Month: December 2014
Proposal to U.S. Treasury and IRS: awaits Final Regulations on “Covered Gifts” and “Covered Bequests”
When people write about the taxes from expatriation, the focus seems to be on the income tax provisions. Maybe that is normal, since an income tax can be immediately triggered with reference to the “expatriation date” as defined in the law.
However, the most costly tax will often be the tax on “Covered Gifts” and “Covered Bequests” which went into effect in 2008, but is awaiting Treasury regulations for publication.
Proposed regulations are in the works and presumably were going to be released before the end of the year. In May of this year, I presented a set of formal recommendations to the U.S. Treasury and IRS on this topic in a paper entitled:
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COVERED GIFTS & BEQUESTS: THE NEED FOR GUIDANCE (5+ YEARS OUT)
This proposal can be read in its entirety here, and the executive summary is set out below:
The reason these regulations are so important, is due to the tax cost of taxes upon U.S. beneficiaries. See, The “Hidden Tax” of Expatriation – Section 2801 and its “Forever Taint.”
The tax is currently levied at a 40% rate on basically the full vale of the asset upon the gift or bequest. It also continues on for potentially generations into the future; e.g., if U.S. beneficiaries receive property held in trust that was funded by a “covered expatriate.” For instance, to demonstrate the consequences, we can assume a former U.S. citizen who is a “covered expatriate” (e.g., for failure to properly certify under Section 877(a)(2)(C) and file IRS Form 8854, even though the income tax or asset tests are not satisfied) funds a trust in a foreign country for her grandchildren and great grandchildren. See, How many former U.S. citizens and long-term lawful permanent residents have filed (or will file) IRS Form 8854?
Over time, the value of those trust assets grow substantially and 30 years after her death (e.g., the year 2055), the trust starts distributing US$100,000 annually to several U.S. citizen grandchildren and grandchildren. Under the current law, each time the distribution is received, a 40% tax should be levied on each distribution. The law leaves many unanswered questions, until the proposed regulations are issued.
Part II: Common Myths about the U.S. Tax and Legal Consequences Surrounding “Expatriation”
· More Myths – about Renouncing U.S. Citizenship
There are many misunderstandings of how the law works when someone renounces U.S. citizenship. See, Part I: Common Myths about the U.S. Tax and Legal Consequences Surrounding “Expatriation”
The author regularly hears a range of myths that will befall an “Accidental American” when and if, they renounce. These “myths” include the following:
- Myth 5: There is no requirement to file U.S. income tax returns if the individual has few assets, little income or has otherwise lived outside the U.S. for almost all of their lives.
- Fact: The old tax law from 1996 and the modifications in 2004 had a 10 year period of taxation concept after “expatriation.” There is no longer such a 10 year period of taxation for those persons who renounce on or after June 17, 2008. However, any former U.S. citizen will necessarily be a “covered expatriate” if they cannot meet the certification requirement of Section 877(a)(2)(C); one of which includes 5 years of compliance with the U.S. tax law. See prior posts explain in more detail – Certification Requirement of Section 877(a)(2)(C) – (5 Years of Tax Compliance) and Important Timing Considerations per the StatuteSee also, some of the consequences of being a “covered expatriate” – The “Hidden Tax” of Expatriation – Section 2801 and its “Forever Taint.”
- Myth 6: There is somehow some “magical difference” under the law, for those who “renounce” citizenship (currently) versus those who “relinquished” citizenship (some time in the past) and the U.S. Department of State should recognize this “magical difference”. Such a difference will create a different U.S. tax result.
- Fact: The tax law nor immigration law makes such a distinction, even though this seems to be a common myth frequently spread throughout the Internet.
- Myth 7 : Former U.S. citizens who are “covered expatriates” can gift assets to their U.S. citizen children and friends without U.S. tax costs to them.
- Fact: This is true, i.e., there is no restriction or tax that is levied against the former U.S. citizen who makes the gift. The problem is for the recipient U.S. citizen or other “U.S. person” children or friends who will become subject to tax upon such gifts at the highest estate and gift ta rate (currently 40%).
- Myth 8: Former U.S. citizens should not worry about the IRS and its ability to collect taxes owing for the “mark-to-market” gains tax on expatriation (or on covered gifts and covered bequests) against assets located outside the U.S.?
- Fact: This depends on the particularl factual circumstances of each former U.S. citizen. Where are their assets? Do they (or will they) travel to and from the U.S.? In what country do they regularly reside? See, U.S. Enforcement/Collection of Taxes Overseas against USCs and LPRs – Legal Limitations and How will the IRS collect tax and penalty assessments against former USCs and LPRs who live exclusively outside the U.S.?
These are just some of the myths commonly floated. There are yet more myths which will be discussed in a later post.
The Number of Citizens Leaving (Renouncing) Versus Coming (Naturalizing) is Just a Speck
Much has been made about the number of citizens who have been renouncing their U.S. citizenship over the last few years. In historical terms, it is a relative explosion. See, earlier post – The 2014 Third Quarter Renunciations Is probably the New Norm –
However, compared to the
number of lawful permanent residents (LPR) who are leaving the U.S., the number is relatively small. See, earlier post The Number of LPRs “Leaving” the U.S. is 16X Greater than the Number of U.S. Citizens Renouncing Citizenship
On a related post, the question was raised –What are the Number of LPRs who Leave U.S. Annually without filing Form I-407 – Abandonment?
However, the number of individuals who wish to come to the U.S. to become citizens is far in excess of the number who are renouncing their citizenship. According to the USCIS, there are about 700,000 individuals annually who become naturalized citizens. In the year 2008, there were more than 1 million naturalized citizens. See table:
Compare these numbers to just about 3,000 annually of individual who are renouncing their citizenship.
Of course, everyone has their own story and reasons for either coming or going, but in relative terms, those who find it desirous to renounce citizenship (at least in absolute numbers and relative terms) represent a small speck (less than 1/2 of 1 percent), compared to those who are becoming naturalized citizens.
Finally, for anyone who wishes to become a naturalized citizen, they must be aware they cannot “reverse” the decision without having potentially adverse U.S. tax consequences. See, Why a Naturalized Citizen cannot avoid “Covered Expatriate” status under IRC Section 877A(g)(1)(B)
Does the U.S. Government Assume U.S. Citizens Having Assets Outside the U.S. are Hiding Assets from the IRS?
Does the IRS Assume U.S. Citizens Having Assets Outside the U.S. are Tax Cheats?
This rhetorical question is asked for a simple reason. In IRS training materials, which are part of the basic core training provided to IRS agents investigating individuals with assets outside the U.S. and international matters and transactions, the IRS makes the following bold statement:
“Most U.S. taxpayers using an offshore entity or structure of entities to hold foreign accounts are simply hiding the accounts from the Internal Revenue Service and other creditors . . . “
A slide from these IRS training materials has this statement along with tax evasion activities that IRS agents are to be on the look out. Certainly, the identification of illegitimate tax evasion activities is appropriate for tax authorities, but such a bold statement ignores the larger reality of the international business world.
Unfortunately, such a bold statement by the IRS does not reflect the reality of millions of U.S. citizens and lawful permanent residents residing outside the U.S.; or indeed maybe millions more who live in the U.S. and have offshore business and investment activities.
For additional background of the estimated millions of USCs residing outside the U.S., see an earlier post: Key Take Aways from Senate Investigations re: Foreign Banks and “Offshore Tax Evasion”: U.S. Citizens Residing Overseas have Become a Focus of the Government.
The world is a very global and international marketplace with international commercial activities undertaken throughout at a scale that rivals the volume of international business just a few years ago. The IRS seems to ignore this important consideration, which is supported by the Department of Commerce – Bureau of Economic Analysis, in their reporting of international export transactions in goods and services. According to these statistics, the amount of exported services has more than doubled from the year 2004 ($336 billion in services) to 2013 ($682 billion) and total exports for 2013 exceeded $3 trillion.
According to the federal government itself in reports prepared by the Department of Commerce – Bureau of Economic Analysis, these international transactions continue to grow robustly in the year 2014.
Therefore, a more balanced understanding and view of how, when and where international business is conducted by U.S. citizens around the world should help IRS agents when they conduct tax audits and not assume – erroneously that – “Most U.S. taxpayers using an offshore entity or structure of entities to hold foreign accounts are simply hiding the accounts from the Internal Revenue Service and other creditors . .”
The “Average Annual Net Income Tax” Amounts for “Covered Expatriate Status” – Increases to US$160,000 for the Year 2015
A previous post explained how the “gain exclusion” amount from the mark to market tax will increase to US$690,000 for the year 2015. See, The “Phantom” Gain Exclusion from the “Mark to Market” Tax – Increases to US$690,000 for the Year 2015.
Today’s post explains that the “average annual net income tax” amount that causes someone to become a “covered expatriate” as set forth in 877 has been indexed for inflation to US$160,000 for the year 2015. See, IRS Revenue Procedure 2014-16, published this month that references those relatively few code sections which are indexed for inflation.
One of the tests for becoming a “covered expatriate” is the “income tax test” explained with the relevant language of the statute as follows:
(A) the average annual net income tax (as defined in section 38(c)(1)) of such individual for the period of 5 taxable years ending before the date of the loss of United States citizenship is greater than $124,000,
This statutory rule is indexed for inflation and the current amount for 2015 will be US$160,000.