Corollary Tax Consequences
Survey of the Law of Expatriation from 2002: Department of Justice Analysis (Not a Tax Discussion)
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:
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What is the 10 year “Collection Statute” and Why is it Suspended for USCs and LPRs Overseas?
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
The lives of United States Citizens and Lawful Permanent Residents living outside the U.S. has necessarily become more complicated due to FATCA.
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 Congress) 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 the 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 indirectly 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)
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.
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).
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
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.
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)
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.
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.
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”?)
Supreme Court’s Decision in Cook vs. Tait and Notification Requirement of Section 7701(a)(50)
The U.S. Supreme Court upheld as Constitutional the concept of citizenship based taxation in 1924 in Cook v. Tait. In that case, the U.S. citizen resided permanently and was domiciled in Mexico City with his Mexican citizen wife.
In those years, the Revenue Act of 1921 imposed a top income tax rate of 8%. The IRS made a demand against Mr. Cook to pay his tax. Mr. Cook paid it and sued for refund of the US$1,193 paid. That amount represents about US$16,893 in 2014 inflation adjusted dollars. Neither amounts are significant in current actions taken by the IRS.
As a point of reference, Mr. Zwerner was alleged to owe US$3,630,119 (on an account with a maximum value during the years at issue of apparently no more than US$1.69M) and ultimately paid about US$ 1.75M (more than he even had in his account?) per the Notice of Settlement filed with the Court referenced here:
Even in 1922 dollars when Mr. Cook was living in Mexico City, the payment by Zwerner of about US$ 1.75M in current dollars, would represent about $123,581 in those dollars. 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)
There was no Foreign Account Tax Compliance Act (“FATCA”) in the days of Cook in Mexico City, so it would be interesting to know how and why the audit and tax assessment collection was commenced. This was long before e-mails and internet, and there was a very different system of international travel. Communication and technology in 2014 is quite different from technology nearly 100 years ago when the first transcontinental (not transnational) telephone call was made in 1915 a few years before the tax issue arose in the case of Mr. Cook.
Now to the key point of this post. The Supreme Court in Cook vs. Tait framed the question before the Court as follows:
- The question in the case . . . as expressed by plaintiff [Mr. Cook], whether Congress has power to impose a tax upon income received by a native citizen of the United States who, at the time the income was received, was permanently resident and domiciled in the city of Mexico, the income being from real and personal property located in Mexico.
Can the United States impose worldwide taxation on U.S. citizens who permanently live overseas and who only have income from property or services outside the U.S.? Of course, the Supreme Court, said, that such a citizenship based rule was Constitutional. The rationale of the Court was explained in the opinion as follows, specific to the rights of citizenship:
- . . . the scope and extent of the sovereign power of the United States as a nation and its relations to its citizens and their relation to it.’ And that power in its scope and extent, it was decided, is based on the presumption that government by its very nature benefits the citizen and his property wherever found, and that opposition to it holds on to citizenship while it ‘belittles and destroys its advantages and blessings by denying the possession by government of an essential power required to make citizenship completely beneficial.’ In other words, the principle was declared that the government, by its very nature, benefits the citizen and his property wherever found, and therefore has the power to make the benefit complete. Or, to express it another way, the basis of the power to tax was not and cannot be made dependent upon the situs of the property in all cases, it being in or out of the United States, nor was not and cannot be made dependent upon the domicile of the citizen, that being in or out of the United States, but upon his relation as citizen to the United States and the relation of the latter to him as citizen. [emphasis added]
The Supreme Court emphasizes at several points that it is because of the benefits of citizenship and the rights conferred to the citizen of the United States, that the United States government has the Constitutional power to impose worldwide taxation.
What is the difference, if someone is NOT a U.S. citizen? How can the U.S. federal government impose worldwide taxation on property outside the U..S. when the individual is not a citizen, has no right to even enter the United States and generally has no benefits or protections afforded to a U.S. citizen? Indeed, a recent interpretation of the U.S. government in a Justice Department memo spells out the rights of certain U.S. citizens. See New York Times recent article, Court Releases Large Parts of Memo Approving Killing of American in Yemen Targeting Anwar al-Awlaki Was Legal, Justice Department Said
Back on topic, the rationale in Cook v. Tait did not extend to someone who was not a citizen. For example, the Internal Revenue in the 1920s was of course not attempting to impose taxation on Mr. Cook’s Mexican national wife who lived exclusively in Mexico.
Herein, is a most interesting problematic and possibly (maybe – probably?) unconstitutional aspect of current law under the provisions off IRC Section 7701(a)(5)(if the loss of nationality is retroactive to a date long ago in the past but the tax code/IRS is not recognizing that past date as the expatriation date.
See, Why Section 7701(a)(50) is so important for those who “relinquished” citizenship years ago (without a CLN)
If someone has lost all rights to U.S. citizenship years or decades ago, how can the U.S. federal government continue to impose worldwide income taxation for all of the intervening years?
How can the tax law impose a “Constitutional fiction” that a person continues to be “. . . treated as a United States citizen . . . ” simply because they did not file a paper notification with the U.S. federal government. See, Section 7701(a)(50) was adopted and has a very clear timing rule about when a person “. . . cease[s] to be treated as a United States citizen. . . ” It is not the same as for immigration law purposes. It’s a fiction in the tax law as to when one ““. . . cease[s] to be . . . a United States citizen. . . ”
The statute says ” . . . An individual shall not cease to be treated as a United States citizen before the date on which the individual’s citizenship is treated as relinquished under section 877A (g)(4). . .”
How can the U.S. federal government continue to impose U.S. worldwide income taxation on former U.S. citizens because of the provisions under Section 7701(a)(50) and 877A (g)(4)?
The U.S. Supreme Court in Cook vs. Tait found the U.S. citizenship based taxation system as Constitutional since ” . . . government by its very nature benefits the citizen and his property wherever found . . .” and because of “ . . . his relation as citizen to the United States and the relation of the latter to him as citizen. . . . ” [emphasis added]
A person who is not a citizen, obviously does not receive these benefits from the government as does a United States citizen.
In practice, the only body that can determine whether a law is Constitutional or not, is the U.S. Supreme Court. It’s not likely that this question will reach the Supreme Court any time soon; if ever. Meanwhile, the IRS generally has the duty to enforce the law as currently written.
Obtaining a U.S. Visa after Renouncing U.S. Citizenship – The Cloud of the Still Living “Reed Amendment”
To state the obvious, every non-U.S. citizen must have a visa (or participate in the visa waiver program as a citizen or national of one of the 38 countries such as Chile, Hungary, Estonia, Spain, Monaco, etc.) to enter into the U.S. There are numerous visas all with different immigration law requirements and restrictions and many which have specific U.S. federal income tax consequences.
A future post with immigration counsel will discuss the type of visas available for entry into the U.S.
To date, I have yet to see any clients not be able to obtain a visa for re-entry back into the U.S.; after renouncing U.S. citizenship.
Importantly, the Attorney General still has the statutory authority to make a determination that a former U.S. citizen is inadmissible under the so-called “Reed Amendment” that was passed into the law in 1996 into the immigration law, Title 8 ((8 U.S.C. § 1182(a)(10)(E)) as part of the so-called Illegal Immigration Reform and Immigrant Responsibility Act of 1996. That provision, which should be obsolete based upon intervening changes in the tax law, nevertheless provides as follows:
- (E) Former citizens who renounced citizenship to avoid taxation
- Any alien who is a former citizen of the United States who officially renounces United States citizenship and who is determined by the Attorney General to have renounced United States citizenship for the purpose of avoiding taxation by the United States is inadmissible.
There are no regulations or administrative guidelines implemented by the US Government agencies to enforce this provision and no former US citizens have ever been found to fall under this category to date. More posts to follow on this important topic, including federal government reports on its applicability.
Please see also, The 1996 Reed Amendment – The Immigration Law with “No Teeth” and “No Bite”
Can the Attorney General make this provision have “teeth”? Will it ever be invoked by the government to make a former U.S. citizen inadmissible into the U.S.?