Tax-Expatriation

Why a non-U.S. citizen may wish to be a U.S. income tax resident (“U.S. person”). Sound like a non-sequitur?

Posted on February 2, 2015 Updated on February 3, 2015

Why a non-U.S. citizen may wish to be a U.S. income tax resident (“U.S. person”).  Sound like a non-sequitur?

Normally, anyone residing outside the U.S. is far better off if they are NOT a “U.S. income tax resident.”  This is for several reasons:

• U.S. individual taxpayers typically have complex tax rules and reporting requirements, even for simple scenarios, such as a nurse or school teacher working in a particular country.  They have to know and understand how to file returns and how to file various forms, such as IRS Form 2555: Foreign-Earned Income Exclusion, Housing Exclusion, and Housing Deduction.  See, The Foreign Earned Income Exclusion is Only Available If a U.S. Income Tax Return is Filed.   Every year, the compliance costs of living outside the U.S. to pay competent professional U.S. tax advisers to avoid penalties will typically be relatively very expensive.

• The Bank Secrecy Act (BSA), imposes detailed bank account information be reported annually, including account numbers, addresses, etc. by any “U.S. person” who has potential incidence of ownership or control over a minimum threshold of assets in foreign accounts (US$10,000).  See, Nuances of FBAR – Foreign Bank Account Report Filings – for USCs and LPRs living outside the U.S.

• The penalties for not complying with these BSA rules are typically a minimum of US$10,000 per violation, or 50% of the account balance (or over 100% in some cases; see Why the Zwerner FBAR Case is Probably a Pyrrhic Victory for the Government – for USCs and LPRs Living Outside the U.S. (Part II)). The stakes can be very high.

• Plus, those who are married to a non-U.S. citizen have to review and understand in detail the laws of their country of residence, regarding property rights of spouses, whether a spouse is a manager or officer of a foreign company, general and special powers of attorney – such as health care powers of attorney, etc., to know if one has a “financial interest” in such foreign accounts, even if they actually have no signature authority over any foreign accounts.  The law  is obligatory in how these definitions broadly include many persons who are not aware of how they can apply.  See, FOREIGN BANK ACCOUNT REPORTS – 2011 REGULATIONS EXTEND RULES TO MANY UNAWARE PERSONS, published in the International Tax Journal.

• Managers of companies and other legal entities that have an account around the world, may also fall into these unwary traps.

As someone who advises multiple clients before the IRS on FBAR penalties, I have seen many cases where the government will take an approach of levying significant FBAR civil penalties in particular cases, depending upon how the case is handled, the particular facts and who is the IRS revenue agent and their manager.

• Anyone concerned about leaking of personal financial data, at any number of points – be it to and from the tax adviser, the return preparer, the uploading of the information on FinCEN’s website, the electronic filing of tax return information, etc., may be reasonably worried about their personal privacy (and safety – if they live in a country where financial information has value if it falls into the hands of criminal individuals or organizations).  See, IRS Warns of Breach of Individual Financial Information – Bank Account Details and other FATCA Related Account Data

Now to the point of this post.  Notwithstanding all of the above considerations, some individuals may find it advantageous to be a “U.S. person” for U.S. federal income tax purposes.  See, Section 7701(a)(30) which uses the technical term “U.S. person” and not a U.S. income tax resident.

If a non-U.S. citizen lives predominantly overseas, they nevertheless can elect to be treated as a U.S. person if they spend at least 31 days in the U.S. during that particular calender year and meet other requirements.   Section 7701(b)(4).

Why would an individual prefer to be a U.S. person for U.S. federal income tax purposes, even if they spend little time in the U.S.?  There could be several reasons.

• An individual may wish to contribute to the Social Security taxation system to become fully vested for future Social Security payments.  See,   Why vested Social Security Retirement Benefits are not lost when a USC or LPR sheds their citizenship or immigration status. The Answer to: What happens to social security benefits to former USCs and LPRS including a “covered expatriate”?

• If the non-citizen has a U.S. citizen spouse, they may have a better overall U.S. income tax result (i.e., lower federal income taxes) by filing married filing jointly?

• If U.S. real estate is owned by the non-U.S. citizen, there may be a better overall U.S. income tax result (i.e., no FIRPTA withholding taxes) by filing as a resident alien.  See, U.S. Tax Implications of Foreign Investment in U.S. Real Estate.

• If the non-citizen has no significant overseas assets or accounts, they may be able to otherwise avoid the labyrinth of rules under the BSA.

• Being a U.S. person” for federal income tax purposes, does not necessarily make the individual domiciled in the U.S. for federal estate, gift and generation skipping transfer taxes.  See, Foreign Individuals and the U.S. Estate Tax (Similar to an Inheritance Tax):  2010 Tax Relief Act Provides Little Relief.