the most frustrating experiences that USCs and LPRs living overseas have for several reasons:
- There are rarely good and efficient U.S. international tax return preparers who understand the specific tax rules in the various countries and specific locations where USCs and LPRs live. See, USCs and LPRs Living Outside the U.S. – Key Tax and BSA Forms
- How many USCs even know they have to file U.S. income tax returns?
- Any USC living outside the U.S. will be required to file a U.S. federal income tax return for the year 2013 if any of the following gross income thresholds (depending upon the filing category) are met:
|Filing Status||Age at December 31, 2013||Gross Income|
|65 or older||$11,500|
|Married Filing Jointly||Under 65 (both)||$20,000|
|65 or older (both)||$22,400|
|Under 65 (one)||$21,200|
|Married Filing Separately||Any||$6,100|
|Head of Household||Under 65||$12,850|
|65 or older||$14,350|
|Qualifying Widow(er)||Under 65||$16,100|
|65 or older||$17,300|
This filing requirement not only applies to United States Citizens, but also to Lawful Permanent Residents (“LPRS”) who live in a country that has no U.S. income tax treaty with the U.S.
The Taxpayer Advocate has been a vocal critic in several reports about the complexities of the tax law, Title 26:
Consider the following:
■■ According to a TAS analysis of IRS data, individuals and businesses spend about 6.1 billion hours a year complying with the filing requirements of the Internal Revenue Code. And that figure does not include the millions of additional hours that taxpayers must spend when they are required to respond to IRS notices or audits.
■■ If tax compliance were an industry, it would be one of the largest in the United States. To consume 6.1 billion hours, the “tax industry” requires the equivalent of more than three million full-time workers.
■■ Compliance costs are huge both in absolute terms and relative to the amount of tax revenue collected. Based on Bureau of Labor Statistics data on the hourly cost of an employee, TAS estimates that the costs of complying with the individual and corporate income tax requirements for 2010 amounted to $168 billion — or a staggering 15 percent of aggregate income tax receipts.
■■ According to a tally compiled by a leading publisher of tax information, there have been approximately 4,680 changes to the tax code since 2001, an average of more than one a day.
■■ The tax code has grown so long that it has become challenging even to figure out how long it is. A search of the Code conducted using the “word count” feature in Microsoft Word turned up nearly four million words.
■■ Individual taxpayers find return preparation so overwhelming that about 59 percent now pay preparers to do it for them.12 Among unincorporated business taxpayers, the figure rises to about 71 percent.13 An additional 30 percent of individual taxpayers use tax software to help them prepare their returns,14 with leading software packages costing $50 or more. For 2007, IRS researchers estimated that the monetary compliance burden of the median individual taxpayer (as measured by income) was $258.
The IRS is not letting up regarding USCs and LPRs living outside the U.S. Quite the opposite, the most recent announcement of the IRS released yesterday on April 11th, emphasizes the U.S. tax law requirements and their applicability to these individuals.
Specifically, the IRS reiterates as follows in IR-2014-52 – IRS Reminds Those with Foreign Assets of U.S. Tax Obligations:
- The Internal Revenue Service reminds U.S. citizens and resident aliens, including those with dual citizenship who have lived or worked abroad during all or part of 2013, that they may have a U.S. tax liability and a filing requirement in 2014.
- The filing deadline is Monday, June 16, 2014, for U.S. citizens and resident aliens living overseas, or serving in the military outside the U.S. on the regular due date of their tax return. Eligible taxpayers get one additional day because the normal June 15 extended due date falls on Sunday this year. To use this automatic two-month extension, taxpayers must attach a statement to their return explaining which of these two situations applies. See U.S. Citizens and Resident Aliens Abroad for details.
The April 11th date of the notice is ironic, since it is on the eve of the filing deadline for individuals who live within the U.S. Surely, the IRS wants to bring attention to these legal requirements days before the April 15th deadline for those residing in the U.S.
The irony is that the tax law does not require USCs or LPRs who live outside the U.S. and have U.S. tax filing obligations to file by April 15th. The deadline for these individuals who live outside the U.S. is not until June 15th as explained in the IRS notice (June 16th in 2014, since the 15th falls on a Sunday).
In this notice, the IRS does not emphasize the draconian penalties that befall these taxpayers for not filing international information returns or FBARs. The minimum civil penalties for failures to file these forms is almost always at least US$10,000. See, USCs and LPRs Living Outside the U.S. – Key Tax and BSA Forms.
Next, the due date for filing of FBARs is not the same as the due date for income tax returns, June 15th, but always falls on June 30th. There is no extension for FBARs, unlike income tax returns. See, Nuances of FBAR – Foreign Bank Account Report Filings – for USCs and LPRs living outside the U.S.
Will the IRS publish another notice, or beat more drums on the eve of the June 15th (16th for 2014) filing deadline for USCs and LPRs living outside the United States?
Prof. Daphne Barak-Erez was born in the U.S. and hence became a U.S. citizen by virtue of her birth in the United States pursuant to the 14th Amendment (Section 1) of the U.S. Constitution. She was appointed in 2012 to the Supreme Court in Israel. The Tel Aviv University website provides a summary of her impressive CV as follows:
|Faculty of Law, Tel Aviv University,
Prof. Daphne Barak-Erez recently left the Faculty of Law after being appointed to the Supreme Court of Israel. She was the Stewart and Judy Colton professor of law and held the chair of law and security.
She is a three time graduate of Tel-Aviv University: LL.B. (summa cum laude) 1988; LL.M. (summa cum laude) 1991, and J.S.D, 1993 (recipient of the Colton Fellowship). She was a visiting researcher at Harvard Law School, a visiting fellow at the Max-Planck Institute of Public Law, Heidelberg, an Honorary Research Fellow at University College London, a Visiting Researcher at the Swiss Institute of Comparative Law in Lausanne, a Visiting Researcher at the Jawarlal Nehru University in Delhi and a Visiting Fellow at the Schell Center at Yale Law School. . . . She was awarded several prizes, including the Rector’s Prize for Excellence in Teaching (three times), the Zeltner Prize, the Heshin Prize, the Woman of the City Award (by the City of Tel-Aviv) and the Women in Law Award (by the Israeli Bar). She is the author and editor of several books and of many articles in Israel, England, Canada and the United States.
They are typically not aware that they must have a U.S. passport to travel to the U.S. pursuant to a 2004 law, known as the Intelligence Reform and Terrorism Prevention Act.
There are many dual nationals living in countries throughout the world. The statistics are a bit fuzzy as to the exact numbers.
The principle focus of most discussions about the U.S. “expatriation tax” is typically on the “mark to market” rules for income tax purposes.
However, the law has two different types of taxes. First, there is the “mark to market” tax on phantom income from the deemed sale of worldwide assets. Second, and often not considered in detail, if at all, there is a tax on the recipient of “covered gifts” or “covered bequests” of 40% of the value of the property received. See, Joint Committee Reports – 2008 Report re: HEROES Act – Mark to Market Regime – New Section 877A (55 pages)
It is this second tax under Section 2801 on gifts and bequests that is the focus of this discussion – which I call the “forever taint”!
Most individuals think the mark-to-market tax upon expatriation is only applicable to rich, wealthy or otherwise individuals with high levels of income and unrealized gains. See, Accidental Americans” – Rush to Renounce U.S. Citizenship to Avoid the Ugly U.S. Tax Web” International Tax Journal, CCH Wolters Kluwer, Nov./Dec. 2012, Vol. 38 Issue 6, p45.
This is often the case, as far as the logic goes as it relates to the former U.S. citizen or LPR and the application (or not) of the “mark to market” tax. Accordingly, many of these former U.S. citizen and LPRs think they should not be concerned if they do not have significant assets with lots of unrealized gain. Unfortunately, the lack of attention to Section 2801 can be very nearsighted.
The idea that only wealthy individuals with assets should be concerned about being a “covered expatriate” is misplaced. The former U.S. citizen or LPR should not lose sight of the U.S. tax costs to their future beneficiaries of their estate, trusts they fund in the future, or future gifts. For instance, if the spouse or one or more of the children are U.S. citizens (or even unborn grandchildren or great grandchildren), there might be an unforeseen tax to pay many years in the future. The tax under Section 2801 is currently 40% of the gross value of the “covered gift” or “covered bequest.” The recipient pays this tax, not the former U.S. citizen or LPR. Plus, the rate of this tax at 40% of the gross value, is always much higher than the “mark-to’market” income tax (only applicable to the income or gain – and not the full value of the property) as the person leaves the U.S.
The application of Section 2801 requires anyone contemplating renouncing (or proving a prior relinquishment) of citizenship to strategically consider the long-term consequences to his or her family and friends.
For instance, trusts formed under the laws outside the U.S., which are funded by a “covered expatriate” that may benefit future generations, which include a U.S. citizen or resident, will have to pay the tax – currently 40%. This tax lives on forever, as long as there are assets from the former U.S. citizen or LPR that have been funded or set aside for family or friends who are “U.S. persons” in the tax sense.
To demonstrate an extreme example, a husband/wife U.S. citizens who have $3M of cash (as their only assets) when they renounce citizenship, will have no “mark to market” tax to pay, as there will be no phantom income. Cash has no unrealized gain. However, if the former citizens then grow a successful business while living in their home country, such that all wealth of this business was created as non-U.S. persons outside the U.S., any future gifts or bequests to U.S. persons would be subject to a 40% tax at current tax rates. For instance if this same person grows the company so he and his wife’s complete estate is worth US$10M at their deaths, and then bequeaths these assets to their three dual national (including U.S. citizen) children, the children will have to pay US$4M in taxes under current rates. This is true even if none of the children live in the U.S.
This would be a very bad tax result, since if they had remained U.S. citizens, there would be no U.S. estate taxes to them under current law and the children would have received the US$10M free from all U.S. federal taxation.
Finally, this “forever taint” could live on for multiple generations. For instance, in the above example, if the former U.S. citizens funded the US$10M in trust for the benefit of their children, grandchildren and great-grandchildren, all of whom have dual citizenship (including U.S.), these descendents will be paying the tax under Section 2801, even if some of these family members are yet to be born on the date (i) the trust is funded, or (ii) the death of husband and wife. This is the “forever taint.”
While the expatriate might be delighted they have no future U.S. income tax obligations during their lifetimes, if they have friends and family who will be beneficiaries of their estate, they should keep their eye on Section 2801 and its “forever taint”.
Today’s law is a “mark to market” deemed disposition of worldwide assets combined with a 40% tax on the receipt of “covered” inheritances and gifts by U.S. persons. The initial tax expatriation law that began in 1966 through its changes in 1996 and then 2004 was quite different, with a 10 year period of taxation after expatriation.
Below is a brief summary of the key changes (and when) that were made to the tax expatriation provisions, although the first law adopted in 1966 The Foreign Investors Tax Act of 1966 (“FITA”) – The Origin of U.S. Tax Expatriation Law is not reflected:
U.S. immigration lawyers around the world often cite the 1996 revision in the immigration law that was introduced by then Representative Reed (now Senator Reed). The provision found at INA 212(a)(10)(E) () is often referred to as the Reed Amendment. It provides as follows:
- (E) Former citizens who renounced citizenship to avoid taxation
- Any alien who is a former citizen of the United States who officially renounces United States citizenship and who is determined by the Attorney General to have renounced United States citizenship for the purpose of avoiding taxation by the United States is inadmissible.
Not surprisingly, immigration lawyers often become alarmed at such provision, if their client can be deemed “inadmissible”; i.e., not be allowed back into the U.S. What if you want to travel to the U.S.?
Fortunately, the Reed Amendment is –
(a) now irrelevant under the current “mark-to-market” expatriation tax provisions, since the motivation of why someone renounces their U.S. citizenship, be it due to the complexity of the U.S. tax laws or otherwise, is not applicable any longer (i.e., the term tax “avoidance” does not appear anywhere in Section 877A); and
(b) has never been invoked by the federal government to bar reentry of a former U.S. citizen in its history (even when it was relevant from the mid 1990s through the following two decades).
The subjective test of “tax avoidance” that existed in the 1996 tax expatriation provisions were eliminated in 2004.
There are a number of legal reasons why the government has never invoked this provision, notwithstanding calls by influential Senators in some cases to have its provision invoked. See, Reed Asks Homeland Security to Enforce Law on Ex-Citizen Tax
Hence, it is a provision with “no teeth” and “no bite.”
For more details, see –
I will be preparing (along with immigration counsel) a series of posts on this important topic over the course of the next two months.
There are a number of important legal differences between the two concepts of how one “sheds” their U.S. citizenship. Often times, most importantly for tax considerations, the question is “when” is the effective date that U.S. citizenship was terminated.
The following Department of State Forms can be reviewed here, which will be discussed in later posts:
Form DS-4079 Request for Determination of Possible Loss of United State Citizenship
This form focuses on facts and details that might lead to prior relinquishment of U.S. citizenship, as opposed to current renunciation.
Form DS-4080, Oath of Renunciation of the Nationality of the United States.
This form is rather self-explanatory.
Form DS-4081, Statement of Understanding Concerning the Consequences and Ramifications of Relinquishment or Renunciation of U.S. Citizenship.
More information to follow.
Today’s “tax expatriation” provisions which are based upon “mark-to-market” concepts of a “deemed/fictional sale” of worldwide assets, look quite different from the original law. The first version was adopted by The Foreign Investors Tax Act of 1966 (“FITA”). FITA introduced a number of specific tax concepts applicable to non-residents.
In addition, it created the first concept of “tax expatriation” for former U.S. citizens, that remained unchanged until the amendments in the law in 1996. There was no reference to lawful permanent residency (or former LPRS) in the 1966 FITA.
The basic concept of the statute remained largely unchanged from the 1996 revisions compared to the original FITA 1966 version, which then I.R.C. § 877(a)(1) provided in relevant part as follows:
These old rules imposed U.S. tax on gains for a 10 year period after the former U.S. citizen became a nonresident alien. The tax rate applicable was the normal U.S. rate and it was levied on gains from the sale of U.S. property, specifically stock and debt in U.S. companies. Those items of income were treated as U.S. source income for that purpose.
The big difference in the 1996 revisions, was the creation of a presumption of a “principal purpose of tax avoidance” that had to be rebutted by submitting a private letter ruling request to the IRS.
For a somewhat provocative look at the law and its history, see, CATCH ME IF YOU CAN: RELINQUISHING CITIZENSHIP FOR TAXATION PURPOSES AFTER THE HEART ACT By: Yu Hang Sunny Kwong