Corollary Tax Consequences

Revocation or Denial of U.S. Passport: More on new section 7345 (Title 26/IRC) and USCs with “Seriously Delinquent Tax Debt”

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New Section 7345 completely modifies how U.S. citizens (“USCs”) living and traveling around the world have to now consider very seriously actions taken by the Internal Revenue Service (“IRS”).  It is the IRS which now holds the power under this new law that requires the U.S. Department of State (“DOS”) to revoke or deny to issue a U.S. passport in the first place.

US Citizens Who Renounced - Chart Qtr 3 - 2015

New Section 7345(e) provides in relevant part as follows:  “upon receiving a certification described in section 7345 of the Internal Revenue Code of 1986 from the Secretary of the Treasury, the Secretary of State shall not issue a passport to any individual who has a seriously delinquent tax debt described in such section. . . ” [emphasis added].

This new law mandates (not at the discretion of the DOS) that various U.S. passports be denied at the direction of the IRS.  Once the IRS issues the certification of “seriously delinquent tax debt.”

All it takes, is for the IRS to claim tax or penalties are owing of at least US$50,000 through an assessment (plus start a lien or levy action).

Of course, US$50,000 sounds like a large sum for many modest USCs, until an individual understands that there are a host of international reporting requirements for taxpayers.  Specifically, the IRS can impose a US$10,000 penalty for each violation of failing to complete and file various IRS information forms; EVEN IF NO income IRS Form 8938 Specified Foreign Financial Assets - Highlighted Markertaxes are owing.  See IRS website – FAQs 5 and 8 regarding civil penalties (see also How is the offshore voluntary disclosure program really working? Not well for USCs and LPRs living overseas).

For a summary of these forms and filing requirements, see a prior post, Oct. 17, 2015, Part II: C’est la vie Ms. Lucienne D’Hotelle! 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))

Indeed, our office has seen and assisted numerous taxpayers around the world where the IRS has assessed tens of thousands, hundreds of thousands and in some cases in excess of US$1M (in proposed assessments) against an individual for failure to simply file information reporting forms.  See, for instance, a prior post on Nov. 2, 2015, 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

Also, we have seen several IRS assessments of income tax (not just penalties) against individuals of hundreds of thousands of dollars which are not supported by the law.  For instance, it is not uncommon for the IRS to issue a “substitute for return” alleging income taxes owing.  See, How the IRS Can file a “Substitute for Return” for those USCs and LPRs Residing Overseas,  posted Nov. 8, 2015.  We have a number of those cases pending, where the IRS has taken erroneous information and made such assessments against USCs residing and working outside the U.S. for much if not most of their professional lives.US Passport

New Section 7345 requires that USCs, wherever they might reside, take great care in knowing about any actions the IRS might be taking against them; as to tax and penalty assessments, whether or not they are supported under the law.

One basic method of learning more about the activities of the IRS is to make a transcript request directly to the IRS regarding the status of a USC’s federal tax status according to IRS records.  See, IRM, Part 21. Customer Account Services . . . Section 3. Transcripts.

It is also possible for the USC to obtain additional tax information from the IRS through a Freedom of Information Act (“FOIA”) request.

Survey of the Law of Expatriation from 2002: Department of Justice Analysis (Not a Tax Discussion)

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Most discussions regarding renunciation/relinquishment of U.S. citizenship are highly focused towards the U.S. federal tax consequences.  Today, the focus is on a 2002 report prepared by the DOJ for the Solicitor General, who supervises and conducts government litigation in the United States Supreme Court.

The report is found here, and I have highlighted some key excerpts:  Survey of the Law of Expatriation: Department of Justice Analysis:World Map

You have asked us for a general survey of the laws governing loss of citizenship, a process known as “expatriation” (also known within the specific context of naturalized citizens as “denaturalization”). See, e.g.,Perkins v. Elg, 307 U.S. 325, 334 (1939) (“Expatriation is the voluntary renunciation or abandonment of nationality and allegiance.”). Part I of this memorandum provides a general description of the expatriation process. Part II notes the relative difficulty of expatriating a person on the grounds that he has either obtained naturalization in, or declared allegiance to, a foreign state, absent evidence of a specific intention to relinquish U.S. citizenship apart from the act of naturalization or declaration itself. Part III analyzes the expatriation of a person who serves in a foreign armed force
engaged in hostilities against the United States.1
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1  Editor’s Note: The original footnote 1 has been removed in order to preserve the  confidentiality of  internal government deliberations.
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. . . In 1868, Congress declared that “the right of expatriation is a natural and inherent right of all people, indispensable to the enjoyment of the rights of life, liberty, and the pursuit of happiness.” Act of July 27, 1868, ch. 249, pmbl., 15 Stat. 223, 223; see also 8 U.S.C. § 1481 note (2000) (quoting Rev. Stat. § 1999 (2d. ed. 1878), 18   Stat. pt. 1, at 350 (repl. vol.)) (same).US Citizens Who Renounced - Chart Qtr 3 - 2015
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That declaration further stated that “any declaration, instruction, opinion, order, or decision of any officers of this government which denies, restricts, impairs, or questions the right of expatriation, is hereby declared inconsistent with the fundamental principles of this government.” 15 Stat. at 224. Similarly, the Burlingame Treaty of 1868 between the United States and China recognized “the inherent and inalienable right of man to change his home and allegiance, and also the mutual advantage of . . . free migration and emigration . . . for purposes of curiosity, of trade, or as permanent resident s.” U.S.-China, art. 5, July 28, 1868, 16 Stat. 739, 740. Congress provided specific legislative authority for nullifying citizenship when, in 1907, it enacted the predecessor of the modern federal expatriation statute.

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II. Foreign Naturalization or Declaration of Foreign Allegiance
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Under federal law, a U.S. citizen can lose his nationality if he voluntarily “obtain[s] naturalization in a foreign state… after having attained the age of eighteen years.” 8 U.S.C. § 1481(a)(1). Likewise, a citizen of the United States could be expatriated if he voluntarily “tak[es] an oath or mak[es] an affirmation or other formal declaration of allegiance to a foreign state or a political subdivision thereof, after having attained the age of eighteen years.” Id. § 1481(a)(2). In either case, however, no loss of citizenship may result unless the citizen acts “with the intention of relinquishing United States nationality.” Id. § 1481(a).
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The most common obstacle to expatriation in cases involving foreign naturalization or declaration of foreign allegiance is sufficient proof of a specific intention to renounce U.S. citizenship. Intent need not be proved with direct evidence, to be sure. It can be demonstrated circumstantially through conduct.  Thus, in some cases, such as service in a hostile foreign military at war with the United States, the act of expatriation itself may even constitute “highly persuasive evidence…of a purpose to abandon citizenship.” Terrazas , 444 U.S. at 261 (quotations omitted).
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Dual nationality, the Supreme Court has explained, is “a status long recognized
in the law.” Kawakita, 343 U.S. at 723. See also id. at 734 (“Dual nationality . . . is
the unavoidable consequence of the conflicting laws of different countries. One
who becomes a citizen of this country by reason of birth retains it, even though by
the law of another country he is also a citizen of it.”) (citation omitted); Savorgnan, 338 U.S. at 500 (although “[t]he United States has long recognized the general undesirability of dual allegiances[,] . . . [t]emporary or limited duality of citizenship has arisen inevitably from differences in the laws of the respective nations as to when naturalization and expatriation shall become effective . . .
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For some prior related posts, see: The Semantically Driven Vortex of “Relinquishing” vs. “Renouncing”, June 21, 2014 and various posts that highlight the statutory tax rules requiring notice be provided to the IRS (which is typically emphasized by an officer at the U.S. Department of State as part of the consulate interview to renounce U.S. citizenship); 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)), Oct 16, 2015.

What is the 10 year “Collection Statute” and Why is it Suspended for USCs and LPRs Overseas?

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There are different periods of time the federal tax law sets forth to protect both the taxpayer and the government.  In short, after a certain period of time (assuming numerous conditions are satisfied), neither (i) the government can take action to assess or recover taxes, or (ii) the taxpayer can demand a tax refund.

This concept is known as the “statute of limitations” and is a concept deeply imbedded throughout U.S. law, not just taxation law.

There are two key aspects for how and when taxes are levied by the IRS.  First, there is the “assessment” part, which helps determine a tax is owing in the first place.    There have been chapters of tax treatises written on how and when an assessment is valid.  A tax return is a “self-assessment”.  See, for instance, the CCH® Expert Treatise Library: Tax Practice and Procedure, and its chapter on Assessment and Collection.

The IRS can also make an assessment through a so-called “substitute return.”  See,  How the IRS Can file a “Substitute Return” for those USCs and LPRs Residing Overseas.

The focus of this post, is on the second aspect; the “collection” part of how the IRS collects upon a final tax assessment.

There is a 10 year collection statute of limitations imposed upon the IRS.   See IRC Section 6502.

The general rule, is that the IRS cannot wait forever to collect against a taxpayer for the amount of taxes owing.  If the taxes are not collected within this 10 year period, the general rule is that the IRS cannot continue to attempt to collect the taxes.

However, there is a huge exception in the 10 year collection statutory law, which does not apply when the individual is physically outside the United States for a continuous period of at least six months.  See, IRC Section 6503(c).  This means that any USC or LPR residing predominantly outside the U.S. will have this 10 year collection statute suspended in favor of the government.

In other words, the IRS will be able to indefinitely use its collection efforts to lien and levy assets of the taxpayer, when she is living outside the U.S.  The only way to “re-start” the collection statute, is for the individual to travel to the U.S. and not stay outside the U.S. for more than a six month period.  Obviously, for those who live outside the U.S., this will typically be impractical, if not impossible, to live several month continuous periods within the U.S.

Finally, traveling to the U.S., can raise additional issues for the overseas USC or LPR who has taxes owing to the IRS. See, Should IRS use Department of Homeland Security to Track Taxpayers Overseas Re: Civil (not Criminal) Tax Matters? The IRS works with Department of Homeland Security with TECs Database to Track Movement of Taxpayers

See also, U.S. Enforcement/Collection of Taxes Overseas against USCs and LPRs – Legal Limitations

More on FATCA Driven IRS Forms, specifically including IRS Form W-8BEN-E ~ It’s All About Information and More Information

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The lives of United States Citizens and Lawful Permanent Residents living outside the U.S. has necessarily become more complicated due to FATCA.  1998 Treasury Report - Factors Limiting Collection p2

Previous posts discussed unintended consequences of FATCA.  See, Part 2 – Unintended Consequences of FATCA – for USCs and LPRs Living Outside the U.S.

Also, see, Part 1- Unintended Consequences of FATCA – for USCs and LPRs Living Outside the U.S.

One of the most significant unintended consequence, is that the U.S. federal government (the IRS, the Treasury Department, or 1998 Treasury Report - Factors Limiting Collection p3Congress) never initially even contemplated USCs and LPRs living overseas.  In other words, the group targeted were U.S. resident individuals who were evading taxes through foreign financial institutions.  I say this, based upon extensive conversations I have had with ex-government officials and some government officials who were involved in the original policy discussions.

Also, see FATCA Driven – New IRS Forms W-8BEN versus W-8BEN-E versus W-9 (etc. etc.) for USCs and LPRs Overseas – It’s All About Information and More Information*

Currently, the IRS has revised or created the following new tax forms as a result of FATCA (all in IRS Forms List Modified by FATCA from IRSthe English language), which can be located at the IRS website at FATCA – Current Alerts and Other News:

Importantly, none of these forms are in other key languages such as Spanish, French, Mandarin, Cantonese, Portuguese, etc.  Imagine the daunting nature of completing these complex forms just in English when English is your first language, let alone completing them when you speak little to no English.

As the financial and account information of U.S. citizens and LPRs at financial institutions worldwide is now being collected to be reported in 2015 to the IRS under FATCA, a better understanding of FATCA forms is required.  A follow-up post will specifically discuss how financial and account information of non-U.S. shareholders and owners of foreign corporations, companies and foreign trusts will also W-8-BEN-E Certification and Substantial U.S. Owners of Entityindirectly be reported to the IRS, when there is a “substantial U.S. owner.”

A detailed discussion of how and when this information will be released to the IRS will be explained in a follow-up discussion of a passive “non-financial foreign entity” (“NFFE”) which will typically be a foreign corporation (non-U.S.), companies and foreign trusts.

This information is set forth and requested in Parts XXX and XXIX on the last page of IRS Form W-8BEN-E on page 8.  These items are highlighted here in yellow reflecting the information requested.

A follow-up post will explain what is a “passive” NFFE and what information is required to be reported per the form.  For a better understanding of the importance of signing a document “under penalty of perjury” see  Certifying Under Penalty of Perjury – Meeting the Requirements of Title 26 for Preceding 5 Taxable Years.

 

529 College Plans – Funded by Former USCs and LPRs (“Long-Term” LPRs)

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There is a basic tax planning opportunity for U.S. taxpayers who wish to fund the costs of higher education for family or friends.  These are referred to as “529 Plans” with reference to the tax code section – IRC Section 529.  In short, a 529 trust is established and funded with contributions for the benefit of named beneficiaries.U of Montana Campus

The principle benefit of a 529 plan, is that the income earned from the investments inside the 529 trust fund are exempt from U.S. income taxation.

There are multiple plans that are operated by various institutions, principally in conjunction with various States in the United States.  Qualifying higher education expenses also apply to about 350 non-U.S. institutions that currently qualify for distributions out of a 529 Plan; e.g., University of Cambridge, University of Dublin Trinity College, University of Edinburgh, University of Oslo, The University of York,  University of Wollongong, etc. 

Unfortunately, non-U.S. citizens who are not resident in the U.S. generally are not eligible to establish and form a new 529 plan.

These “529 Plans” fall expressly into the category of a “specified tax deferred account” under the law.  See, IRC Section 877A(e)(2).Rice University Campus

In short, the law causes the entire amount in the 529 Plan to be treated as distributed to the “covered expatriate” the day before the expatriation date, although no early distribution tax will apply.  If a 529 Plan has $500,000, that will represent taxable income to the “covered expatriate” to the extent of the tax-free growth in the plan.  For instance, if the individual funded $200,000 into this plan, in this example, and he or she is subject to the 39.6% tax rate upon “expatriation”, this means there will be US$118,800 less to pay for college and universities (i.e., $500,000 less the $200,000 invested; leaving $300,000 X 39.6% = US$118,800 of tax).

This is yet another example, of how and why it is so important to avoid “covered expatriate” status; if permitted by the law in any particular circumstances.  See, Certification Requirement of Section 877(a)(2)(C) – (5 Years of Tax Compliance) and Important Timing Considerations per the Statute, also see Can the Certification Requirement of Section 877(a)(2)(C) be Satisfied “After the Fact”?

Careful thought should be taken for the range of considerations and U.S. tax consequences that can befall a former USC or long-term LPR.

U.S. Tax Court Rules Against Lawful Permanent Resident (LPR) in Abrahamsen

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The U.S. Tax Court, in an opinion written by Judge Lauber (Abrahamsen v. Commissioner) placed much legal tax significance on the immigration form I-508 that Ms. Abrahamsen signed.  I-508 Waiver of Rights Privileges

The Court noted this form, I-508, Waiver of Rights, Privileges, Exemptions and Immunities (Under Section 247(b) of the INA) specifically provides that the non-U.S. citizen “waive all rights, privileges, exemptions and immunities which would otherwise accrue to [her] under any law or executive order by reason of [her] occupational status.

In that case, the individual was a Finnish citizen who eventually applied for lawful permanent residency.  The immigration forms were not related to any specific tax form, such as the new IRS Forms W-8BEN;  see, IRS Releases New IRS Form W8-BEN. * U.S. citizens and LPRs beware of completing such form at the request of a third party.

The takeaway from this opinion, is that individuals need to be aware of how signing a particular form (that is not a tax form) can have adverse tax consequences.  In this case, the Court ruled that she had waived her benefits to IRC Section 893 by signing immigration Form I-508.  The opinion of the Tax Court raises an interesting legal question about how signing a form (I-508) can seem to override the statutory protection granted which provides protection to a qualifying “. . .  employee [who] is not a citizen of the United States . . . “

Signing various tax forms can cause even greater risks for non-citizen taxpayers; e.g., IRS Form W-9 versus W-8BEN.  See, FATCA Driven – New IRS Forms W-8BEN versus W-8BEN-E versus W-9 (etc. etc.) for USCs and LPRs Overseas – It’s All About Information and More Information*

Fortunately for the taxpayer in the Abrahamsen case, she was not subject to the Section 6662 accuracy related penalty (“negligence” penalty) assessed by the IRS.

A subsequent post will analyze some potential U.S. tax consequences for individuals who sign immigration Form I-485,  Application to Register Permanent Residence or Adjust Status

IRA Distributions – (Counter-intuitive Results) U.S. Tax Consequences to Former USCs and Long Term Residents (LPRs)

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IRA Distributions –  (Counter-intuitive Results) U.S. Tax Consequences to Former USCs and Long Term Residents (LPRs)

Those USCs who have renounced citizenship (or who are contemplating renunciation) and those LPRs who (were/are/will) fall into the category of “long-term residents” who have qualified retirement accounts, known as “Individual Retirement Arrangement” (“IRAs”) have special considerations to consider under IRC Sections 877, et. seq.  For more details on how IRAs work and the deduction limits, see the IRS website explanation.

In short, if an individual is a “covered expatriate” upon renunciation (or LPR abandonment), they will generally be subject to U.S. income taxation on the entire amount of the IRA (along with all other assets with unrealized gains), reduced by the exemption amount (currently US$680,000 for the year 2014).

Unfortunately, it is fairly easy to become a “covered expatriate” even if the asset or tax liability tests are not satisfied, simply if the individual fails to satisfy the certification requirement under Section 877(a)(2)(C).  There are multiple posts that address this important certification requirement of Section 877(a)(2)(C), irrespective of how poor or how few of assets might be held by the individual.  See, Certification Requirement of Section 877(a)(2)(C) – (5 Years of Tax Compliance) and Important Timing Considerations per the Statute, also see Can the Certification Requirement of Section 877(a)(2)(C) be Satisfied “After the Fact”?

Plus, the topic is covered yet further in More on “PFICs” and their Complications for USCs and LPRs Living Outside the U.S. -(What if there are No Records?)

Generally “covered expatriate” status is to be avoided, give the various adverse tax consequences.  See, for instance,  Why “covered expat” (“covered expatriate”) status matters, even if you have no assets! The “Forever Taint”!

However, since the U.S. tax law is complex and oftentimes full of unintended consequences, there may be times when “covered expatriate” status is desirable in any particular circumstance.  I have seen and advised on several; including scenarios, where some planning steps can help get a much better U.S. tax result in various cases.IRA Calculation Example 1 Covered Expatriate

Assume a former USC does not meet the certification requirement (e.g., since they neglected to properly file a complete and accurate IRS Form 8854, or they otherwise did not comply with Title 26 for one or more of the five years preceding the renunciation/abandonment).  Further, let us assume, she has an IRA with a total value of US$1.4M and all of her other assets have no unrealized gain (e.g., Euros in a bank in Europe and an apartment she purchased in her country of residence in Europe that continues to have depressed real estate prices).   These other assets, the apartment and Euros are US$500,000 in value; hence, less than the US$2M net worth threshold.  However, we will assume she did not timely comply with the certification requirements under the law.

In such an “unfortunate” case, she would have to accelerate all of the income (gain) from her IRA in the year she has her “date of expatriation”.   This would cause a U.S. federal income tax liability of about US$260,000 that would become immediately due and payable.  This amount is calculated as follows: US$1.4M total IRA, less the $680,000 exclusion amount, for a total taxable income of about $720,000 (which will generate an approximate US$260,000 income tax for someone who is not married filing jointly.  This represents an effective tax rate of approximately 36% on the taxable income portion (US$260,000/US$720,000).  Remember, however, $680,000 escapes taxation under the exclusion amount.  Hence, the effective tax rate on the entire IRA portion is actually only about 18.6% in this case.  This amount is calculated as total IRA income of US$1.4M against tax of US$260,000 (i.e., $260,000/$1.4M= 18.6%).

An 18.6% tax rate is generally a very “attractive” U.S. individual income tax rate for those who have high amounts of income, as is this case with US$1.4M.IRA Calculation Example 2 Not Covered Expatriate

If instead, she is not a “covered expatriate” at the time she renounces her citizenship in 2014 (as she did comply with the certification requirements and otherwise would not meet the $2M net worth and her average annual net income tax liability for the preceding 5 years did not exceed $157,000) she would have a very different tax result.  In short, she would not have to accelerate the entire tax liability.  That sounds like good news, until one considers the U.S. tax rate on future IRA distributions to her after she ceases to be a U.S. citizen.  Absent, an income tax treaty, she would have a 30% tax withheld at source (i.e., by the U.S. payer – trustee of the IRA) on each distribution made.  If all US$1.4M is distributed out in one lump sum, there will be a tax of US$420,00 (US$1.4M X 30%); much more than the $260,000 for the “covered expatriate” scenario above.  See calculations in this table:

Also, if she prefers to defer the IRA distributions (e.g., to make 14 annual distributions of US$100,000), she will have the same 30% tax withheld on each payment; hence, a total tax of US$420,00.

Obviously, a 30% tax is much worse than an 18.6% tax.  Accordingly, this is a scenario where an individual may prefer to be a “covered expatriate” as opposed to avoiding such status.  A bunch of factual analysis and strategic considerations would need to be considered in her case (e..g, where are her future heirs, what other income might she receive, will she receive any future gifts of inheritances herself, etc. etc.?).

Indeed, in this particular case, I can imagine a scenario (if accompanied by some focused tax planning), she could pay no more than a total effective tax rate of 12.2% on her income.  Of course,  12.2% is better than 18.6% and 30%.

Finally, there is one more important wrinkle that can modify these results yet further; a particular income tax treaty with the U.S. that has a specific tax result that is better than the statutory 30% rate on distributions from an IRA to a non-resident alien.  The U.S. has numerous income tax treaties with numerous countries, almost all of which have different terms and conditions.  See, Countries with U.S. Income Tax Treaties & Lawful Permanent Residents (“Oops – Did I Expatriate”?)