Month: May 2015
Please note that the current application for passports include the following language and provisions throughout the application (which have been partially reproduced below):
International tax lawyer, Roy Berg at Moody’s in Calgary, Alberta, Canada brought my attention to several key issues regarding this assertion:
- Senate Finance Chairman Hatch’s amendment to the trade bill that recently passed the Senate with a favorable vote of 79:21, S.1269 – Trade Facilitation and Trade Enforcement Act of 2015 provides the following:
(e) Revocation Or Denial Of Passport In Case Of Individual Without Social Security Account Number.—
(A) IN GENERAL.—Except as provided under subparagraph (B), upon receiving an application for a passport from an individual that either—
(i) does not include the social security account number issued to that individual, or
(ii) includes an incorrect or invalid social security number willfully, intentionally, negligently, or recklessly provided by such individual, the Secretary of State is authorized to deny such application and is authorized to not issue a passport to the individual.
(B) EMERGENCY AND HUMANITARIAN SITUATIONS.—Notwithstanding subparagraph (A), the Secretary of State may issue a passport, in emergency circumstances or for humanitarian reasons, to an individual described in subparagraph (A).
(A) IN GENERAL.—The Secretary of State may revoke a passport previously issued to any individual described in paragraph (1)(A).
(B) LIMITATION FOR RETURN TO UNITED STATES.—If the Secretary of State decides to revoke a passport under subparagraph (A), the Secretary of State, before revocation, may—
(i) limit a previously issued passport only for return travel to the United States; or
(ii) issue a limited passport that only permits return travel to the United States.
(f) Effective Date.—The provisions of, and amendments made by, this section shall take effect on January 1, 2016.
Finally, Mr. Berg also noted that there is a procedure for USCs without SSNs, at least currently, to apply for U.S. passports; albeit subject to the US$500 money penalty described above. See, proposed Form 13997 by the U.S. Treasury Department and the comments:
The purpose of this form,and the necessity to collect information, is to obtain a valid SSN, TIN, a written statement of reasonable cause, or an explanation from the individual as to why they don’t have a SSN or TIN.
Maybe this question, “When does “Covered Expatriate” Status -NOT- matter?” sounds more like a philosophical question?
What does “matter” mean in this context? !?!?!?
Back to being a bit more practical and serious . . . 😉
Assuming the point of the discussion is taxes, and whether additional taxes will ever be owing, being a “covered expatriate” can have adverse tax consequences. Sometimes, however, being a “covered expatriate” will cause no additional taxation to either (1) the “covered expatriate” or (2) future beneficiaries.
It all depends upon the facts of the particular circumstances.
“Covered expatriate” status is the “general rule” for U.S. expatriation tax rules. There are some exceptions (income tax liability, net worth, and dual nationality exceptions), which hopefully a particular U.S. citizen (“USC”) or long-term resident can fall into, so as to avoid the adverse tax consequences of “covered expatriate” status.
Those adverse tax consequences can be summarized into two categories of taxes:
- “Mark to Market” taxation on unrealized gains of worldwide assets, arising from the renunciation of U.S. citizenship (i.e., the so-called “exit tax”); See, Inflation Adjusted Exclusion Amounts Since Inception of 2008 “Mark to Market” Expatriation Tax Law: Example and
- The tax payable by U.S. beneficiaries whenever they receive so-called “covered gifts” and/or “covered bequests.” See, The “Hidden Tax” of Expatriation – Section 2801 and its “Forever Taint.”
The first tax is what most people talk and write about.
The second tax, can often times be the most costly over the long-run and is little understood for lots of reasons; the least of which is the Treasury and IRS have still not issued required regulations. See, Proposal to U.S. Treasury and IRS: awaits Final Regulations on “Covered Gifts” and “Covered Bequests”
People of modest means often think they have nothing to worry about if they are a “covered expatriate” at the time they cease being a USC or a long-term resident. This is where they may be deeply mistaken; if they have any future U.S. beneficiaries (e.g., children who were born in the U.S. or who might move to the U.S. many years out into the future). Moreover, these U.S. beneficiaries do not need to receive substantial assets, in order to be subject to sizable U.S. taxes in the future.
The first “mark to market” tax is not an issue, if the USC has relatively little assets and relatively little “unrealized gains” in those assets. For instance in 2015, the unrealized gains excluded from taxation is US$690,000. See, The “Phantom” Gain Exclusion from the “Mark to Market” Tax – Increases to US$690,000 for the Year 2015 (15 November 2014). Only individuals with assets of significant value, i.e., with unrealized gains greater than US$690,000 would be concerned with this first tax.
However, those former USCs who have future U.S. beneficiaries who might receive gifts or bequests, will be subject to the second tax that is currently 40% of the amount of the gift or bequest received. This imposes the tax at effectively the highest estate and gift tax rate, which is currently 40%.
If, the covered expatriate has no unrealized gains of greater than US$690,000 and no future U.S. beneficiaries, they probably will not be too concerned with their status as a “covered expatriate.”
The problem is that someone today may have little or no idea that although today, she or he has no U.S. beneficiaries, they may have one more in the future.
In other words, someone might renounce their citizenship today with no U.S. citizen or resident children. However, in the future, one of those children might move to the U.S., might marry a U.S. citizen and have U.S. citizen children (grandchildren to the “covered expatriate”) or become a naturalized U.S. citizen.
If that were to be the case, the former U.S. citizen (e.g., mom or dad) might be reluctant to leave any assets for their child who later moves to the U.S., knowing that effectively 40% of the value of those assets will go to Uncle Sam for the tax under IRC Section 2801.
As stated earlier, it all depends upon the facts of the particular family and life circumstances; some of which might change in the future in unforeseeable ways.
Inflation Adjusted Exclusion Amounts Since Inception of 2008 “Mark to Market” Expatriation Tax Law: Example
The current “expatriation” “exit tax” forces a “covered expatriate” to pay U.S. income taxation on their unrealized gains (the “mark to market” concept) as if they sold their worldwide assets.
An “unrealized gain” is the amount of gain “built into” the property or other investment of the individual, which has yet to be sold or otherwise disposed of by the him or her. For instance, the diagram below reflects various assets held by a “Covered Expatriate” which includes Mexican real estate with a tax basis of US$200,000 but a current fair market value of US$1.1M. This means the unrealized gain in that Mexican real property is US$900,000 (US$1.1M – US$200K).
Who is a “covered expatriate” is a very important legal analysis that needs to be considered for each U.S. citizen who wishes to renounce or “long-term resident.” See, The dangers of becoming a “covered expatriate” by not complying with Section 877(a)(2)(C) (9 March 2014).
Importantly, the law provides for an exclusion from taxation on the former (a) U.S. citizen’s (“USC”) or (b) long-term resident’s unrealized gains. (See, Who is a “long-term” lawful permanent resident (“LPR”) and why does it matter? – 19 Aug. 2014). In other words, no U.S. income tax is due and payable by a “covered expatriate” if they did not have assets with unrealized gains greater than a certain threshold amount.
That threshold amount has been changing annually, since the initial US$600,000 that was originally adopted into the law in 2008. It is changing due to annual inflation adjustments.
The current 2015 exclusion amount adjusted for inflation is US$690,000. See, The “Phantom” Gain Exclusion from the “Mark to Market” Tax – Increases to US$690,000 for the Year 2015 (15 November 2014).
Hence, in this case, if the only asset owned by the “covered expatriate” (assuming she became one in 2015) was the real estate in the above example with unrealized gain of US$900,000, only US$210,000 would be subject to the “mark to market” tax on expatriation (i.e., the exit tax). This is because $690,000 of the total US$900,000 unrealized gain will be excluded from taxation (US$900K – US$690K).
The Mark to Market tax regime imposes taxation on this amount, even though the real estate is never sold. This means, the “covered expatriate” must come “out of pocket” to find the cash and means necessary to pay the tax imposed under the law.
There is no economic benefit obtained from this annual inflation adjustment if a U.S. citizen or long-term resident waits to become at a later time a covered expatriate; unless they consume, deplete or lose their assets in the interim. But at least, there is an inflation adjustment, so the taxpayer is not subject to an increasing amount of gain subject to tax as time progresses and inflation eats away at the true economic value and economic growth of the individual’s assets.
Is “It’s Almost Impossible for Me to Get a U.S. Taxpayer Identification Number”; a Defense to Not Filing U.S. Tax Returns?
The U.S. federal government has made the basic task of getting taxpayer identification numbers (“TINs”) very difficult for many individuals. Without a TIN, an individual cannot file tax returns or information reporting returns.
U.S. citizens (USCs) residing overseas without a social security number (“SSN”) must use a SSN for their TIN. I presented a recent report to various government officials, including the international tax counsel at the U.S. Treasury Department and the Joint Committee of Taxation, among other groups. Some key excerpts of that paper titled URGENT NEED FOR U.S. CITIZENS RESIDING OUTSIDE THE U.S. TO BE ABLE TO OBTAIN A TAXPAYER IDENTIFICATION NUMBER (“TIN”) OTHER THAN A SOCIAL SECURITY NUMBER are set out below in this section:
The U.S. tax law imposing taxation on the worldwide income of USCs residing overseas has created a dilemma that prejudices these USCs without a SSN. This strict SSN/TIN regulatory rule undermines the basic tax administration system and discourages tax compliance for those USCs who never obtained a SSN. This dilemma affects numerous USCs throughout the world, which is now compounded by the certification and reporting requirements of USCs and third parties, such as FFIs and NFFEs under the Foreign Account Tax Compliance Act (“FATCA”).
This dilemma is a creature of the Title 26 regulatory law going back to 1974 and how the Social Security Administration (“SSA”) imposes strict requirements on the issuance of SSNs to residents overseas. One essential step is that the USC overseas must have an in-person interview, with a designated individual (who are typically U.S. Department of State employees and some designated military personnel). They are located in only a few cities around the world. Some USCs need to travel thousands of miles to merely be able to apply for and obtain a SSN.
 See, IRC § 61 and Treas. Reg. §§ 1.1‑1(b) and 1.1‑1(a)(1).
 See, IRC §§ 1471 et. seq. and the regulations thereunder which define “foreign financial institutions” (“FFIs”) and “non-financial foreign entity” (“NFFEs”).
 See, Treas. Reg. § 301.6109-1(a)(1)(ii)(A).
 See, 7 FAM 534.3 Applications for a Social Security Number (Form SS-5-FS).
 Id, page 7 FAM 534.3 Applications for a Social Security Number (Form SS-5-FS).
Further posts will discuss a number of the adverse consequences imposed on USCs who do not have a SSN and the severe penalty regime that exists under current law for those unwitting individuals.
- Non-U.S. Citizens and ITINs –
Many individuals who are not USCs nevertheless need to file a tax return and must obtain what is called an individual taxpayer identification number (“ITIN”). See IRS report Obtaining an ITIN from Abroad. An ITIN is applied for by filing an IRS Form W-7, and providing various original documents, principally a passport, directly to the IRS. The process is complex and time consuming. Indeed, the Taxpayer Advocate report included a key summary explanation of the problems associated with obtaining ITINs as follows:
- IRS ITIN Policy Changes Make Return Filing Difficult and Frustrating
Recent changes to the IRS’s Individual Taxpayer Identification Number (ITIN) application program are burdening taxpayers and may harm voluntary compliance.
ITINs play an important role in tax administration, as any individual who has a federal tax filing obligation but is not eligible for a Social Security number must apply to the IRS for an ITIN and then use the ITIN on any return, statement, or other document which requires a taxpayer identifying number
Under the new procedures, most applicants must now submit original documentation by mail or travel to Taxpayer Assistance Centers (TACs) to have documents certified, making the application process more difficult
Since December 17, 2003, the IRS has required ITIN applicants with a filing requirement to attach a valid federal tax return with their application (unless they qualify for an exception).
On June 22, 2012, the IRS implemented temporary changes that required all ITIN applicants to submit original documents supporting the information on their applications. Under these procedures, applicants could no longer submit notarized copies and had to send in original documentation, even if a certified acceptance agent (CAA) reviewed and certified the documentation.
On November 29, 2012, the IRS announced revised procedures for the 2013 filing season that require applicants to submit original documentation or copies certified by the issuing agency.
Although the IRS allows CAAs to submit copies of documentation for primary and secondary taxpayers after reviewing original documentation or certified copies, CAAs must still send in original documentation for all dependent applicants.
A limited number of TACs can certify documents for primary, secondary, and dependent taxpayers.
The Revised Procedures Create an Impediment for Taxpayers Required to File Returns.
The recent changes to the ITIN program have made it difficult for taxpayers to file returns.
More on ITINs to follow in later posts.
- Legal Defense?
The complexities of obtaining a U.S. TIN begs the question: “Is it a legal defense for a taxpayer to NOT file U.S. tax returns, international information returns, if it is particularly difficult (or nearly impossible in some cases) for that individual to even obtain a TIN?”
Will such a taxpayer have a “reasonable cause” defense to avoid penalties in the case of an audit? These are questions unanswered by any case law to date.
USCs throughout the world are required by FATCA to provide their U.S. TIN to financial institutions throughout the world (on IRS Form W-9, or its equivalent), which under current law necessarily must be a SSN. Of course, if they have no SSN, they cannot sign IRS Form W-9 which provides in Part II: “Under penalties of perjury, I certify that: 1. The number shown on this form is my correct taxpayer identification number . . . “
As FATCA requires overseas individuals, including USCs to certify under penalty of perjury their U.S. taxpayer identification number (and if they have none), they necessarily will not be able to comply with this basic reporting requirement.
Will these individuals have a defense under the law for not complying under these circumstances?
Will the government provide relief for these individuals?
FBAR Penalties – Government Pushes Civil “$10K a Pop – Penalties”: U.S. citizens residing outside the U.S. are subject to the same penalty structure as U.S. citizens residing in the U.S.
Case law is starting to develop, slowly but surely, on various legal issues raised under Title 31, as to reporting foreign bank accounts.
The electronic filing deadline for foreign bank account reports (“FBARs”) is June 30th. This filing deadline (under Title 31) cannot be extended unlike filing of federal income tax returns (under Title 26).
U.S. citizens residing overseas and most lawful permanent residents who live substantial time (if not all of their time) outside the U.S. are generally subject to these FBAR reporting requirements as the government has made no exceptions in the regulations for such overseas residents.
Earlier in April, the U.S. District Court in Moore v. United States, 2015 U.S. Dist. LEXIS 43979 (W.D. WA 2015) published an opinion where the IRS had assessed multiple year US$10,000 penalties. See Jack Townsend’s thoughtful comments and reference to the arguments presented by both the U.S. citizen and the government here.
There are many key questions that remain undecided by the Courts, which continue to generally be asserted by the government:
- The US$10,000 penalty should be assessed at the maximum level (versus a lesser amount);
- The US$10,000 penalty should and can be assessed multiple times for each year reporting is required, when there are multiple accounts (e.g., 8 accounts means the government will try to assess 8 violations and hence a US$80,000 penalty);
- U.S. citizens residing outside the U.S. are subject to the same penalty structure as U.S. citizens residing in the U.S.; and
- Lawful permanent residents residing outside the U.S. are subject to the same penalty structure as U.S. citizens and LPRs residing in the U.S.
The IRS internal revenue manual (22.214.171.124.1) summarizes how and why the IRS has authority to assess penalties for FBAR Title 31 violations as set forth below:
- As of April 8th 2003, IRS was delegated the authority to assess and collect FBAR civil penalties. 31 C.F.R. § 103.56(g). The delegation includes the authority to investigate possible FBAR civil violations, provided in Treasury Directive No. 15-41 (Dec. 1, 1992), and the authority to assess and collect the penalties for violations of the reporting and recordkeeping requirements.
- When performing these functions, the IRS is not acting under Title 26 but, instead, is acting under the authority of Title 31. Provisions of the Internal Revenue Code generally do not apply to FBARs.
- Criminal Investigation has been delegated the authority to investigate possible criminal violations of the Bank Secrecy Act. 31 C.F.R. §103.56(c)(2)