Myth #8:  As a U.S. citizen (USC) there is no need to pay tax on income or gains from assets outside the U.S., as long as the proceeds are not repatriated to a U.S. bank or financial institution.

As a follow-on to the post of Nov. 19, 2015, See WSJ = World/Expats – For an Excellent Overview of U.S. Taxation for U.S. Citizen Individuals in Plain English, I just heard this one this past week from a cross border businessman.  It has a perfect logic to it the same as the idea that a controlled foreign corporation that moves cash to its own U.S. bank account (as opposed to a financial account outside the U.S.), is subject to U.S. income taxation at that moment.

Laypeople often focus on – “where is the money” not “who has *’recognized’ the income” irregardless of where the money or property is physically located.

This international business operator is thoughtful and has been doing cross border business for some 20+ years with a principle part of his business outside the U.S.; although he is a dual national citizen and hence necessarily a U.S. income tax resident.

It’s a fairly common misunderstanding that I have seen multiple times in my career.

The federal tax law does not look to where the property or income is physically located or earned; unlike some countries which have a territorial based taxation system for individuals, e.g., Costa Rica, Hong Kong, Malaysia, Panama, Singapore and Paraguay, among many others which are smaller economies.

Plus, the federal tax law is not changed by the laws of the country where the income was earned.

Instead, the tax law looks to who “recognized”* the income, irrespective of where the property or cash from that income is located.

A common sense example brings home the concept.  Assume you live in Georgia (the one next to Florida not Russia) and sell real estate in Texas and leave the proceeds from the sale in a Texas bank.  Texas may not impose individual income taxation on the sale of the Texas real estate (where the property was physically located), but still the state of Georgia looks to who earned the income.  In this case, the income was earned by a resident of Georgia, so Georgia imposes taxation on the income from the sale, even though the cash proceeds from the sale are left in a Texas bank.

By analogy, this is how the U.S. federal government imposes taxation; with one important break in the analogy.  The U.S. federal government treats USCs as income tax residents, irrespective as to where they reside; whereas George only taxes those who are physically resident in their state on a worldwide basis.

For instance, a U.S. citizen residing in Singapore, who sells real estate in a country outside both the U.S. and even Singapore, e.g., Malaysia where the tax rate on the real estate capital gains is 0%, will have earned that income in Malaysia (the where).  Even if the U.S. citizen keeps his funds in a Malaysian bank or even moves the funds to a Singapore bank the country of residence (still the where), he or she will be subject to U.S. income taxation, since the USC status (the who) creates tax residency irregardless of the physical residency.  See, Supreme Court’s Decision in Cook vs. Tait and Notification Requirement of Section 7701(a)(50) posted June 27, 2014 and The U.S. Civil War is the Origin of U.S. Citizenship Based Taxation on Worldwide Income for Persons Living Outside the U.S. ***Does it still make sense? posted April 1, 2014.

It does not matter that the funds are not moved to a U.S. bank account, just like it did not matter for the Georgian resident that she kept her proceeds from the Texas real estate sale’s transaction in a Texas bank.

• *  The term “recognized” is a technical U.S. federal tax term that determines at that moment in time a U.S. taxpayer has income for federal tax purposes; and hence, generally the requirement to report the income on their tax return.

For an excellent overview (without penalty hype or exaggeration of the U.S. tax law), read the following article from Eric Scali of H&R Block’s expat-focused service titled –Puncturing 7 Common Myths about U.S. Expat Tax Rules, Nov. 15, 2015, WSJ = Globe, EXPAT, For global nomads everywhere

The following 7 myths are accurately addressed with respect to U.S. citizens residing outside the U.S. (although caution should be taken if you are a lawful permanent resident – “LPR”- residing inside a country with a U.S. income tax treaty – see, Does the IRS have access to the USCIS immigration data for former lawful permanent residents (LPRs)?, posted April 11, 2015 and the discussion of how many LPR individuals will have “expatriated” without actually having filed USCIS Form I-407.  See, Oops…Did I “Expatriate” and Never Know It: Lawful Permanent Residents Beware! International Tax Journal, CCH Wolters Kluwer, Jan.-Feb. 2014, Vol. 40 Issue 1, p9):

Myth #1: Individuals living outside of the U.S. and filing tax returns with a foreign government don’t have to file annual U.S. tax returns. 

Myth #2: Expats only need to report their U.S. income on their U.S. tax return.

Myth #3: If their foreign income is below the Foreign Earned Income Exclusion (FEIE), expats don’t need to file a U.S. tax return.

Myth #4: Work performed by an expat within the U.S. but paid by an expat’s foreign employer is foreign income because it’s paid by the foreign employer and not issued on a W-2.

Myth #5: Expats’ non-U.S.-based pension plans have the same tax treatment in the U.S. as they do in their country of residence.

Myth #6: When expats receive certain items of income, they’re only taxable in their country of residence under the rules provided for in the income tax treaty the foreign country has with the U.S.

Myth #7: An expat’s foreign investments are treated the same as they are in the foreign country.

Unfortunately, I have heard all of these and more (many times over) during my professional career as an international tax lawyer (and an accountant in the late 1980s) from both individuals and their tax advisers both inside the U.S. and outside the U.S.  As someone who lives with their family outside the U.S., I have a good understanding about the difficulty of finding good U.S. tax resources that accurately and simply explain these very complex laws.

Is the IRS Undercounting Americans Renouncing U.S. Citizenship?, posted Sept. 16, 2015.

The names of U.S. citizens who have renounced is published quarterly pursuant to IRC Section 6039G.  See, prior related posts:  1,426 Individuals Give Up Passport: Record Number of U.S. Citizens Renouncing: Quarter 3 for 2015, October 30, 2015.

No one knows for certain if the IRS (including the IRS per some of my conversations) is getting complete data from the Department of State regarding each name and individual.

The graph I have prepared shows the number of names reported quarterly as I track all reported names quarterly that related to clients and non-clients.  The latest cumulative amounts for 2015 (which does not include the 4th quarter) shows 3,221 thus far in the year.  If there is close to 1,400 as was the case for the last quarter, the total will be a record – by a bunch; i.e., close to 5,000 renunciations for the year.

Anecdotally, I have seen renunciations surge in our practice, largely as U.S. citizens residing around the world (typically in the “Accidental American” category) learn about the long arm of the U.S. tax law by way of their local financial institutions and reporting and documents requested as part of FATCA.  See, Why Most U.S. Citizens Residing Overseas Haven’t a Clue about the Labyrinth of U.S. Taxation and Bank and Financial Reporting of Worldwide Income and Assets, posted Nov. 2, 2015.

None of this answers the question of whether there is under-reporting of the names? Indeed, the question will likely not be answered without more information provided by the U.S. Department of State and the U.S. Treasury (i.e., the IRS officers responsible for issuing the names and report in the Federal Register).

The government is also likely to reject issuing information on these details to individuals and their advisers as part of a Freedom of Information Act (“FOIA”) request.  I have had similar requests rejected by the government under the so called “Exemption 7(E)” of FOIA.  See,

There have been prior posts discussing what is referred to as the offshore voluntary disclosure program (“OVDP”) and what the IRS later created – the so-called “streamlined program” filing procedure.

For more background, see, GAO Yr2014 Report on Offshore Voluntary Disclosure Program Indicates Less Than 4% of Taxpayers Lived Outside the U.S., posted March 11, 2014.

Importantly, these OVDP and streamlined programs created by the IRS are not creatures of any statutory law, for instance Title 26 (the Internal Revenue Code) or Title 31 (the so-called Bank Secrecy Act); or any law for that matter.  There are no court cases or Treasury Regulations that spell out the terms of these programs as part of any legal framework.

I like to say they are similar to the Hasbro rules of “Monopoly”; a game I was fond of as a child.  The IRS is like Hasbro in that they can change the rules of the game as they wish, and often do in the form of publicized frequently asked questions (“FAQs”).  The IRS submits these rules of their game and ask, encourage and in some cases (in my view) browbeat taxpayers, often times through their advisers, into participating.  See some of the various rule changes below –

• IRS OVDP FAQs and Answers 2014

• IRS OVDP FAQs and Answers 2012
• Transition Rules: Frequently Asked Questions (FAQs)
• IRS 2011 Offshore Voluntary Disclosure Initiative
  • January 8, 2010 — added Q&As 53-54
  • August 25, 2009 — added Q&A 52
  • July 31, 2009 — modified A6, A21 and A22
  • June 24, 2009 — modified A26 and added Q&A 31-51
  • May 6, 2009 — posted Q&A 1-30

• IRS 2009 Offshore Voluntary Disclosure Program

The above reflect just some of the modifications and rules the IRS has made, and keeps making to their rules of their proposed OVDP structure; which again, I repeat, is not part of the law.

Many taxpayers and their advisers, in my view have not thought carefully about the law and its application; but rather have focused on the “Monopoly” rules.  They cite and read the FAQs if that is somehow the law!  See How is the offshore voluntary disclosure program really working? Not well for USCs and LPRs living overseas posted May 10, 2014 and The 2013 GAO Report  of the IRS Offshore Voluntary Disclosure Program, International Tax Journal, CCH Wolters Kluwer, January-February 2014.   PDF version here.

Similarly, the streamlined filing procedures is not part of the law, and also has been modified several times by the IRS.  Fortunately, the IRS realized that U.S. taxpayers residing outside the U.S. are not the same as those who reside in the U.S. when they created two separate programs last year in 2014.

See, U.S. Taxpayers Residing Outside the United States: The following streamlined procedures are referred to as the Streamlined Foreign Offshore Procedures.  Eligibility for the Streamlined Foreign Offshore Procedures

The point of this post is that I have seen numerous cases where U.S. citizens residing around the world were ill advised to participate in the OVDP.  In short, if an individual has no criminal tax liability, I think there is little purpose or reason for almost all USC overseas to participate into the OVDP.  Analyzing thoughtfully the facts of each case and the law (not the Monopoly rules) is what is important for each individual.

Finally, a clear understanding of what are the Monopoly rules compared to the law is crucial when advising USCs residing overseas.  Sometimes, filing through the streamlined procedure might be well advised for a particular taxpayer; e.g., if they would otherwise have substantial late payment and late filing penalties.  However, there are plenty of cases where simply filing tax returns pursuant to the law will be preferable in a particular case.  This is a process that needs to be thoughtfully considered in each case with a clear understanding of the law – not just the Monopoly rules.

For some related commentary on this topic, see the following posts:

• How Congressional Hearings (Particularly In the Senate) Drive IRS and Justice Department Behavior, Sept 28, 2014
• IRS Attorney – Dan Price, Provides Specific Recommendations for U.S. Citizen Taxpayers Overseas at USD – Procopio International Tax Institute, posted Oct 30, 2015.

This post is written simply because so many U.S. citizens residing overseas are reasonably confused about the complexity of U.S. tax law.  The mere requirement to file U.S. income tax returns for those overseas often comes as a great surprise.  My non-U.S. born wife is an exception (as she also lives outside the U.S.) simply because I have repeatedly told her for our 20 some years of marriage. 

Some in the IRS erroneously think U.S. citizens residing overseas do and should understand U.S. tax law.  I posed one simple scenario to a very sophisticated IRS attorney not very long ago who specializes in the FATCA rules.

Her view is (hopefully was) that U.S. citizens throughout the world know or should know the U.S. tax laws because the instructions to IRS Form 1040 are clear.

This thought knocked me off my figurative chair onto the floor!  Smack. 

My surprise is based upon my own experience working with individuals and families throughout the world, in numerous countries.  I have noticed a number of notions, based upon these andectodal experiences as follows:

1. A minority of U.S. citizens (unless they lived most of their lives in the U.S. and recently moved overseas as an “expatriate”) have no real basic idea of how the U.S. federal tax laws work; let alone to their assets and income in their country of residence.  See USCs and LPRs Living Outside the U.S. – Key Tax and BSA Forms
2. There are indeed plenty of immigrant U.S. residents (certainly less than 50% by my own experience – especially when concepts of PFICs and foreign tax credits start being discussed) who even understand the basics of U.S. international tax law.
3. If they reside in an English speaking country that has relatively strong family or historical ties to the U.S. (e.g., England, Ireland, Scotland, and Canada, etc.) they are likely to have a better idea of the U.S. federal tax laws, but still the majority don’t know key concepts.  See, Nuances of FBAR – Foreign Bank Account Report Filings – for USCs and LPRs living outside the U.S.
4. Even those in English speaking countries that have less historical or family ties to the U.S. have a lesser understanding (e.g., New Zealand, Australia, Kenya, South Africa, India, etc.).
5. Those who do not speak English know even less about U.S. tax laws and how they apply to them.
6. Many individuals who learn of these requirements overseas are sometimes driven to great despair.  The message they receive is not a correct one under the law in my view: as they read IRS materials (for instance, see FAQs 5, 6 and and former 51.2 from the Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers 2014) and come to the conclusion they will soon be going to jail, criminally prosecuted or otherwise be subject to tens of thousands of dollars worth of penalties for their failure to file a range of tax forms.
7. Literally, sometimes as a tax lawyer I feel more like a psychologist, when these individuals come to me saying they can’t sleep, they can’t eat, they are seeing a cardiologist for high blood pressure, etc. and even in a most extreme case they thought suicide was a solution.  See, How is the offshore voluntary disclosure program really working? Not well for USCs and LPRs living overseas.
8. Individuals around the world (even tax professionals) and certainly laypeople, are not commonly reading TaxAnalysts (nor would they subscribe) or other tax professional publications that explain many of the intricacies of U.S. tax laws.
9. Learning and understanding U.S. tax laws, including just the basics, requires a great deal of time, aptitude for nuances and details, literacy, patience and a level of aptitude for such matters that simply escape many people around the world (most I would say).  see, “PFICs” – What is a PFIC – and their Complications for USCs and LPRs Living Outside the U.S.  I can relate to this personally, as I am an international tax professional (indeed I even studied a post graduate law course outside the U.S. in a non-English language), have spent my entire professional career of more than 25 years in the area, and yet only generally have a very superficial understanding of tax laws throughout the countries where I am dealing with clients.  I don’t try to understand the details of those laws. 
10. Many people are angry and frustrated (justifiably so, in my view, in many cases) after learning they are subject to these rules.  See comment above about being a psychologist.  Plus, USCs and LPRs residing outside the U.S. – and IRS Form 8938. In addition, see, Taxpayer Advocate Report on Burdens of Benign Taxpayers who Make Mistakes

Back to the intelligent IRS tax attorney.  My question to her was:  “Why would you, as a U.S. born individual not be reviewing the tax laws, tax forms and tax instructions of the country where your parents were born prior to immigrating to the U.S.?”  I asked:  “Are you not reviewing those laws in the original language of your parents (not English, but the other language of your parent’s country) to understand what tax forms and returns you should be filing?”

The IRS attorney’s response was:  “What:  of course, I am not reviewing such tax forms or filing information or tax laws, as I would have no tax obligations in that foreign country where I have no income, no assets or no bank or financial accounts!”

My follow-up question was a simple one:  “Don’t you realize that U.S. federal tax law (Title 26) and financial bank reporting laws (Title 31) do just that!”

“Hmm she paused: how can that be?”  I don’t recall if she said this out loud, or just said it with her puzzled expression.

The answer of course is that through citizenship (including derivative citizenship through a U.S. parent even though the child never spent a single day of residence in the U.S., let alone received any income or assets); that same individual in the mirror position as that IRS attorney is subject to a host of U.S. federal tax and financial reporting laws.  See, Sir Winston Churchill – Famous People. Did he become a U.S. citizen at birth via “derivative citizenship”? Did he file U.S. income tax returns?

Here is the big disconnect.    It’s not just among the ill-informed or those lesser educated on the fine points of law.  I had the pleasure this week along with my wife to host two educated, worldly and engaging individuals who have been married some 20 years together.  They are well read and highly educated.  Both are lawyers by training, one practices law that often pushes him fairly deeply into the tax law and his wife is a wonderful and experienced judge in the California state courts.

I asked them (as I like to ask people around the world) if they had ever heard or understood that the U.S. federal tax law imposes taxation and very detailed reporting on the worldwide income and assets of U.S. citizens who reside outside the U.S.  I discussed Cook v. Tait and the U.S. Civil War a bit.  See both Supreme Court’s Decision in Cook vs. Tait and Notification Requirement of Section 7701(a)(50) and The U.S. Civil War is the Origin of U.S. Citizenship Based Taxation on Worldwide Income for Persons Living Outside the U.S. ***Does it still make sense?

All of it was a great surprise to them! They were in utter shock and both are residents in the U.S., highly educated in the law and are like the vast majority of the world, including U.S. citizens who reside outside the U.S.

This is the common response for many U.S. citizens residing overseas.

The government announced on October 27, 2015 that a record number of U.S. citizens, for the quarter renounced.  These 1,426 former U.S. citizens combine for the year to equal more than 3,200 former citizens for the three quarters.  The last year annual record of former citizens of just more than 3,400 will soon be broken by the end of the year.

All of the names of the individuals are reported at the Federal Register: Quarterly Publication of Individuals, Who Have Chosen To Expatriate, as Required by Section 6039G

See prior posts New Record of U.S. Citizens Renouncing – The New Normal, dated February 10, 2015.

Also, see the recent article in CNN Money, A record 1,426 Americans return their passports

Tax Analyst’s reported some of the key comments made by IRS Attorney Dan Price at the 11th Annual University of San Diego School of Law – Procopio International Tax Institute.  The course panel he discussed was – Course 10: Current Practical Problems for Taxpayers in OVDP and Streamlined.

The article written by Ms. Amanda Athanasiou provided good coverage of comments from IRS Office of Chief Counsel Attorney Dan Price about the streamlined procedure.  See, the complete article that was published October 27, 2015, Confusion Over Offshore Accounts Prompts IRS Response, Worldwide Tax Daily and Tax Notes Today: News Stories.

The common fact pattern is that many U.S. citizens around the world have simply not filed U.S. federal income tax returns.  Many of them were unaware of the requirements and/or they thought in good faith they were not required to file since their income levels were below the “foreign earned income” exclusion amounts.  See a prior post, March 24, 2014, The Foreign Earned Income Exclusion is Only Available If a U.S. Income Tax Return is Filed. 

The streamlined procedure for U.S. citizens residing overseas does not require that they have previously filed U.S. income tax returns.  See, U.S. Taxpayers Residing Outside the United States: The following streamlined procedures are referred to as the Streamlined Foreign Offshore Procedures.  Eligibility for the Streamlined Foreign Offshore Procedures

Incidentally, with a record number of citizenship renunciations reported just a few days ago (more than 1,400 in the latest quarter – Quarterly Publication of Individuals, Who Have Chosen To Expatriate, as Required by Section 6039G, Oct. 27, 2015) this is particularly important to U.S. citizens living all around the world.

One particularly salient quote regarding the streamlined procedure from Mr. Price was, “The IRS is going to presume the taxpayer was non-willful unless facts indicate otherwise.”

One of the important questions that U.S. citizens overseas face is whether their particular facts indicate they would be better off by simply filing initial or amended tax returns.   There are also so-called “qualified amended returns” which will be discussed in another post.

Neither the federal tax law nor the Treasury Regulations provide that a taxpayer has an affirmative statutory duty to file an amended income tax return, as long the original return reflects a good faith effort to comply with the law at the time the tax return was originally filed.  The Treasury Regulations, which are drafted by the IRS, instruct that a taxpayer “should,” within the period of limitation, amend to correct prior errors in a tax return, but not that a taxpayer “must” amend.  See Treas. Reg. § 1.451-1(a).

When a taxpayer fails to file a tax return by the due date, the taxpayer may be subject to failure to file and failure to pay penalties and interest charges.  See IRC Section 6561; IRC Section 6601.  The real problem can be that if a taxpayer fails to file a return voluntarily, the IRS may file a substitute return for the taxpayer instead, including on the basis of information received by third parties.  See IRC Section 6020.  This substitute return may not give the taxpayer credit for deductions and exemptions they are entitled to.  Substitute returns prepared by the IRS are valid for calculating a taxpayer’s income tax deficiencies and penalties for failure to file and failure to pay. See Holloway v. Commissioner,  T.C. Memo. 2012-137; see also Brewer v. U.S., 764 F. Supp. 309 (S.D.N.Y. 1991).

However, at the end of the day, those U.S. citizens residing overseas who were/are not aware of the U.S. federal tax law filing requirements have not committed a “mortal sin” in the vernacular of the Roman Catholic Church.  Indeed, in these circumstances, they have probably only exposed themselves to penalties (late payment, late filing, etc.) which are based upon the amount of tax owing.  Of course, the IRS does sometimes use the stick of international information reporting penalties over the head of taxpayers.  See, excellent summary by the American Citizens Abroad, Delinquent FBAR and Tax Filing Penalties

The question is:  “Streamlined (to be) or not Streamlined, i.e., just file returns (not to be)”?

This sums up the argument of many critics of U.S. citizenship based taxation of worldwide income.

Many may agree with this conclusion from an equity or sense of fairness argument.  See proposal below at the end of this post. 

However, the argument of fairness has little place in interpretations of Title 26, the U.S. federal tax law.  For example, the U.S. Tax Courts are not courts of equity.  See, The United States Tax Court – An Historical Analysis, Dubroff and Hellwig, footnote 668.

Also, virtually no courts of the U.S. find U.S. tax laws to be unconstitutional.  It is a very rare occurrence that the U.S. Supreme Court even takes up a tax case to determine its constitutionality.  The “Obamacare” with broad application throughout society was a case heard by the Supreme Court which upheld a law signed by President Obama on March 23, 2010, more correctly called the Patient Protection and Affordable Care Act.  That law increased Medicare taxes and imposed a penalty surcharge on individuals who do not maintain certain health coverage.

In contrast, U.S. citizens and lawful permanent residents (LPRs) residing overseas are a relatively small population of the U.S. taxpayer population.  Accordingly, it was only until late the U.S. government even began focusing on this population to collect taxes from them.  See, Is the new government focus on U.S. citizens living outside the U.S. misguided or a glimpse at the new future?, posted March 6, 2014. 

Finally, see various proposals to modify the law:  e.g., U.S. Citizenship Based Taxation – Proposals for Reform –   “Tax Simplification: The Need for Consistent Tax Treatment of All Individuals (Citizens, Lawful Permanent Residents and Non-Citizens Regardless of Immigration Status) Residing Overseas, Including the Repeal of U.S. Citizenship Based Taxation,”  by Patrick W. Martin and Professor Reuven Avi-Yonah, September 2013.

Executive Summary

This paper proposes to eliminate the U.S. citizenship based taxation and create a consistent exit tax system.  The complex web of the current U.S. tax law has made it nearly impossible for all but the most sophisticated U.S. citizens and lawful permanent residents (“LPRs”) residing overseas to file complete and accurate tax returns. The proposal should bring consistency, tax simplicity for taxpayers residing outside the U.S., and do so in part by eliminating the U.S. citizenship based tax system, which is unique in the world, dates to the civil war and is inappropriate for the global world we live in.

• Summary of Current Status of the Law

To date, there is no serious and comprehensive proposal to modify the U.S. federal tax law imposing U.S. taxation of the worldwide income of USCs and LPRs residing outside the U.S. 

There are also no serious proposals to repeal the current U.S. “expatriation tax” on (1) mark to market income and gains (When does “Covered Expatriate” Status -NOT- matter?) and (2) the 40% tax on covered gifts and inheritances (see, Proposed Regulations for “Covered Gifts” and “Covered Bequests” Issued by Treasury Last Week (Be Careful What You Ask For!)

This is Part II, a follow-on discussion of older U.S. case law and IRS rulings that address how and when individuals are subject to U.S. taxation before and after they assert they are no longer U.S. citizens.

I might point out that I am of the belief that we humans always like to hear the news we want to hear; and/or interpret it in the way we find most beneficial to us.  Who doesn’t like good news versus bad news?  Whether we (laypeople and tax lawyers alike) interpret Section 877A(g)(4) in any particular way; it is of no real consequence when it is the IRS that will enforce the law and ultimately the Department of Justice, Tax Division who will handle any such case interpreting this provision before a U.S. District Court or the Court of Federal Claims.  For those who have not litigated before these Courts and seen how aggressive are the government lawyers in advocating for the government, the following discussion will hopefully be illustrative.

See, Part I: Tax Timing Problems for Former U.S. Citizens is Nothing New – the IRS and the Courts Have Decided Similar Issues in the Past (Pre IRC Section 877A(g)(4)), dated October 16, 2015.

The question is what is the correct date of “relinquishment of citizenship” as defined in the statute; IRC Section 877A(g)(4)?  Many argue the law cannot be applied retroactively?

However, the specific case discussed here, did just that; applied the law retroactively to determine U.S. citizenship status of an individual and corresponding tax obligations.  This was also in a time of a much simpler tax code with (i) no international information reporting requirements (e.g., IRS Forms 8938, 8858, 5471, 8865, 3520, 3520-A, 926, 8621, etc.), (ii) no Title 31 “FBAR” reporting requirements and (iii) no constant drumbeat by the IRS of international taxpayers and enforcement.  See, recent announcement by IRS on Oct. 16, 2015 (one day after tax returns were required to be filed by many) Offshore Compliance Programs Generate $8 Billion; IRS Urges People to Take Advantage of Voluntary Disclosure Programs.  However, for cautionary posts on the IRS OVDP and the deceptive numbers published (e.g., “$8 Billion”), see How is the offshore voluntary disclosure program really working? Not well for USCs and LPRs living overseas posted May 10, 2014 and The 2013 GAO Report  of the IRS Offshore Voluntary Disclosure Program, International Tax Journal, CCH Wolters Kluwer, January-February 2014.   PDF version here.

Of course, the answer to this question helps determine if and when will the individual be subject to the federal tax laws of the U.S. on their worldwide income and global assets.  In the case of Ms. Lucienne D’Hotelle (an interesting 1977 appellate opinion from the firs circuit) she had spent little time in the U.S. and had sent a letter in her native language French to the U.S. Department of State, which stated “I have never considered myself to be a citizen of the United States.”  This is  not unlike many individuals around the world today;  at least as of late – in the era of FATCA, who assert they are not a U.S. citizen because they “relinquish[ed] it by the performance of certain expatriating acts with the required “intent” to give up the US citizenship” and did not notify the U.S. federal government.

The Court nevertheless found Ms. Lucienne D’Hotelle retroactively subject to U.S. income taxation on her non-U.S. source income (up until she received a certificate of loss of nationality from the Department of State); for specific years even when the immigration law provisions of the day said she was no longer a U.S. citizen during that same retroactive period.

There have been many contemporary commentators who argue an individual does not need to (i) have, (ii) do, or (iii) receive any of the following, and yet still should be able to successfully argue they have shed themselves of U.S. citizenship and hence the obligations of U.S. taxation and reporting on their worldwide income and global assets –

(i) receive a U.S. federal government issued document (e.g., a certificate of loss of nationality “CLN” per 877A(g)(4)(C)),

(ii) receive a cancelation of a naturalized citizen’s certificate of naturalization by a U.S. court (per 877A(g)(4)(D)),

(iii) provide a signed statement of voluntary relinquishment from the individual to the U.S. Department of State (per 877A(g)(4)(B)), or

(iv) provide proof of an in person renunciation before a diplomatic or consular officer of the U.S. (per  paragraph (5) of section 349(a) of the Immigration and Nationality Act (8 U.S.C. 1481(a)(5)), in accordance with 877A(g)(4)(C)).

Some older tax cases that interpreted similar concepts are worthy of consideration.  They will certainly be in any brief of the attorneys for the U.S. Department of Justice, Tax Division and/or Chief Counsel lawyers for the IRS in any case where the individual challenges that none of the above items are required in their particular case to avoid U.S. taxation and reporting requirements.

The D’Hotelle case is illustrative of the efforts taken by the Department of Justice, Tax Division in collecting U.S. income tax on a naturalized citizen.  You will notice they did not take a sympathetic approach to her case.   Ms. Lucienne D’Hotelle was born in France in 1909 and died in 1968 in France, yet the U.S. government continued to pursue collection of U.S. income taxation on her foreign source income from the Dominican Republic, France and apparently Puerto Rico even after her death during a period of time when she used a U.S. passport.  Lucienne D’Hotelle de Benitez Rexach, 558 F.2d 37 (1st Cir.1977).  She, not unlike many individuals today, claimed she was not a U.S. citizen – or at least stated “I have never considered myself to be a citizen of the United States.”

Some of the particularly interesting facts relevant to Ms. D’Hotelle, a naturalized citizen, which are relevant to the question of U.S. taxation of citizens, were set forth in the appellate court’s decision as follows:

Lucienne D’Hotelle was born in France in 1909. She became Lucienne D’Hotelle de Benitez Rexach upon her marriage to Felix in San Juan, Puerto Rico in 1928. She was naturalized as a United States citizen on December 7, 1942. The couple spent some time in the Dominican Republic, where Felix engaged in harbor construction projects. Lucienne established a residence in her native France on November 10, 1946 and remained a resident until May 20, 1952. During that time s 404(b) of the Nationality Act of 1940² provided that naturalized citizens who returned to their country of birth and resided there for three years lost their American citizenship. On November 10, 1947, after Lucienne had been in France for one year, the American Embassy in Paris issued her a United States passport valid through November 9, 1949. Soon after its expiration Lucienne applied in Puerto Rico for a renewal. By this time she had resided in France for three years.

                                         * * *

On May 20, 1952, the Vice-Consul there signed a Certificate of Loss of Nationality, citing Lucienne’s continuous residence in France as having automatically divested her of citizenship under s 404(b). Her passport . . . was confiscated, cancelled and never returned to her. The State Department approved the certificate on December 23, 1952. Lucienne made no attempt to regain her American citizenship; neither did she affirmatively renounce it.

                                         * * *

Predictably, the United States eventually sought to tax Lucienne for her half of that income. Whether by accident or design, the government’s efforts began in earnest shortly after the Supreme Court invalidated *40 the successor statute⁴ to s 404(b). In in Schneider v. Rusk, 377 U.S. 163 (1964), the Court held that the distinction drawn by the statute between naturalized and native-born Americans was so discriminatory as to violate due process. In January 1965, about two months after this suit was filed, the State Department notified Lucienne by letter that her expatriation was void under Schneider and that the State Department considered her a citizen. Lucienne replied that she had accepted her denaturalization without protest and had thereafter considered herself not to be an American citizen.

There are other facts that make clear the government was not fond of her husband, the income that he earned and how he managed his and his wife’s assets during and after her death.  The Court also discusses at length the fact that she had used a U.S. passport during the years when she alleges she was not a U.S. citizen.  The Court goes on to analyze her U.S. citizenship, and the following discussions are illustrative of the ultimate tax consequences.

One of the most burning questions of the day in expatriation tax law is whether changes in the tax law in 2008 regarding the date of “relinquishment of citizenship” mean what the plain language of the statute says in IRC Section 877A(g)(4).  This statutory rule is referenced in IRC Section 7701(a)(50).  See, a prior post on 6 May 2014, Why Section 7701(a)(50) is so important for those who “relinquished” citizenship years ago (without a CLN). . .

–

Section 877A(g)(4), provides as follows:

–

(4) Relinquishment of citizenship

Many thoughtful attorneys have argued that the statute cannot have the literal meaning it provides, because many U.S. citizens relinquished their citizenship without ever obtaining any document from the U.S. federal government, let alone, a certificate of loss of nationality (“CLN”).  See, for instance, Michael J. Miller Expats Live in Fear of Malevolent Time Machine  .  Also, see  Virginia La Torre Jeker J.D., Part III: Living in the Past: Citizenship “Relinquishments” – Am I Still a US “Tax Citizen”?

I sympathize with the arguments made by Mr. Miller and Ms. La Torre Jeker and others.  The statutory language creates what appears to be a very harsh result to a U.S. citizen who argues they did some type of act that terminated their U.S. citizenship many years ago.  Many individuals argue:  “I should not have to be subject to U.S. federal tax law that follows U.S. citizens, their assets and their income, wherever in the world they might be located, as I am no longer a U.S. citizen (although I have no CLN or similar document from the U.S. government saying otherwise).”

Reviewing old case law and IRS revenue rulings is instructive in this area to see how the Courts and the IRS considered the tax consequences to those individuals who had purportedly lost their U.S. citizenship in the past.

This is the first discussion (Part I) of a discussion of these cases and IRS rulings.

In a 1970 IRS Revenue Ruling (Rev. Rul. 70-506) the naturalized individual had actually been deemed to have lost her citizenship under a specific statutory provision (section 352(a)) of the Immigration and Nationality Act.  This immigration law determination however was found to be unconstitutional by the U.S. Supreme Court in Schneider v. Rusk, 377 U.S. 163 (1964).  In the revenue ruling, the IRS made the following determination saying she ” . . always has been since naturalization, a citizen of the United States and is taxable under section 1 or section 1201(b) of the Code on income from sources both within and without the United States. [emphasis added]”: