Tax Compliance

LPR status can be abandoned for tax purposes (since 2008 tax law changes) by merely leaving and moving outside the U.S. in some cases?

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Lawful permanent residents may erroneously think they have not “expatriated” for U.S. tax purposes, as long as they have not returned it to the U.S. Citizenship and Immigration Services (USCIS) – i.e., formally abandoned their green cards.  Unfortunately, for these individuals, they can be in for a rude awakening regarding the application of IRC Section 7701(b)(6) that was added by Congress in 2008.

The relevant portion of the statute provides as follows:

  • 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.

This statutory language has three tests for when the individual is no longer a LPR for federal tax purposes:

  1. The individual is treated as a resident of a foreign country under the provisions of a tax treaty;
  2. The individual does not waive the benefits of the treaty, and
  3. Notifies the Secretary of the commencement of such treatment.

I-407 Abandonment Form

Each of the above tests seem to be satisified by any “green card” holder who files IRS Form 1040NR as a non-resident, when they live in a country with a U.S. income tax treaty.  A list of treaty countries is to follow in a later post.

There can be a host of unintended consequences to the individual who falls into this category; i.e., who ceases to be a “lawful permanent resident” under the federal tax law.  The expatriation provisions of Section 877A and 2801 (among others) can be implicated, along with many other provisions of the law.  See, Accidental Americans” – Rush to Renounce U.S. Citizenship to Avoid the Ugly U.S. Tax Web” International Tax Journal, CCH Wolters Kluwer, Nov./Dec. 2012, Vol. 38 Issue 6, p45.

For those who wish to formally abandon their LPR, there is a specific DHS/USCIS form (I-407) that is used for this purpose:

The -Times of Israel- article Regarding Taxation and U.S. Citizenship Overseas is Worth a Read

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Taxed into renouncing their US citizenship?

Drowning in a sea of new financial regulations, and with IRS audits on the Israel Newspaper Expatriationrise, some American citizens in Israel say they are weighing expatriation.

There are a number of personal perspectives of individuals who live outside the U.S. that are worth reading.  This article, from the Israeli Times, although highly critical of U.S. tax policy (probably unfairly critical against the IRS) is worth reading for a more global perspective.

Many Canadians have expressed frustration with U.S. tax policy of worldwide taxation of U.S. citizens.

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The recent article published in The Globe and Mail, written by two academics** entitled

How the U.S. pulled off the great Canadian privacy giveaway

reflects the frustration of some Canadian academic leaders.  The article’s tone is set with its first paragraph:

  • For the first time in Canadian history, our federal government is preparing to provide a foreign government with sensitive personal financial information about hundreds of thousands of Canadians. It is doing so to stave off threatened economic sanctions, and is getting nothing in return.

It seems to me the United States government is faced with a real dilemma regarding the foreign frustration with U.S. tax policy.  Do they correctly enforce the law as written?  Doing so, will clearly bring a host of tax penalties to be levied against dual national citizens living throughout the world.  Canada and Mexico are the two countries most affected.  Most of these penalties and tax assessments will, for all practical affects, be unenforceable in the international context.

Most of those dual citizens who will be affected, will be subject to a host of U.S. tax penalties, mostly related to failure to file information returns (e.g., FBARs, IRS Forms 8938, 5471, 3520, etc.) which carry a minimum of US$10,000 fine per violation.  On the other hand, if the IRS and Justice Department does not enforce the tax and “FBAR” law against all U.S. citizen taxpayers, including “benign” taxpayers, what will be the response of taxpayers who are not “benign” and have actively engaged in tax evasion and tax fraud?

This is a dilemma that the very law has created for U.S. tax administrators.

 

**Arthur Cockfield is a Professor with Queen’s University Faculty of Law. Allison Christians is the Heward Stikeman Chair in the Law of Taxation at McGill University Faculty of Law. This article draws from their submissions on FATCA to the Department of Finance, which are posted on the Internet.

Revisiting the consequences of becoming a “covered expatriate” for failing to comply with Section 877(a)(2)(C).

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There are many unanswered questions about the tax IRS Form 8854 consequences of Sections 877 and 877A.  The language in the statute is not clear as to its meaning for those who file incomplete, fail to file, or fail to “timely file” IRS Form 8854.  Be careful to understand the meaning and how the IRS interprets the law.

One of the greatest risks for anyone who thinks they will not be a “covered expatriate” because of the asset test or income tax liability test, is the certification requirements set forth in Section 877(a)(2)(C).

Anyone who renounces their citizenship at the Embassy or Consulate will find that process relatively easy. See forms.   However, no one at the U.S. Department of State will provide tax advice or try to interpret the meaning of Section 877(a)(2)(C).  Indeed, the Foreign Affairs Manual used to read to the person taking the oath, simply provides the standard overview language of “special tax consequences” arising form the renunciation.

Even the most economically modest individual, with little assets or income, can fall into this trap for the unwary – Section 877(a)(2)(C).  The statute is spelled out below –

  • This section shall apply to any individual if—
  • (A) the average annual net income tax . . . is greater than $124,000,
  • (B) the net worth of the individual as of such date is $2,000,000 or more, or
  • (C) such individual fails to certify under penalty of perjury that he has met the requirements of this title for the 5 preceding taxable years or fails to submit such evidence of such compliance as the Secretary may require.
The provision is clear that anyone who does not satisfy it, will be a “covered expatriate” and hence subject to the taxation and reporting requirements under Sections 877 and 877A and 2801.  Also, the IRS has its own interpretation of what it means to satisfy the requirements of Section 877(a)(2)(C).  See, Does IRS Notice 2009-85 regarding expatriation have the “force of law”? Posted on April 14, 2014. 
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What happens to the former U.S. citizen or “long-term resident” (former lawful permanent resident who abandoned his or her “green card”) if they –
  1. Did not fully complete or file the information set forth in IRS Form 8854?
  2. Did not convert the values of the assets and liabilities from the foreign currency where they were held into U.S. dollars?
  3. What if the former USC or long-term resident does not file a dual-status return for the part of the taxable year that includes the day before the expatriation date?
  4. What if the tax returns (and hence IRS Form 8854) are filed beyond their normal filing dates required?  See filing dates in –IRS Beats the Drums – Re: Foreign Assets, Just Days Before April 15 Posted on April 12, 2014
  5. What if the date of relinquishment (not renunciation) is a date prior to the year when the last tax return is required to be filed pursuant to IRS Notice 2009-85?  For instance, what if the relinquishment date is October 1, 2009 (as reflected by the final Certificate of Loss of Nationality from the U.S. Department of State) and the former USC has to decide how and when to file in the year 2014?
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This is worth understanding well, before rushing off to take the oath of renunciation at the U.S. Embassy or the U.S. Consulate.
Plus, there are a number of adverse long-term consequences of not satisfying Section 877(a)(2)(C), which include the “forever taint” of Section 2801 (covered gifts and covered bequests).  See, The “Hidden Tax” of Expatriation – Section 2801 and its “Forever Taint.”

What are Academics Saying about the G20’s Efforts to Crackdown on International Tax Evasion?

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Two academics, Niels Johannesen and Gabriel Zucman (see CVs below) wrote an interesting analysis of their theory of what is happening to capital of individuals worldwide since the financial crises.  The paper can be reviewed here.

 

By Niels Johannesen and Gabriel Zucman*
(Feb. 2014)
  • During the financial crisis, G20 countries compelled tax havens to sign bilateral treaties providing for exchange of bank information. Policymakers have celebrated this global initiative as the end of bank secrecy. Exploiting a unique panel dataset, our study is the first attempt to assess how the treaties affected bank deposits in tax havens. Rather than repatriating funds, our results suggest that tax evaders shifted deposits to havens not covered by a treaty with their home country. The crackdown thus caused a relocation of deposits at the benefit of the least compliant havens. We discuss the policy implications of these findings. (JEL G21, G28, H26, H87, K34)

The crux of their analysis, in my view, can be summed up best in their own words:

  • During the financial crisis, the fight against tax evasion became a political priority in rich countries and the pressure on tax havens mounted. At the summit held in April 2009, G20 countries urged each tax haven to sign at least 12 information exchange treaties under the threat of economic sanctions. Between the summit and the end of 2009, the world’s tax havens signed a total of more than 300 treaties.
  • The effectiveness of this crackdown on offshore tax evasion is highly contested. A positive view asserts that treaties significantly raise the probability of detecting tax evasion and greatly improve tax collection (Organisation for Economic Co-operation and Development 2011). According to policy makers, “the era of bank secrecy is over” (G20 2009). A negative view, on the contrary, asserts that the G20 initiative leaves considerable scope for bank secrecy and brings negligible benefits (Shaxson and Christensen 2011). Whether the positive or the negative view is closer to reality is the question we attempt to address in this paper.

 

 

* Johannesen: Department of Economics, University of Copenhagen, Øster Farimagsgade 5, 1353 Copenhagen, Denmark (e-mail: niels.johannesen@econ.ku.dk); Zucman: University of California, Berkeley, 530 Evans Hall
#3880, Berkeley, CA 94720, and London School of Economics, 32 Lincoln’s Inn Fields, London WC2A 2AE
(e-mail: zucman@berkeley.edu).

Does IRS Notice 2009-85 regarding expatriation have the “force of law”?

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The above statement may sound quite provocative, until one explores in more detail some of the basic principles identified by the U.S. Supreme Court.

IRS Notice 2009-85 is the guidance issued by the IRS after Section 877A was adopted in 2008 and attempts to address a number of issues regarding the mark to market rules.  This IRS Notice is a type of so-called “IRB” guidance (Internal Revenue Bulletin).   Other IRS guidance that falls into this “IRB” guidance category includes revenue rulings and revenue procedures.

Two key Supreme Court cases, Mayo Clinic and Home Concrete and the 3rd Circuit Cohen  decision, among many others, help articulate when such IRS authority is valid, and when it can be successfully challenged by taxpayers.  A thoughtful law review article by Kristin Hickman, Unpacking the Force of Law, articulates in much detail the law in this regard and when IRS guidance, specifically including IRS Notices are subject to other U.S. laws, including the Administrative Procedures Act (“APA”).

Below is a list of some of the provisions of IRS Notice 2009-85 that seem to fall outside the language of the statute:

  • A covered expatriate who is required to file Form 8854 for such taxable year will be considered to have timely filed Form 8854 if it is filed by the due date of the original Form 1040NR or Form 1040 (including extensions) for such taxable year. Covered expatriates who are U.S. citizens or long-term residents for only part of the taxable year that includes the day before the expatriation date must file a dual-status return.
  • D. Interaction with treaties

    Section 877A(f)(4)(B) provides that a covered expatriate shall be treated as having waived any right to claim any reduction under any treaty with the United States in withholding on any distribution to which section 877A(f)(1)(A) applies unless the covered expatriate agrees to such other treatment as the Secretary determines appropriate.

 

What are the consequences if a former USC or LPR does not comply with one or more of the above requirements that are only set forth in a Notice and not the statute?

Can the IRS make a determination that the taxpayer is a “covered expatriate”, even if they otherwise do not meet the asset or tax liability thresholds?

There is no “timely filed” requirement in the statute or even an inference in it, as to the time and effective nature of notifying the IRS?

Can the IRS successfully argue that the certification requirement of Section 877(a)(2)(C) has not been satisfied and the individual is a “covered expatriate” if IRS Form 8854 is not “timely filed” as defined by the IRS in the Notice?

Must a taxpayer necessarily agree to “such other treatment as the Secretary determines” appropriate, even if such determination is contrary to the terms of an applicable income tax treaty?  Can the Secretary unilaterally override the terms of an income tax treaty negotiated between two countries?

These and other questions remain as a result of IRS Notice 2009-85.

 

 

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WSJ Says – Nearly One-Third of Expats Confused by U.S. Tax Filing Requirements?

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The difference between news and advertisement/self-promotion can sometimes be confusing.  In this sense, I am not sure the report in the WSJ is very helpful, thoughtful or accurate.  It consists largely of a survey conducted by H&R Block, which has its own bias and looks more like an advertisement.

Nevertheless, the following tidbit of information from this H&R Block survey may be of interest:

  • The survey found that a majority of expats seek assistance. And when they do, more than three-quarters of the time — 78 percent — they seek the help of a U.S.-based tax preparer. The survey also found that more than 4 out of 10 expats file in March or April — a full two to three months before the filing deadline of June 15.

I question whether the majority of citizens residing overseas do seek assistance?  I also doubt whether the vast majority of those, 78%, actually seek a U.S. based tax return preparer?

Filing U.S. income tax returns (along with the tax returns in the country of residence) is one of the most frustrating experiences that USCs and LPRs living overseas have for several reasons:

  1. There are rarely good and efficient U.S. international tax return preparers who understand the specific tax rules in the various countries and specific locations where USCs and LPRs live.  See, USCs and LPRs Living Outside the U.S. – Key Tax and BSA Forms
  2. How many USCs even know they have to file U.S. income tax returns?
  3. Any USC living outside the U.S. will be required to file a U.S. federal income tax return for the year 2013 if any of the following gross income thresholds (depending upon the filing category) are met:
Filing Status Age at December 31, 2013 Gross Income
Single Under 65 $10,000
65 or older $11,500
Married Filing Jointly Under 65 (both) $20,000
65 or older (both) $22,400
Under 65 (one) $21,200
Married Filing Separately Any $6,100
Head of Household Under 65 $12,850
65 or older $14,350
Qualifying Widow(er) Under 65 $16,100
65 or older $17,300

This filing requirement not only applies to United States Citizens, but also to Lawful Permanent Residents (“LPRS”) who live in a country that has no U.S. income tax treaty with the U.S.

The Taxpayer Advocate has been a vocal critic in several reports about the complexities of the tax law, Title 26:

1. The Current Tax Code Imposes Huge Compliance Burdens on Individual Taxpayers and Businesses.

Consider the following:
■■ According to a TAS analysis of IRS data, individuals and businesses spend about 6.1 billion hours a year complying with the filing requirements of the Internal Revenue Code. And that figure does not include the millions of additional hours that taxpayers must spend when they are required to respond to IRS notices or audits.
■■ If tax compliance were an industry, it would be one of the largest in the United States. To consume 6.1 billion hours, the “tax industry” requires the equivalent of more than three million full-time workers.
■■ Compliance costs are huge both in absolute terms and relative to the amount of tax revenue collected. Based on Bureau of Labor Statistics data on the hourly cost of an employee, TAS estimates that the costs of complying with the individual and corporate income tax requirements for 2010 amounted to $168 billion — or a staggering 15 percent of aggregate income tax receipts. TAS Report Complexity of Tax Law - Graphic
■■ According to a tally compiled by a leading publisher of tax information, there have been approximately 4,680 changes to the tax code since 2001, an average of more than one a day.
■■ The tax code has grown so long that it has become challenging even to figure out how long it is. A search of the Code conducted using the “word count” feature in Microsoft Word turned up nearly four million words.
■■ Individual taxpayers find return preparation so overwhelming that about 59 percent now pay preparers to do it for them.12 Among unincorporated business taxpayers, the figure rises to about 71 percent.13 An additional 30 percent of individual taxpayers use tax software to help them prepare their returns,14 with leading software packages costing $50 or more. For 2007, IRS researchers estimated that the monetary compliance burden of the median individual taxpayer (as measured by income) was $258.

 

 

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IRS Beats the Drums – Re: Foreign Assets, Just Days Before April 15

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The IRS is not letting up regarding USCs and LPRs living outside the U.S.  Quite the opposite, the most recent announcement of the IRS released yesterday on April 11th, emphasizes the U.S. tax law requirements and their applicability to these individuals.

Specifically, the IRS reiterates as follows in IR-2014-52IRS Reminds Those with Foreign Assets of U.S. Tax Obligations:

  • The Internal Revenue Service reminds U.S. citizens and resident aliens, including those with dual citizenship who have lived or worked abroad during all or part of 2013, that they may have a U.S. tax liability and a filing requirement in 2014.
  • The filing deadline is Monday, June 16, 2014, for U.S. citizens and resident aliens living overseas, or serving in the military outside the U.S. on the regular due date of their tax return. Eligible taxpayers get one additional day because the normal June 15 extended due date falls on Sunday this year. To use this automatic two-month extension, taxpayers must attach a statement to their return explaining which of these two situations applies. See U.S. Citizens and Resident Aliens Abroad for details.

The April 11th date of the notice is ironic, since it is on the eve of the filing deadline for individuals who live within the U.S.  Surely, the IRS wants to bring attention to these legal requirements days before the April 15th deadline for those residing in the U.S.

The irony is that the tax law does not require USCs or LPRs who live outside the U.S. and have U.S. tax filing obligations to file by April 15th.  The deadline for these individuals who live outside the U.S. is not until June 15th as explained in the IRS notice (June 16th in 2014, since the 15th falls on a Sunday).

In this notice, the IRS does not emphasize the draconian penalties that befall these taxpayers for not filing international information returns or FBARs.  The minimum civil penalties for failures to file these forms is almost always at least US$10,000.  See, USCs and LPRs Living Outside the U.S. – Key Tax and BSA Forms.

Next, the due date for filing of FBARs is not the same as the due date for income tax returns, June 15th, but always falls on June 30th.  There is no extension for FBARs, unlike income tax returns. See, Nuances of FBAR – Foreign Bank Account Report Filings – for USCs and LPRs living outside the U.S.

Will the IRS publish another notice, or beat more drums on the eve of the June 15th (16th for 2014) filing deadline for USCs and LPRs living outside the United States?

 

 

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Coming to America. . . Accidental Americans Beware – The Law Requires a U.S. Passport!

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Dual nationals who have lived almost all of their lives outside the U.S. routinely travel with their passport of their country of residence.  US Passport

They are typically not aware that they must have a U.S. passport to travel to the U.S. pursuant to a 2004 law, known as the Intelligence Reform and Terrorism Prevention Act.

There are many dual nationals living in countries throughout the world.  The statistics are a bit fuzzy as to the exact numbers.

Apparently, Mexico is the country where more U.S. citizens reside, according to the State Department, and Canada is number two on the list. Approximately 1 million U.S. citizens lived in Mexico, while 687,000 were in Canada. Other countries with large numbers of U.S. citizens included the United Kingdom (224,000), Germany (211,000), Israel (184,000), Italy (169,000), Philippines (105,000), Australia (103,000), France (102,000), and Spain (95,000). According to State Department data, these ten countries contain about 70% of all U.S. citizens living abroad.  See, Accidental Americans” – Rush to Renounce U.S. Citizenship to Avoid the Ugly U.S. Tax Web” International Tax Journal, CCH Wolters Kluwer, Nov./Dec. 2012, Vol. 38 Issue 6, p45.
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Most of these individuals (who were born in the U.S. or who have U.S. citizenship via derivative citizenship) living outside the U.S. are probably unaware that U.S. law requires they obtain a U.S. passport to travel in or out of the U.S.  A foreign resident individual with a U.S. parent, must consider whether they too are also a U.S. citizen by the concept known as “derivative citizenship“; i.e., “derived” from a U.S. citizen parent.  If so, this law, Intelligence Reform and Terrorism Prevention Act, requires a U.S. passport.
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The Department of Homeland Security and Department of State published regulations in 2008 that specifically require all U.S. citizens (including dual nationals) to generally have a U.S. passport to enter into or leave the U.S.  This was not the case in previous years.  There are 4 substitute documents (instead of a U.S. passport) that can be used in certain circumstance (although the U.S. passport card – is the only practical document in most cases), which consist of the following:
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(2) a U.S. passport card; (3) a valid trusted traveler card (NEXUS, FAST, or SENTRI);
(4) a valid MMD when traveling in conjunction with official maritime business; or
(5) a valid U.S. Military identification card when traveling on official orders or permit.
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At the end of the day, the law almost always requires any U.S. citizen, including “Accidental Americans” to have a U.S. passport  or U.S. passport card when they travel into the U.S.  Having a passport of the country of residence is not sufficient.

 

 

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The “Hidden Tax” of Expatriation – Section 2801 and its “Forever Taint.”

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The principle focus of most discussions about the U.S. “expatriation tax” is typically on the “mark to market” rules for income tax purposes.

However, the law has two different types of taxes.  First, there is the “mark to market” tax on phantom income from the deemed sale of worldwide assets.  Second, and often not considered in detail, if at all, there is a tax on the recipient of “covered gifts” or “covered bequests” of 40% of the value of the property received.  See, Joint Committee Reports – 2008 Report re: HEROES Act – Mark to Market Regime – New Section 877A (55 pages)

It is this second tax under Section 2801 on gifts and bequests that is the focus of this discussion – which I call the “forever taint”!

Most individuals think the mark-to-market tax upon expatriation is only applicable to rich, wealthy or otherwise individuals with high levels of income and unrealized gains.  See, Accidental Americans” – Rush to Renounce U.S. Citizenship to Avoid the Ugly U.S. Tax Web” International Tax Journal, CCH Wolters Kluwer, Nov./Dec. 2012, Vol. 38 Issue 6, p45.

This is often the case, as far as the logic goes as it relates to the former U.S. citizen or LPR and the application (or not) of the “mark to market” tax.  Accordingly, many of these former U.S. citizen and LPRs think they should not be concerned if they do not have significant assets with lots of unrealized gain.  Unfortunately, the lack of attention to Section 2801 can be very nearsighted.

The idea that only wealthy individuals with assets should be concerned about being a “covered expatriate” is misplaced.  The former U.S. citizen or LPR should not lose sight of the U.S. tax costs to their future beneficiaries of their estate, trusts they fund in the future, or future gifts.  For instance, if the spouse  or one or more of the children are U.S. citizens (or even unborn grandchildren or great grandchildren), there might be an unforeseen tax to pay many years in the future.  The tax under Section 2801 is currently 40% of the gross value of the “covered gift” or “covered bequest.”  The recipient pays this tax, not the former U.S. citizen or LPR.  Plus, the rate of this tax at 40% of the gross value, is always much higher than the “mark-to’market” income tax (only applicable to the income or gain – and not the full value of the property) as the person leaves the U.S.

The application of Section 2801 requires anyone contemplating renouncing (or proving a prior relinquishment) of citizenship to strategically consider the long-term consequences to his or her family and friends.

For instance, trusts formed under the laws outside the U.S., which are funded by a “covered expatriate” that may benefit future generations, which include a U.S. citizen or resident, will have to pay the tax – currently 40%.  This tax lives on forever, as long as there are assets from the former U.S. citizen or LPR that have been funded or set aside for family or friends who are “U.S. persons” in the tax sense.

To demonstrate an extreme example, a husband/wife U.S. citizens who have $3M of cash (as their only assets) when they renounce citizenship, will have no “mark to market” tax to pay, as there will be no phantom income.  Cash has no unrealized gain.  However, if the former citizens then grow a successful business while living in their home country, such that all wealth of this business was created as non-U.S. persons outside the U.S., any future gifts or bequests to U.S. persons would be subject to a 40% tax at current tax rates.  For instance if this same person grows the company so he and his wife’s complete estate is worth US$10M at their deaths, and then bequeaths these assets to their three dual national (including U.S. citizen) children, the children will have to pay US$4M in taxes under current rates.  This is true even if none of the children live in the U.S.

This would be a very bad tax result, since if they had remained U.S. citizens, there would be no U.S. estate taxes to them under current law and the children would have received the US$10M free from all U.S. federal taxation.

Finally, this “forever taint” could live on for multiple generations.   For instance, in the above example, if the former U.S. citizens funded the US$10M in trust for the benefit  of their children, grandchildren and great-grandchildren, all of whom have dual citizenship (including U.S.), these descendents will be paying the tax under Section 2801, even if some of these family members are yet to be born on the date (i) the trust is funded, or (ii) the death of husband and wife.  This is the “forever taint.”

While the expatriate might be delighted they have no future U.S. income tax obligations during their lifetimes, if they have friends and family who will be beneficiaries of their estate, they should keep their eye on Section 2801 and its “forever taint”.

 

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