Corrallary Tax Consequences
Immigration Forms, I-407; I-485, Application to Register Permanent Residence or Adjust Status & Tax Forms, 1040, 1040NR, 8833, 5471, 8854, 8621, 3520, 8864, 8858 and FinCEN forms 114, etc. etc. (Part I of III)
The U.S. tax law is complex, including when an individual (i) becomes and (ii) ceases to be, a U.S. income tax resident (USITR). USITR is not a technical term used under the tax law. The U.S. tax and information reporting requirements are very different depending the status of an individual. Anyone who is not a United States citizen, is either a –
- “Resident alien“, or a
- “Nonresident alien” as the tax law defines both of these categories.
You can’t be both.
“Resident aliens” are generally also “United States persons” (both technical terms in the federal tax law).
“Non-resident aliens” as defined are necessarily not “United States persons.”
Being one versus the other has huge U.S. tax and reporting consequences.
An individual who is a “lawful permanent resident” as referenced in the tax law (Section 7701(b)(6)) cross-references the U.S. immigration law. The first requirement of that statutory tax rule in § 7701(b)(6)(A)) is that “(A) such individual has the status of having been lawfully accorded the privilege of residing permanently in the United States as an immigrant in accordance with the immigration laws [such status not having changed]. . .[emphasis added]” This means the tax definition is dependent upon the immigration laws, which are found in Title 8, Immigration and Nationality Act. Importantly, the last part of that sentence (i.e., [such status not having changed] is a requirement in the immigration law (Title 8), but does not appear in the tax definition.
The term “lawful permanent resident” cannot be found in Title 8 as a noun or object (i.e., the individual). Instead, the immigration law defines the status of a person in 8 U.S. Code § 1101(a) as follows:- “. . . (20) The term “lawfully admitted for permanent residence” means the status of having been lawfully accorded the privilege of residing permanently in the United States as an immigrant in accordance with the immigration laws, such status not having changed.“
This analysis is fundamental to be able to determine whether an individual who holds a “green card” in their pocket even has the status of being “lawfully admitted for permanent residence . . . such status not having changed.” It’s a fundamental legal question under immigration law that must be answered first, to then be able to answer the tax question.
Each form an individual files or does not file (e.g., IRS tax form 1040 v. 1040NR; 8833, 5471, 8854, 8621, 3520, 8864, 8858 and FinCEN forms 114; and immigration forms, e.g., I-485, I-407, etc.) can have a potential impact on the tax residency status of an individual.
The immigration law and when forms, such as Form I-485, Application to Register Permanent Residence or Adjust Status are submitted to the U.S. federal government can have an impact on this determination. The government can use it against the individual as they did unsuccessfully in Aroeste (see below – Pages 9 and 11 of 17); asserting that Mr. Aroeste waived the treaty by not submitting certain forms.
See an earlier post that explains in some detail how and when an individual can cease to be a “United States person” if they live in a country with an income tax treaty and yet retained their “green card” in their pocket: Federal District Court Rules in Favor of Mexican Citizen – Aroeste vs. United States (LPR) – Tax Treaty Applies: Government’s Motion for Summary Judgment is Denied
The entire case from the Federal District Court can be read here: Aroeste v. United States, 22-cv-00682-AJB-KSC (20 Nov. 2023):
The tax residency analysis for those who have kept their “green card” in their pocket, can be even more complex as was analyzed by the Court. There are additional provisions of the law that must be considered including old Treasury Regulations that pre-date many provisions of various U.S. income tax treaties.
For instance, each of the following federal tax statutory rules, which will be considered in more detail in later posts (II and III):
- 26 U.S. Code § 894 – Income affected by treaty
- 26 U.S. Code § 7852(d) – Other applicable [treaty] rules
Additional posts will review the impact of these provisions in the law and how various immigration forms (including I-485 and I-407, Record of Abandonment of Lawful Permanent Resident Status) and tax forms (including 1040 v. 1040NR; 8833, 5471, 8854, 8621, 3520, 8864, 8858) and FinCEN form 114, can impact the determination of whether someone who has a “green card” in their pocket is or is not a United States person.
IRS Form W-8 or W-9? “Green Card” Holders (LPRs) – Certifications Re: Tax Status after Aroeste v. United States
The author has extensively discussed the appropriate IRS Form for individuals to sign under penalties of perjury when dealing with their banks and third parties, irrespective of the banks’ location. The choice between IRS Forms W-8 and W-9 hinges on the U.S. income tax residency status of the individual. Forms W-8 and W-9 serve the purpose of conveying the tax residency status of the individual to third parties. The correct (or incorrect form) can have a range of different tax and legal consequences to the individual. A non-resident is generally not subject to income taxation in the United States, except for on limited types of income. In contrast, a resident (for federal income tax purposes) is subject to taxation on their worldwide income. If an income tax resident of the United States falsely certifies their status using Form W-8, severe adverse legal consequences can follow. See e.g., W-8s for U.S. Citizens Abroad: Filing False Information with Non-U.S. Banks (2016)
- IRS Forms W-8 or W-9 (or Other)?
For U.S. citizens, the process is straightforward—they must sign IRS Form W-9. However, for individuals without U.S. citizenship, the situation becomes more intricate. The following posts delve into critical legal considerations surrounding IRS Form 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 (2014/2015)
Also, W-8s for U.S. Citizens Abroad: Filing False Information with Non-U.S. Banks (2016)
These comments provide in-depth insights into the legal consequences of filing and signing specific IRS forms (or their equivalents produced by financial institutions: W-8 vs. W-9). Notably, UBS’s explanation titled “UBS One Source Understanding tax forms—non U.S. taxpayers” sheds light on the efforts foreign financial institutions need to dedicate to assist clients who are not “United States persons” for federal tax purposes, ensuring compliance with U.S. federal tax laws.
- Green Card Holders Living Abroad Have Further Analysis to Consider
The complexity heightens for “Green Card” holders living abroad, especially those residing in countries covered by an income tax treaty with the United States. See, Aroeste v. United States, Case No. 22-cv-00682-AJB-KSC. Aroeste v United States – Order Nov 2023, emphasizes a 5-step analysis for Green Card holders who have not formally abandoned their status. The ultimate test is whether the individual is entitled to be treated as a resident of a foreign country under a tax treaty.
- Aroeste v. United States: Decision’s Impact on LPR Individuals
The decision could potentially affect millions of Green Card holders living outside the U.S. Aroeste Court’s 5-step analysis becomes crucial for the 3+ million LPRs residing abroad, determining whether they qualify as “United States persons” under the law.
- LPR Individuals Living in 66 Different Countries Could Be Impacted by Aroeste vs. U.S.
The United States has a total of 58 income tax treaties that covers 66 countries. See, Countries with U.S. Income Tax Treaties & Lawful Permanent Residents (“Oops – Did I Expatriate”?) (2014); ironically reflecting the same tax treaties in force in 2023 as of 2014. The 1973 U.S. – U.S.S.R. income tax treaty applies to Armenia, Azerbaijan, Belarus, Georgia, Kyrgyzstan, Moldova, Tajikistan, Turkmenistan, and Uzbekistan.
- Importance of Figuring Out your Residency Status if you Never Formally Abandoned your Green Card and Live in an Income Tax Treaty Country.
The impact of the Aroeste v United States decision presents a dual scenario for individuals who have not formally abandoned their “lawful permanent residency” status. On the positive side, there is an opportunity to inform the Internal Revenue Service (IRS) of their non-resident status by utilizing the applicable income tax treaty. There are specific steps to take as explained by the Court in Aroeste vs. United States. This action can relieve them of U.S. federal income tax filing obligations and Foreign Bank Account Report (FBAR) filing requirements, helping to steer clear of potential penalties and taxes that might otherwise be owed. The Court in Aroeste concluded such late filings could subject the individual ” . . . to penalties pursuant to I.R.C. § 6712(a) equal to $1,000 per failure to timely report his Treaty position. . . “
Aroeste v United States – Order Nov 2023Download
- Potential Downside for “LPRs” Living in an Income Tax Treaty Country.
However, on the flip side, this termination of U.S. income tax residency status may lead to the individual “cease[ing] to be a lawful permanent resident of the United States (within the meaning of section 7701(b)(6)).” Such a shift can trigger adverse U.S. tax consequences, affecting not only the individual but also extending to children, spouses, family members, and friends who could receive “covered gifts” or “covered bequests.” This classification may result in the individual being deemed a “covered expatriate” under the expatriation tax law, as outlined in IRC 877A(g)(3). See, IRC 877A(g)(3). Potentially severe adverse tax consequences can follow from this edge of the sword. The Court in Aroeste vs. United States did not address these adverse tax consequences as they were not at issue.
See, Patrick W. Martin, 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
Important resources for United States international tax rules for those considering renouncing or relinquishing United States citizenship or abandoning lawful permanent residency
This Blog is intended to provide general information about tax expatriation legal concepts under U.S. law to help readers better understand often very complex issues within the U.S. international tax field for citizens and lawful permanent residents. General legal information is not the same as legal advice, that is, the concrete application of law to a specific case with unique and particular facts.
Legal advice also should include strategic planning and advice to a particular case. A legal adviser should be able to assist an individual in taking important decisions and steps, related to the specific goals of the individual, while understanding the legal and tax consequences of each step. There are a range of consequences that the “U.S. tax expatriation” laws impose upon different types of transactions, transfers, reorganization of assets, etc. None of these items are discussed in this Blog.
Although the author has taken great care to make sure that the information contained herein is accurate and useful, it is necessary that you consult an experienced attorney to address any particular situation. Most importantly, if you are contemplating renouncing (or proving relinquishment) of U.S. citizenship or formally abandoning your LPR status, you must get legal advice. This is a very important decision with a range of complex legal consequences.
FATCA Driven (Even More . . . ) – 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 (Part III)
Information and more information is the mantra of revised IRS Forms as a result of FATCA. 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
U.S. citizens residing outside the U.S. along with lawful permanent residents (“LPRs”) are not the only
persons who need to understand the IRS forms referenced above. Indeed, all entities and institutions, whether they are small privately held companies or large and traditional financial institutions are required to complete and have signed a range of IRS forms.
The forms can be either the actual IRS form, or a satisfactory substitute form. Many individuals are of the erroneous view that if they are not financial institutions, they do not need to concern themselves with these classifications.
Unfortunately, that is not the case. Also, these classification rules apply to the surprise of many, if there are (or are not) U.S. persons involved.
In addition to a basic understanding of U.S. laws, it is also crucial that the parties see if their country has entered into an IGA. For instance, if we examine the tiny little country of Liechtenstein which has a relatively large financial sector, it is necessary to first classify the type of entity.
For instance, if it is a Liechtenstein Stiftung, it will probably (but not necessary) be a trust and not a corporation. See the IRS Memorandum from 2009 that provides that a Liechtenstein Stiftung will be classified as a trust, if its primary purpose is to protect or conserve the property transferred to the Stiftung for the Stiftung’s beneficiaries and is usually not established primarily for actively carrying on business activities.[1]
[1] See Memorandum Number: AM2009-012, dated October 16, 2009, issued by the Office of Chief Counsel, Internal Revenue Service.
Next, in this example, with a Liechtenstein Stiftung, the country of Liechtenstein has entered into an Intergovernmental Agreement (“IGA”).
Hence, the terms of the IGA are most important. Under the IGA, as is the case generally for FATCA, the entity has to be either an Foreign Financial Institution (“FFI” or “FI”) or a Non-Financial Foreign Entity (“NFFE”).
1) Definition of Financial Institution (“FI”)
A financial institution is any entity that:
- Accepts deposits in the ordinary course of a banking or similar business (“Depository Institution”);[1]
- Holds, as a substantial portion of its business financial assets for the benefit of one or more other persons (“Custodial Institution”);[2]
- Is an investment entity; or
- Is an specified insurance company or holding company that is a member of an expanded group;[3]
[1] See Article 1(i), IGA.
[2] See Article 1(h), IGA.
[3] See Article 1(k), IGA.
Generally a private Liechtenstein Stiftung would not satisfy any of these requirements (although it could conceivably be the case that one could be an “investment entity”). Hence, it would generally be an NFFE and not an FI.
NFFEs can be passive or active. The kind of compliance obligations varies depending on the type of NFFE (passive or active).
- Passive NFFEs
A passive NFFE is an NFFE which is not an active NFFE or a withholding foreign partnership or withholding foreign trust.[1]
There are several criteria under which a NFFE can be classified as an active NFFE. The following explain the most relevant criteria.
- Active NFFEs
Among the criteria that the IGA establishes, under which a NFFE can be considered as an Active NFFE, are the following:
1) If less than 50% of the NFFE’s gross income is passive income and less than 50% of the assets held by the NFFE are assets that produce or are held for the production of passive income during the preceding calendar year. A
2) Substantially all of the activities of the NFFE consist of holding (in whole or in part) the outstanding stock of, or providing financing and businesses other than the business of a Financial Institution.
Sometimes trusts or Stiftungs will also participate in or hold interests in companies, some of which may engage in active trades or businesses or simply hold passive investments. On the contrary, the companies/subsidiaries only hold other assets from which they derived passive income (e.g., dividends, interests, rents, royalties, etc.).[2]
This will determine if a Stiftung will be classified as a Passive NFFE or not under FATCA regulations and the IGA.
[1] It also can make a difference if the trust (or Stiftung in this example) is a so-called “withholding” foreign trust; which generally requires an agreement with the IRS.
[2] Treas. Reg. § 1.1472-1.
Not surprisingly, the above analysis is complex, because the rules are complex. Accordingly, it has been the author’s experience, that many institutions around the world which request one or more of the above IRS Forms have great difficulty in even implementing these rules. Most of their employees seem to have little understanding of what is a very complex area of law, even when their resident country has issued extensive regulations or guidance about how the terms of the IGA are to be implemented.