Last week (Nov. 20, 2023), Judge Battaglia in the Southern District of California (San Diego) ruled in favor of our client Mr. Alberto Aroeste regarding the application of the U.S.-Mexico Tax Treaty. The DOJ, Tax Division arguments on behalf of the Internal Revenue Service in the case (and their Motion for Summary Judgment – MSJ) were largely rejected by the Court.
A thorough read of the Order from the Court is recommended to understand the substantial legal findings and legal analysis made by the Court relevant to those who possess a “green card” referred to as “lawfully admitted for permanent residence” in Title 8, § 1101(a)(13) [Immigration and Nationality Act]. Key to this case, Title 26, § 7701(b)(6) [Federal Tax Code] then rather contorts the concept by saying an individual is a “lawful permanent resident” in accordance with immigration laws; but then goes on to put conditions on who apparently is a “lawful permanent resident” for federal tax purposes. While immigration law requires the individual be ” . . . accorded the privilege of residing permanently in the United States as an immigrant in accordance with the immigration laws, such status not having changed”; the tax definition seems to ignore that status (i.e., has it changed and is the personal no longer accorded the privilege of residing permanently in the U.S.?).
The Board of Immigration Appeals (the “Board”), has long recognized that an alien’s status may change by operation of law, such that an alien may abandon his LPR status without a finding of removability (or, formerly, deportability or excludability) after a formal adjudicatory process. See United States v. Yakou, 428 F.3d 241, 247 (D.C. Cir. 2005); at 247-51 (discussing case law regarding abandonment and holding that an alien may abandon LPR status without formal administrative action); see also Matter of Quijencio, 15 I. & N. Dec. 95 (B.I.A. 1974); Matter of Kane, 15 I. & N. Dec. 258 (B.I.A. 1975); Matter of Muller, 16 I. & N. Dec. 637 (B.I.A. 1978); Matter of Abdoulin, 17 I. & N. Dec. 458, 460 (B.I.A. 1980); Matter of Huang, 19 I. & N. Dec. 749 (B.I.A. 1988).
The Court did not need to get into the nuances of immigration law to rule against the government in this case.
Some of the substantial takeaways from the decision are:
Waiver of the Tax Treaty: The government cannot assert an individual waived the treaty law because she initially filed the wrong IRS forms (1040) instead of the non-resident form (1040NR) and IRS Form 8833.
The Court agrees with Aroeste. Although Aroeste gave untimely notice of his treaty position, the Court finds this does not waive the benefits of the Treaty as asserted by the Government. Rather, I.R.C. § 6712 provides the consequences for failure to comply with I.R.C. § 6114, namely a penalty of $1,000 for each failure to meet § 6114’s requirements of disclosing a treaty position.
Aroeste v United States – Order 20 Nov 2023 (p. 17)
Expatriation Tax form – IRS Form 8854: Validity and its Failure to Comply with the Administrative Procedure Act (“APA”)
C. Whether Aroeste Was Required to File Form 8854 The Government next argues that even if the IRS had accepted Aroeste’s amended returns, neither amended return would have properly notified the IRS of a commencement of treaty benefits because both failed to attach Form 8854, as required by IRS Notice 2009-85. (Doc. No. 76-1 at 4–5.) The Government concedes Aroeste attached Form 8833 to both amended forms. (Id.) Aroeste responds that Notice 2009-85 is not binding authority as it fails to comply with the Administrative Procedures Act (“APA”). (Doc. No. 78-1 at 8 (citing Green Valley Investors, LLC v. Comm’r of Internal Revenue, 159 T.C. No. 5, at *4 (Nov. 9, 2022)) (under the APA, agencies must follow a three-step procedure for “notice-and-comment” rulemaking, but this requirement does
not apply to “interpretive rules, general statements of policy, or rules of agency organization, procedure, or practice.”).) The Court agrees. In Mann Construction, Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022), the court found that Notice 2007-83 failed to comply with the APA’s notice-and-comment procedure. Similarly here, because Notice 2009-85 has not been subject to a notice-and-comment procedure, it does not comply with the APA and thus is not binding. As such, Aroeste was not required to file Form 8854 with his amended returns.
Aroeste v United States – Order 20 Nov 2023 (p. 11)
Tax Treaty Law Applies – Article 4 Regarding Tax Residency
Various detailed analysis and discussions from the Court –
Aroeste v United States – Order 20 Nov 2023 (p. 11-14)
The Preamble to the FBAR Regulations is Not the Law –
. . . the Government points to the preamble to the 31 C.F.R. Part 1010 regulations, providing that “[a] legal permanent resident who elects under a tax treaty to be treated as a non-resident for tax purposes must still file the FBAR.” Amendment to the Bank Secrecy Act Regulations—Reports of Foreign Financial Accounts, 76 Fed. Reg. 10234-01 (Feb. 24, 2011). The Court finds this unavailing. The Government’s argument does not refute the plain language of the FBAR regulations, which explicitly invoke provisions of Title 26, including the provision that requires consideration of an individual’s status under an applicable tax treaty for the purpose of determining whether an individual is a “United States person” subject to FBAR filing. Specifically, Title 31 C.F.R. § 1010.350, which governs reporting of FBARs, subsection (b)(2) states that a “resident of the United States is an individual who is a resident alien under 26 U.S.C. 7701(b) and the regulations thereunder . . . .” The Government fails to cite to any case law or statue indicating otherwise, and the Court finds none. As such, because the Court finds the Treaty applicable to Aroeste, then the residence provisions of the Treaty, or the “tie breaker rules” dictates whether Aroeste may be treated as a nonresident alien.
Aroeste v United States – Order 20 Nov 2023 (p. 14)
This is the third court case (the other two were in U.S. Tax Court) I have had over the last several years where the IRS tried to assess substantial penalties and taxes against LPRs who resided substantially outside the United States. The other two cases were conceded by the IRS prior to going to trial. One case had over US$40M at stake as assessed by the IRS. This case, in federal district court, was pushed all the way to this favorable (to Mr. Aroeste and those around the world in similar circumstances) outcome by the government. We were successful with all of these non-U.S. citizen cases (two brothers from Mexico and an individual from Germany).
In just over six weeks, there have been three key judicial precedents favorable to international individuals. These cases have helped clarify the requirements of individuals and the limitations on the powers of the IRS in assessing IIR penalties. These IIR decisions relate to –
Title 31 penalties for Foreign Bank Account Reports (“FBARs”),
How these two federal statutory regimes of Title 31 and 26 crossover into international law as set forth in U.S. income tax treaties negotiated with different countries around the world.
Each of these three cases are interconnected and have significant impact to individuals with global lives, global assets, multi-national family members and those who have businesses or accounts in different parts of the world.
Aroeste v. United States
First, on February 13th, 2023, the Southern District of California District Court (the “District Court”) made a key determination in a Joint Discovery Motion decision in Aroeste.[2] The District Court concluded in Aroeste that the IRS/DOJ[3] could not ignore the U.S.-Mexico income tax treaty (“Treaty”) and its application to a Mexican national who has resided almost all of his life in Mexico City and has maintained a “green card” for immigration purposes in the United States. It is a non-willful FBAR case. The District Court applied the interconnected statutes and regulations of Titles 31 and 26 to help determine who qualifies as a “United States person”; specifically with reference to international law and obligations set forth in the Treaty. The key question in that case that remains to be answered is who (specifically Mr. Aroeste and by extension to a pool of millions of green card individuals residing outside the United States who are not citizens[4]) must file FBARs?
Second, on February 28th, 2023, the Supreme Court of the United States (“SCOTUS”) resolved in Bittner[5], that the applicable non-willful FBAR penalty is not measured by every foreign account of the individual as the Service has argued for years. That case also dealt with non-willful filing of FBARs and the SCOTUS concluded the IRS cannot impose penalties of $10,000 on each and every account held; but rather the penalty is “per report” that was not correctly filed. Hence, the total maximum penalty per year is $10,000. A maximum penalty of $50,000 (x5 years) applied per the SCOTUS versus the IRS determined amount of US$2.7M+.
Farhy v. Commissioner
Lastly, on April 3rd, 2023, the United States Tax Court (the “Tax Court”) issued a decision in Farhy,[6] stating that the IRS does not have statutory authority to assess IIR penalties under section 6038(b). The IIR that is required by this statute is IRS Form 5471, which includes multiple filing categories. This has far reaching implications about how the government will be able to collect the IIR penalties the Service administratively determines are owed.[7] The Taxpayer Advocate previously issued a report on point titled: The IRS’s Assessment of International Penalties Under IRC §§ 6038 and 6038A Is Not Supported by Statute, and Systemic Assessments Burden Both Taxpayers and the IRS[8] In that report, the Taxpayer Advocate identified more than $310M of penalties just for the tax year 2014 the IRS “assessed” under Sections 6038 and 6038A.[9] We now know these “assessments” were invalid.
[1] See, footnote 19 regarding United States Tax Court’s Order in the case of Alberto Aroeste & Estela Aroeste vs. Commissioner.
[3] The “IRS” or the “Service” are used as shorthand for the Internal Revenue Service; and the Department of Justice; Tax Division is referred to as the “DOJ.”
[4] See, the Homeland Security, Office of Immigration Statistics – Estimates of the Lawful Permanent Resident Population in the United States and the Subpopulation Eligible to Naturalize: 2015-2019. According to the report, more than 1 million individuals become LPRs each year and 4.8 million are estimated to have died and/or emigrated. The authors have extrapolated from these estimates in the report to conclude that more than 3 million of these individuals have emigrated and left the United States. The millions of individuals do not reside in the U.S. of which Mr. Aroeste is one of these individuals; although a tax treaty must exist in the country of residence for the analysis of the District Court in Aroeste v. United States to be applicable.
[5] No. 31—1195 (U.S. Feb. 28, 2023); 598 U. S. ____ (2023); The majority opinion by Justice Gorsuch cited to the ACTEC amicus brief (where Patrick W. Martin, the author of tax-expatriation.com and a fellow of ACTEC worked on the drafting of the brief) and concluded:
“Best read, the BSA treats the failure to file a legally compliant report as one violation carrying a maximum penalty of $10,000, not a cascade of such penalties calculated on a per-account basis.” The ACTEC brief was cited by the majority opinion- “ We see evidence, too, that the point of these reports is to supply the government with information potentially relevant to various kinds of investigations, criminal and civil alike. But what we do not see is any indication that Congress sought to maximize penalties for every nonwillful mistake (whether a late filing, a transposed account number, or an out-of-date bank address). See Brief for American College of Trust and Estate Counsel as Amicus Curiae 5–7.”
[7]See, Patrick W. Martin, Megan L. Brackney, Robert Horowitz, and Javier Diaz de Leon Galarza: Problems Facing Taxpayers with Foreign Information Return Penalties, November 12, 2020.
Millions of lawful permanent residents (LPRs) who have left the U.S. and not “formally abandoned” their LPR status (by filing Form I-407, Record of Abandonment of Lawful Permanent Resident) typically remain in some kind of “LPR U.S. tax limbo.” How many individuals worldwide are in this LPR U.S. tax limbo?
Why are these numbers important for the tax-expatriation analysis? See, a recent post, Why Most LPRs Residing Overseas Haven’t a Clue about the Labyrinth of U.S. Taxation and Bank and Financial Reporting of Worldwide Income and Assets (Part I). Indeed, most individuals probably do not think they are a U.S. federal income tax resident when they leave the U.S. to reside overseas back to their home country. Why would they? There is no tax training manual provided to LPRs who leave the U.S. and no tax advisories – reflected on the card itself (unlike the last page of the U.S. passport, paragraph D). More precisely, most are probably not giving much, if any thought, to the complex U.S. federal tax residency rules and their extraterritorial application.
The “big gap” referred to above can be identified from the the Office of Immigration Statistics (OIS) report titled: Estimates of the Lawful Permanent Resident Population in the United States and the Subpopulation Eligible to Naturalize: 2015-2019. According to the report, more than 1 million individuals become LPRs each year. Between naturalization, mortality and emigration the report shows that the LPR population, year over year, has remained stable. In 2019 the total number of LPRs per this report was 13.6 million, up from just 13.0 million in 2015.
The “gap” is the difference between the numbers of LPRs who have left-emigrated the U.S. (some 3+ million) compared to something like an annual average of 15-19 thousand who have filed Form I-407. The gap is in the millions of persons who are in LPR U.S. tax limbo.
Mexico
The report is also worth reading if you want to understand the demographics of the LPR population. Mexico has about 2.5 million (which is by far the greatest number) of the total 13+ million LPR population.
As the report points out there is no reliable direct measurements of LPR emigration. They do not exist. This lack of information is what drove me to file a FOIA request with the government to request information about the number USCIS Forms I-407 that are filed with the government. See, also quarterly statistics of the USCIS – Form I-407, Record of Abandonment of Lawful Permanent Resident Status (partial information for years 2016-2019).
The information I obtained in the FOIA response was surprising, since the government had records showing only 46,364 Forms I-407 were filed in the years 2013 through 2015, as follows:
SOURCE: Federal Government Response to FOIA Request: Office of Performance and Quality (OPQ), Performance Analysis and External Reporting (PAER), JJ
This represents an average of only 15,455 individuals who formally abandoned their LPR status. Contrasted with more than 3.6 million estimated to have emigrated in 2019 per the DHS report leaves a massive gap of well over 3 million persons who held a “green card” and have left. They are now in LPR U.S. tax limbo.
What about the tax consequences? How many of these LPRs who left the U.S. know, understand or have any idea whatsoever of the federal tax filing obligations regarding their status?
What is the takeaway from the DHS report and LPR – I-407 information provided to me by the FOIA response? There is a discrepancy in the millions of people. Millions of individuals who actually leave or have left the U.S. to reside somewhere else around the world; compared to only some tens of thousands of individuals who have formally filed Form I-407, Record of Abandonment of Lawful Permanent Resident.
What can these individuals do to get out of the LPR U.S. tax limbo?
Who is a “resident”? What is a “resident”? This sounds like such a basic question. It is not so simple for tax purposes; nor for other provisions of the law.
There is the colloquial meaning of resident. For instance, if Mr. Smith says, “I have been a resident of Montana on my ranch for 30 years”; to what does he refer? What if Mr. Smith has a house in California (which he has owned for 15 years) and another ranch in Alberta, Canada that he has owned for 45 years. Is he also a “resident” of Canada and California?
What if he is not a U.S. citizen but holds a particular type of visa, such as lawful permanent residency (an immigrant visa)? What if he has a non-immigrant visa, such as an E-2 visa? What if he only spends 4 months a year on his ranch in Montana, of where is he a “resident”?
Is he a “resident” in some or all of these scenarios? Why is this important in the context of “U.S. expatriation taxation”?
There are three sources of federal law where it becomes very important, which will be discussed in later posts:
In addition, various states, such as California, Texas and Washington D.C. (actually not a state; but all places I happen to be licensed to practice law) have their own definitions of who are “residents” for income tax and other purposes.
Subsequent posts will discuss the importance of understanding who is a “resident” and the implications under these various laws.
Laymen regularly have an idea of where they are “resident” – but that idea is often very different from definitions of “resident” under federal Titles 31, 26 and 8 and state laws (e.g., Texas, D.C., Florida, California, New York, etc.).
A post in August 2014 explained the basic rule of who is a “long-term resident” as that technical term is defined for tax purposes in IRC Section 877 (e)(2). There is much confusion about how the tax law defines a “lawful permanent resident” (“LPR”) versus how immigration law defines what is almost the same concept. The statutes are different and have definitions in two separate federal codes (Title 26, the federal tax provisions and Title 8, the immigration law provisions).
This follow-up comment is to highlight some key concepts about why it matters if you become a “long-term” resident as that term is defined in the tax law.
A LPR can reside for substantially shorter periods in the U.S. (shorter than the apparent 7 or 8 years identified in the statute), and still be a “long-term resident” per IRC Section 877 (e)(2) depending upon the facts of any particicular case.
There are far more LPRs who abandon their status (formally) than U.S. citizens who formally take the oath of renunciation. See the table above reflecting those who have formally renounced U.S. citizenship versus those who have formally abandoned their LPR status.
Plenty of LPRs informally abandon their LPR status for immigration purposes by moving and living permanently outside the U.S.
There are plenty of timing issues for LPRs surrounding how and when they have “abandoned” their LPR status for purposes of IRC Section 877 (e)(2). See –
The 12th annual international tax conference was held on campus on October 20 & 21st, 2016: The University of San Diego School of Law – Procopio International Tax Institute.
This specific course was addressed by tax and immigration law experts and views from a federal immigration court judge, as follows:
Course 3B: U.S. Lawful Permanent Residents – Tax Law vs. Immigration Law ResidenteslegalespermanentesdelosEstadosUnidos – Leyfiscalvs.Ley de inmigración
An individual shall cease to be treated as a lawful permanent resident of the United States if such individual commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country, does not waive the benefits of such treaty applicable to residents of the foreign country, and notifies the Secretary of the commencement of such treatment. [emphasis added]
Act of Abandonment for Immigration Law Purposes?
Some of the key points made by the immigration law experts, including the immigration judge were:
Permanent resident card is not a tourist visa.
DHS will make a finding of abandonment following a single trip outside the U.S. of more than one year.
Rebuttable presumption of abandonment following a single trip outside the U.S. of six months to one year.
Residency may be deemed abandoned following multiple trips abroad, even if no single trip exceeds six months.
–Factors include the noncitizen’s family ties, employment, property holdings, and business affiliations in the U.S. and in the foreign country
–Filing a U.S. income tax return as a tax nonresident alien raises a rebuttable presumption of abandonment.
See prior posts regarding how and when lawful permanent residents can be deemed to have expatriated:
It is rare to have the President of the United States hold press conferences specifically dealing with international tax policy and tax enforcement. Nevertheless, this is what happened last week when President Obama announced his administration’s recent efforts in the field of international tax, anti-corruption and financial transparency.
The U.S. international tax law has become increasingly complex. I am confident when I say that very few individuals in the world (including IRS revenue agents) understand the complexities of Title 26 and Title 31 as they apply to international matters such as gifts of foreign property, gifts involving U.S. intangible property, gifts to or inheritances from foreign estates with U.S citizens (USCs) or Lawful Permanent Residents (LPRs) beneficiaries, foreign partnerships with USCs, transfers of property to foreign trusts by USCs or LPRs residing outside the U.S., transfers of property to foreign corporations, etc.
Most USCs and LPRs who live in the U.S. certainly know and understand the basics of IRS Form 1040.
The lack of knowledge of these complex laws within the IRS, and the LB&I (Large Business and International group) which specializes in international matters has led to IRS “International Practice Units”. These are designed to allow IRS revenue agents who are not necessarily specialists in the international tax area to review transactions and be prepared to assess taxes and penalties against USCs and LPRs in the international context. The preamble says in part ” . . . Practice Units provide IRS staff with explanations of general international tax concepts as well as information about a specific type of transaction. . . ”
These IRS materials give a good perspective from where the IRS views the world; including the introduction to this particular IRS International Practice Unit where it states: “This Practice Unit focuses on a U.S. Person’s proactive steps to “conceal” their ownership of foreign financial accounts, entities and other assets for the purposes of tax avoidance or evasion, even though, there may be some situations where there are legitimate personal or business purposes for establishing such arrangements. This unit falls under the outbound face of the matrix and thus, will focus on U.S Persons living in the United States . . . Most U.S. taxpayers using an offshore entity or structure of entities to hold foreign accounts are simply hiding the accounts from the Internal Revenue Service and other creditors . . .” [emphasis added]
This is a breathtaking statement from the IRS internal training manuals that “Most U.S. taxpayers using an offshore entity or structure of entities to hold foreign accounts are simply hiding the accounts from the Internal Revenue Service and other creditors . . .”?
The vast majority of the USCs or LPRs who I see who renounce or abandon their citizenship or LPR status, are living outside the United States and in most cases have spent almost all (if not all) of their lives outside the U.S.
Does the IRS mean that a family living in Switzerland that have dual national family members are “. . . .simply hiding the accounts from the Internal Revenue Service . . . ” if they are using, for instance, a Liechtenstein Stiftung to hold their family assets as part of an estate plan recommended to them by their Swiss legal and tax advisers?
Does the statement that this IRS International Practice Unit focuses on ” . . . U.S Persons living in the United States . . . ” give USCs and LPRs residing outside the U.S. relief from the IRS perspective of USCs simply hiding assets from the Internal Revenue Service? Will IRS revenue agents be sophisticated enough to distinguish between these two different groups; U.S. resident versus non-resident USCs and LPRs? Will the law be applied differently with respect to these resident versus non-resident U.S. taxpayers?
What role will these IRS “International Practice Units” play in forming perceptions and molding ideas of IRS revenue agents who have had little to no life experience in international affairs, multi-national families, global finance and international business operations?
The statute of limitations is one of the most important considerations for any individual when considering what tax consequences the Internal Revenue Service (“IRS”) might argue they have for years past. This can occur many years into the future as explained further below.
Former USCs and LPRs can be in a particularly precarious position, as was recently demonstrated by a U.S. Tax Court case for a gift that was made decades ago in 1972. See, Redstone vs. Commissioner (TCM 2015-237). Although this U.S. Tax Court case involving Sumner Redstone had nothing to do with renunciation of citizenship, it shows how the IRS can reach back many years and even decades in assessing taxes it claims are owing. The newly (in year 2010) added IRC Section 6501(c)(8) makes this highly likely under current revised law.
2. There is fraud on the part of the taxpayer (e.g., the taxpayer intentionally does not report income). IRC Sections 6501(c)(1), (c)(2).
3. The USC or LPR fails to report certain foreign transactions, including inadvertently neglecting to report. IRC Section 6501(c)(8). This rule was only recently adopted as part of the “HIRE Act” which also created FATCA. The types of transactions set above in the table provides a brief summary of when transactions can give rise to an “open” statute of limitations period. In other words, as many years and decades can pass (see Redstone 1972 gift transaction) before the IRS ever has to make a proposed assessment of taxes and penalties. These include numerous ownership or economic interests in foreign (non-U.S.) companies, partnerships, foreign trusts, foreign investment accounts, among others.
For a more in depth review of the international (non-U.S.) transactions that give rise to this reporting, see IRS Forms 3520, 3520-A, 5471, 8865, 5472, 8938, 8858, 926 among others.
The automatic exchange of bank and financial information is driven by the U.S. Treasury driven Intergovernmental Agreement (IGA).
As a follow-up, the Mexican newspaper Reformareported on the 17th of December that the U.S. just provided Mexico’s treasury with a gigabyte of Mexican taxpayer information regarding U.S. financial and bank accounts. See, Entrega EU un gigabyte a Hacienda, dated Dec 17, 2015.
This news comes on the heals of the earlier criticism by the Commissioner of the Mexican IRS (SAT – Servicio de Administración Tributaria (SAT)), Mr. Aristóteles Núñez Sánchez. The Reformaarticle quotes Óscar Molina Chié (who is in charge of the large taxpayers division at SAT) generously regarding how and what information was provided by the U.S. federal government.
Finally, the article emphasized that Mexico has sent the IRS information regarding Mexican bank accounts of U.S. citizens.
how immigration law defines what is almost the same concept. The statutes are different and have definitions in two separate federal codes (Title 26, the federal tax provisions and Title 8, the immigration law provisions).
international matters such as gifts of foreign property, gifts involving U.S. intangible property, gifts to or inheritances from foreign estates with U.S citizens (USCs) or Lawful Permanent Residents (LPRs) beneficiaries, foreign partnerships with USCs, transfers of property to foreign trusts by USCs or LPRs residing outside the U.S., transfers of property to foreign corporations, etc.
Filers.
other creditors . . .”?
NOT Providing FATCA IGA Information on Their Taxpayers with U.S. Accounts, dated December 14, 2015.
Administración Tributaria (SAT)), Mr. Aristóteles Núñez Sánchez. The Reforma article quotes Óscar Molina Chié (who is in charge of the large taxpayers division at SAT) generously regarding how and what information was provided by the U.S. federal government.