Today’s law is a “mark to market” deemed disposition of worldwide assets combined with a 40% tax on the receipt of “covered” inheritances and gifts by U.S. persons. The initial tax expatriation law that began in 1966 through its changes in 1996 and then 2004 was quite different, with a 10 year period of taxation after expatriation.
Below is a brief summary of the key changes (and when) that were made to the tax expatriation provisions, although the first law adopted in 1966 The Foreign Investors Tax Act of 1966 (“FITA”) – The Origin of U.S. Tax Expatriation Law is not reflected:
U.S. immigration lawyers around the world often cite the 1996 revision in the immigration law that was introduced by then Representative Reed (now Senator Reed). The provision found at INA 212(a)(10)(E) () is often referred to as the Reed Amendment. It 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.
Not surprisingly, immigration lawyers often become alarmed at such provision, if their client can be deemed “inadmissible”; i.e., not be allowed back into the U.S. What if you want to travel to the U.S.?
Fortunately, the Reed Amendment is –
(a) now irrelevant under the current “mark-to-market” expatriation tax provisions, since the motivation of why someone renounces their U.S. citizenship, be it due to the complexity of the U.S. tax laws or otherwise, is not applicable any longer (i.e., the term tax “avoidance” does not appear anywhere in Section 877A); and
(b) has never been invoked by the federal government to bar reentry of a former U.S. citizen in its history (even when it was relevant from the mid 1990s through the following two decades).
The subjective test of “tax avoidance” that existed in the 1996 tax expatriation provisions were eliminated in 2004.
There are a number of legal reasons why the government has never invoked this provision, notwithstanding calls by influential Senators in some cases to have its provision invoked. See, Reed Asks Homeland Security to Enforce Law on Ex-Citizen Tax
Hence, it is a provision with “no teeth” and “no bite.”
For more details, see –
I will be preparing (along with immigration counsel) a series of posts on this important topic over the course of the next two months.
There are a number of important legal differences between the two concepts of how one “sheds” their U.S. citizenship. Often times, most importantly for tax considerations, the question is “when” is the effective date that U.S. citizenship was terminated.
The following Department of State Forms can be reviewed here, which will be discussed in later posts:
Form DS-4079 Request for Determination of Possible Loss of United State Citizenship
This form focuses on facts and details that might lead to prior relinquishment of U.S. citizenship, as opposed to current renunciation.
Form DS-4080, Oath of Renunciation of the Nationality of the United States.
This form is rather self-explanatory.
Form DS-4081, Statement of Understanding Concerning the Consequences and Ramifications of Relinquishment or Renunciation of U.S. Citizenship.
More information to follow.
Today’s “tax expatriation” provisions which are based upon “mark-to-market” concepts of a “deemed/fictional sale” of worldwide assets, look quite different from the original law. The first version was adopted by The Foreign Investors Tax Act of 1966 (“FITA”). FITA introduced a number of specific tax concepts applicable to non-residents.
In addition, it created the first concept of “tax expatriation” for former U.S. citizens, that remained unchanged until the amendments in the law in 1996. There was no reference to lawful permanent residency (or former LPRS) in the 1966 FITA.
The basic concept of the statute remained largely unchanged from the 1996 revisions compared to the original FITA 1966 version, which then I.R.C. § 877(a)(1) provided in relevant part as follows:
These old rules imposed U.S. tax on gains for a 10 year period after the former U.S. citizen became a nonresident alien. The tax rate applicable was the normal U.S. rate and it was levied on gains from the sale of U.S. property, specifically stock and debt in U.S. companies. Those items of income were treated as U.S. source income for that purpose.
The big difference in the 1996 revisions, was the creation of a presumption of a “principal purpose of tax avoidance” that had to be rebutted by submitting a private letter ruling request to the IRS.
For a somewhat provocative look at the law and its history, see, CATCH ME IF YOU CAN: RELINQUISHING CITIZENSHIP FOR TAXATION PURPOSES AFTER THE HEART ACT By: Yu Hang Sunny Kwong
William Edward Burghardt “W. E. B.” Du Bois was an individual of great accomplishment born in 1868. He was the first African American to earn a doctorate at Harvard. He was a co-founder of the National Association for the Advancement of Colored People (NAACP) in 1909, which has had a profound affect on U.S. policies and worked hard to eliminate racism in the U.S.
The U.S. federal government persecuted Mr. DuBois. “The U.S. Department of Justice ordered DuBois and others to register as agents of a “foreign principal.” DuBois refused and was immediately indicted under the Foreign Agents Registration Act. Sufficient evidence was lacking, therefore DuBois was acquitted.” See A Biographical Sketch of W.E.B. DuBois
The NAACP describes the incident as follows on their website – “In 1950-1951 Du Bois was tried and acquitted as an agent of a foreign power in one of the most ludicrous actions ever taken by the American government.”
Mr. Du Bois was a prolific writer and played a most historic role in the U.S., particularly during the first half of the 20st Century.
He wrote The Souls of Black Folk among many other works.
The U.S. government apparently confiscated his U.S. passport in 1951 and Du Bois was unable to travel to Africa. In 1963, the U.S. government refused to renew his U.S. passport and he became a naturalized citizen of Ghana. Did he relinquish his U.S. citizenship by application of U.S. law? Some reports and biographies claim he lost his U.S. citizenship by swearing an oath of allegiance to a foreign country.
Interestingly, the first tax provision imposed on “expatriation” (i.e., individuals who ceased to be U.S. citizens) was adopted by The Foreign Investors Tax Act of 1966 (“FITA”), shortly after the time Mr. Du Bois took allegiance to a foreign country. The concept of former LPRs as expatriates with tax provisions was not included in the statute until the 1995 amendments.
The 1966 FITA tax law on expatriation created a watershed concept, which has largely only had great affect during the last two decades, and particularly since the 2008 “HEART” Amendments.
USCs and LPRs who reside exclusively outside the U.S. are nevertheless subject to reporting in the U.S. of their bank and financial accounts within their country of residence (or any other accounts in another country outside the U.S.). For instance, a USC residing in France with accounts in London and Geneva is subject to these reporting requirements, in addition to her accounts in France.
A LPR residing in Sao Paulo, Brazil with accounts in Brazil and Uruguay are also subject to these reporting requirements for the Brazilian and Uruguayan accounts.
The law is obligatory. See, FOREIGN BANK ACCOUNT REPORTS – 2011 REGULATIONS EXTEND RULES TO MANY UNAWARE PERSONS, published in the International Tax Journal.
Specifically, Title 31, Section 5314 imposes the reporting requirement. The Title 31 regulations used an entirely different law, Title 26 – the Internal Revenue Code, and its definition of who is a “resident” contained in Internal Revenue Code Section 7701(b). Some have questioned the legal authority of the Treasury Department’s ability to utilize provisions of one federal statute and incorporate it into a completely different federal statute, without having statutory authority to do so.
1. Statute of Limitations. There is a statute of limitations whether or not an FBAR was filed. Hence if a USC neglected to file an FBAR for the year 2006, for instance, the time period for the government to assess penalties has lapsed. See, When does the Statute of Limitations Run Against the U.S. Government Regarding FBAR Filings?
2. Duplicate Reporting. FBARs are often duplicate with tax provision reporting – specifically, IRS Form 8938. See,USCs and LPRs Living Outside the U.S. – Key Tax and BSA Forms and USCs and LPRs residing outside the U.S. – and IRS Form 8938
3. No Statute of Limitations. Although the law that creates FBARs does have a statute of limitations, there is no time limit against the IRS to assess income taxes and tax penalties when the taxpayer does not file tax information returns, such as IRS Form 8938.
4. FBAR Penalty is Elective. The imposition of the FBAR penalty is not mandatory under the statute, which provides the government the power to may [not shall] assess a penalty. The relevant statutory provision is that “The Secretary of the Treasury may impose a civil money penalty on any person who violates, or causes any violation of, any provision of section 5314.” 31 U.S.C. Section 5321(a)(5)(B)
5. Collection Mechanism by Government is Limited. The collection of the FBAR penalty is not as easily collected under the law, as is a tax claim. A Title 26 tax lien and levy claim against the taxpayer’s property cannot be used to collect an FBAR penalty. Instead, the government has rights of set-off and will typically be required to bring a judicial action in Court to enforce the penalty assessment. See, U.S. vs. Williams, where the government sued to collect the 50% FBAR willfulness penalty.
6. All FBARs must now be filed electronically. The filing of the FBAR form is not with the IRS, but rather with FinCEN. It must now be filed electronically on Form 114, Report of Foreign Bank and Financial Accounts through the BSA E-Filing System website. The electronic form supersedes TD F 90-22.1 (the FBAR form that was used in prior years).
For a good overview of additional aspects of the law, see, Jack Townsend’s federal tax crimes blog and the guest blog written by Robert Horowitz – Guest Blog: Litigating the FBAR Penalty in District Courts and Court of Federal Claims (3/31/14)
By definition, anyone who does not live in the United States will have assets in their home country. Their value and amount may not be significant, but ownership of assets of various kinds is of course routine for all persons.
I have put a number of posts regarding FBARs – foreign bank account reports. See, When does the Statute of Limitations Run Against the U.S. Government Regarding FBAR Filings? and USCs and LPRs Living Outside the U.S. – Key Tax and BSA Forms
In addition, IRS Form 8938 is the form where USCs and LPRs (those who are “resident aliens” by definition) must report so-called “specified foreign financial assets.”
These include shares, partnership interests, investment accounts, bank accounts, etc. This reporting requirement started in 2012 for the years 2011 and hence is relatively new.
In addition to the asset type, any income and gains from the sale of the asset must be reported. There are detailed items of information that must be reported on this form.
One of the practical problems taxpayers always have, is making sure their tax return and the information they reported on it and the plethora of forms (such as Form 8938) is “complete and accurate”. A return which is not, is always subject to potential attack by the IRS. See, What could be the focal point of IRS Criminal Investigations of Former U.S. Citizens and Lawful Permanent Residents?
Next, the civil penalties for failing to file IRS Form 8938 is US$10,000 for each violation that can increase to US$50,000 after notification by the IRS. It’s an area you do not want to make a mistake – which can be costly.
The Taxpayer Advocate Report provides a graphical showing of how many taxpayers filed both IRS Form 8938 and the FBAR. The point is that filing one form, does not relieve the USC or LPR from also filing the other form. If they both apply, they both must be filed under the law.
See, 2014 Taxpayer Advocate Report – Re: Expanded Reporting Obligations and IRS Form 8938 (FATCA – specified foreign financial assets)
Sir Winston Churchill – Famous People. Did he become a U.S. citizen at birth via “derivative citizenship”? Did he file U.S. income tax returns?
The U.S. tax law imposes federal tax on all worldwide income of any U.S. citizen no matter where they reside. Sir Winston Churchill, was the famous Englishman who was credited with helping defeat the Axis powers in World War II. He became Prime Minister during that War.
Sir Winston Churchill’s mother was born Jeannette Jerome in Brooklyn, New York. His mother later became known as Lady Randolph Churchill and would have been a U.S. citizen by virtue of her birth in the United States pursuant to the 14th Amendment (Section 1) of the U.S. Constitution. However, the 14th Amendment was adopted after her date of birth.
Every individual, such as Winston Churchill who was born to a parent who was a U.S. citizen 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. The U.S. Citizenship and Immigration Services (USCIS) has a “Nationality Chart 1, for Children Born Outside U.S.” to help determine if the individual was a U.S. citizen at birth.
Having “derivative citizenship” means the individual became a citizen at birth, even if no (i) Application for Certificate of Citizenship (Form N-600) or (ii) U.S. passport (Form DS-11: Application For A U.S. Passport) is ever applied for by the individual.
In addition, Winston Churchill was granted honorary citizenship of the United States during his lifetime. Was he already a U.S. citizen by virtue of his mother?
Did he ever file U.S. income tax returns? Did he die owing U.S. income taxes to Uncle Sam?
If he was a U.S. citizen, he would have also been subject to U.S. estate taxes on his worldwide estate. Did his executor ever file U.S. estate tax returns when there was only a US$60,000 exemption and a top estate tax rate of 77%?
At least, fortunately for Sir Winston Churchill, the law of FBARs was not created until 1970, some 5 years after his death in 1965.
Passive Foreign Investment Companies (“PFICs”) have one of the most complex set of tax rules in the Internal Revenue Code.
What is a PFIC?
Many USCs and LPRs have no idea that they may have one – or several of them? Maybe they have owned hundreds of PFICs in their “plain vanilla” investment accounts? Maybe they have a private and closely held company with a few assets that cause it to be a PFIC?
A PFIC can be as simple as an investment in a mutual fund that is formed outside the U.S.
Of course, if you live in your country of residence outside the U.S., you will most certainly be investing through the financial institutions that dominate that marketplace.
PFICs can also arise from owning shares in a small private company that owns shares in another foreign corporation.
The basic rule of when a foreign corporation is a PFIC, is if it meets either the (i) “income test” or (ii) “asset test”.
There is no minimum ownership requirement. Owning 1 unit or share out of 200 million issued can still cause the investment to be a PFIC to the USC or LPR investor.
The income test is met when at least 75% of the income is passive income as defined under the law. The asset test is satisfied when at least 50% of the foreign corporation’s average assets produce such passive income.
The USC or LPR residing outside the U.S. has to report the PFIC on IRS Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.
As is almost always the case with the federal tax law, there are complex definitions and in this case complex regulations. New temporary () and proposed () regulations were recently issued by the Treasury Department for PFICs.
The effects of a PFIC will be discussed in another post. They are not fun for the USC or LPR residing overseas – and can cause excess U.S. taxes depending upon (i) how long the the PFIC investment is held and (ii) whether any U.S. tax elections have been made by the United States Citizen or LPR.
Unfortunately, the tax law does not provide any relief for USCs who, in good faith, failed to file or report their PFICs and the income and gains generated from such investments.
More to come . ..
Was Mother Teresa a “U.S. person” under the Internal Revenue Code subject to worldwide income taxation and FBAR reporting?
Mother Teresa received her honorary citizenship while she was still living in 1996 pursuant to Public Law 104-218.
Did Mother Teresa need to file FBARS (foreign bank account reports) for the accounts in India and throughout the world where she oversaw non-profit organizations and had “signature authority over” such accounts? The FBAR filing requirement has been around since 1970, although only in the last few years have individuals and the U.S. federal government become aware and enforced it vigorously.
Fortunately, for Mother Teresa and the executor of her estate, there was a 6 year statute of limitations against an assessment of FBAR penalties against her individually, over such non-U.S. accounts. When does the Statute of Limitations Run Against the U.S. Government Regarding FBAR Filings?
Assume, however, that her Missionaries of Charity that operated in over 100 countries had some 50 accounts in countries outside the U.S. where Mother Teresa had signature authority over such accounts in 1996. In such a scenario, since Mother Teresa was an “honorary citizen” during that year, she presumably was a “U.S. person” under Section 7701 of the Internal Revenue Code. She would therefore also have been subject a host of other tax and filing requirements as a U.S. citizen. See USCs and LPRs Living Outside the U.S. – Key Tax and BSA Forms.
Would she have had a legal defense (e.g., “reasonable cause”) for not being subject to the US$10,000 civil penalty per account for each failure to file the FBAR? In this example, 50 accounts multiplied by US$10,000 per account equals US$500,000 of civil penalties per year for failure to file.
The law is obligatory. See, FOREIGN BANK ACCOUNT REPORTS – 2011 REGULATIONS EXTEND RULES TO MANY UNAWARE PERSONS, published in the International Tax Journal. Specifically, 31 Section 5314 imposes the reporting requirement. Fortunately (or unfortunately) for individuals like Mother Teresa, the actual imposition of the penalty is in the hands of the government, since the statute provides in relevant part –
Sounds crazy – but it is the law and life in the U.S.
As Mother Teresa said –
. . . La vida es misterio, devélalo.
La vida es promesa, cúmplela.
La vida es tristeza, supérala.
La vida es himno, cántalo.
La vida es combate, acéptalo.
La vida es una tragedia, domínala.
La vida es aventura, arrástrala.
La vida es felicidad, merécela.
La vida es la vida, defiéndela.