Few LPRs Who Leave (Emigrate from) the U.S. Formally Abandon their Immigration Status: Important Tax Consequences (Part I)
There are generally important tax consequences to lawful permanent residents (“LPRs”) who leave the U.S. See, for instance an earlier post, Timing Issues for Lawful Permanent Residents (“LPR”) Who Never “Formally Abandoned” Their Green Card. There are a range of income, withholding and potentially estate and gift tax consequences depending upon the circumstances of each LPR. See, Oops…Did I “Expatriate” and Never Know It: Lawful Permanent Residents Beware! International Tax Journal (2014).
The next few posts will explain the significance of key immigration law concepts for LPRs (e.g., filing Form I-407, Record of Abandonment of Lawful Permanent Resident to formally abandon LPR status). They discuss formal administrative or judicial abandonment of LPR status and the specific relationship to U.S. tax law requirements.
MILLIONS HAVE LEFT – YET FEW HAVE FORMALLY ABANDONED – NO FORM I-407: Apparently a few million LPR individuals have emigrated from the U.S. with their green card in their pocket/purse and most are probably still deemed “United States persons” for federal income tax purposes. This conclusion comes from comparing (i) federal government data indicating the number of LPRs who have emigrated (3.6 million LPRs through 2019) contrasted with (ii) those who have filed Form I-407. The next few posts explore the important tax/legal distinctions of LPRs who formally abandon and those who simply leave the U.S. ignorantly blissful of the complex U.S. tax laws.
A LPR is a so-called “resident alien” by application of the U.S. federal tax law if she or he satisfies the statutory requirements of IRC Section 7701(b)(6), without application of an applicable income tax treaty. Tax treaties can change everything. A “resident alien” includes those who have LPR status who have not formally abandonment that status. See, the Treasury regulations that provide for the so-called “green card test” –
(1) Green card test. An alien is a resident alien with respect to a calendar year if the individual is a lawful permanent resident at any time during the calendar year. A lawful permanent resident is an individual who has been lawfully granted the privilege of residing permanently in the United States as an immigrant in accordance with the immigration laws. Resident status is deemed to continue unless it is rescinded or administratively or judicially determined to have been abandoned.Treas. Reg. § 301.7701(b)-1(b).
There is extensive LPR data published by the Department of Homeland Security (DHS). These reports identify the estimated number of LPRs who currently reside in the U.S. and those who have left-emigrated. See, Estimates of the Lawful Permanent Resident Population in the United States and the Subpopulation Eligible to Naturalize: 2015-2019.
The number of LPRs emigrating exceed 3 million starting in 2015. These numbers bear no correlation to the formal abandonment numbers registered with the government, which require filing Form I-407, Record of Abandonment of Lawful Permanent Resident.
As one DHS report points out there is no reliable direct measurements of LPR emigration. It does not exist. A 2019 Office of Immigration Statistics report states:
Emigration. Estimating emigration accurately is difficult.The U.S. government has not collected official statistics since 1957. Most observers agree that emigration of the LPR population from the U.S. is substantial. Between 1900-90, an estimated one-quarter to one-third of LPRs emigrated from the U.S. (see Warren and Kraly, 1985; Ahmed and Robinson, 1994; Mulder, et al., 2002).DHS: Estimates of the Legal Permanent Resident Population and Population Eligible to Naturalize in 2002 (May 2014)
This apparent lack of information is what drove me to file a Freedom of Information Act (FOIA) request with the government to ask for the number of USCIS Forms I-407 that are filed with the government.
The information I obtained in the FOIA response was surprisingly low, since the government had record of only 46,364 Forms I-407 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 15,455 individuals annually who formally abandoned their LPR status. Contrast this relatively small number with the more than 3.6 million LPRs estimated to have emigrated up to and through the year 2019 per the DHS report. This leaves a massive gap of some millions (assuming about 15,000 per year file Form I-407) of LPRs who have left-emigrated from the U.S. yet never formally abandoned by filing Forms I-407.
What about the tax consequences? How many of them know, understand or have any idea whatsoever of their federal tax filing obligations regarding their continued status? Subsequent posts will explore these consequences.
What is the takeaway from (i) the Office of Immigration Statistics reporting and (ii) the LPR – I-407 information provided by the government’s response to my FOIA request? There is a discrepancy in the millions of individuals. Millions of LPRs where most of them are simply not aware of how the U.S. federal tax law continues to impact their lives after they have left the country.
The successive posts will discuss the language and definition of a “lawful permanent resident” for purposes of the tax law and what it means for individuals residing outside the U.S. that still hold their green card in their purse/pocket:
(6) Lawful permanent resident. . . . an individual is a lawful permanent resident of the United States at any time if—
(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, and
(B) such status has not been revoked (and has not been administratively or judicially determined to have been abandoned). [emphasis added]IRC Section 7701(b)(6) without flush language.
Note: The USCIS provides quarterly reports that “Contains quarterly performance data on the abandonment of lawful permanent resident status, organized by field office and country.” Form I-407, Record of Abandonment of Lawful Permanent Resident Status. Fiscal Year 2020, 1st Quarter (17 forms processed); Fiscal Year 2019- 4th Quarter (693 forms processed); Fiscal Year 2019, 3rd Quarter (4,102 forms processed); Fiscal Year 2019, 2nd Quarter (3,874 forms processed); Fiscal Year 2019, 1st Quarter (3,886 forms processed); Fiscal Year 2018, 4th Quarter (3,559 forms processed); Fiscal Year 2018, 3rd Quarter (3,633 forms processed); Fiscal Year 2018, 2nd Quarter (2,725 forms processed); Fiscal Year 2017, 2nd Quarter (3,315 forms processed); Fiscal Year 2017, 1st Quarter (3,153 forms processed). The average annual Forms I-407 filed are approximately 14,000 annually in these years.
I have not actively written on this blog for one and a half years. There has certainly been a lot to write about in the area of taxation, expatriation, citizenship renunciation and abandonment of lawful permanent residency status in that time. I was distracted (20/20) starting in the last quarter of 2018 when my writing was suspended. At least one good distraction among others was some awesome underwater cave exploration (see cave and cenote entrance below of one just discovered last year in the Yucatán peninsula). Plus membership into the Explorer’s Club – along with a case of dengue after a cave exploration excursion in the jungle. The latter not being a good distraction. https://www.explorers.org/about/about_the_club
None of which has anything to do with tax-expatriation matters, but I will now be back to writing about new developments in the tax law.
This jump starts the Tax-Expatriation blog which has been viewed by hundreds of thousands (from around the world) since its inception. Hopefully it will have valuable information for you as you peruse its contents.
Most topics covered by this blog are civil in nature and not criminal. However, unlike Kipling’s ” . . .Oh, East is East, and West is West, and never the twain shall meet. . . ” federal tax law sometimes crosses over from civil to criminal. That’s the story of the recently unsealed indictment of a naturalized U.S. citizen, 52 year old Mr. Tinkov. The IRS reviewed his tax filings, and the U.S. Attorney’s Office (Northern District of California) has brought an indictment for filing a false IRS Form 8854 and a false tax return, for under-reporting his net worth. The indictment charges Tinkov with two counts of filing false returns or other documents in violation of 26 U.S.C. § 7206(1). The Indictment was filed under seal and the docket can be reviewed here.
The press release of the DOJ can be reviewed here.
This is not the first time the U.S. federal government has used IRS Form 8854, required to be filed by those who “expatriate”, as part of a criminal tax case.
The twain shall meet. See, the 2016 indictment of a NY business professor discussed here: Expatriation Tax Form 8854 is Part of Criminal Tax Case
Importantly, when the taxpayer signs their U.S. federal tax return, they do so under declaration of penalty of perjury. This declaration generally applies to and includes any statements, attached forms and IRS Form 8854, Initial and Annual Expatriation Statement (in those cases where the individual is “expatriating” from a taxation perspective). This “expatriation” Form 8854 has its own signature block that must be signed under penalty of perjury. This specific declaration plays a prominent role in the indictment.
The indictment alleges Mr. Tinkov became a U.S. citizen by naturalization in 1996 and he renounced his U.S. citizenship in October 2013. Therefore, if he was a naturalized citizen, he necessarily would have become a “covered expatriate” had he met any of the three statutory tests: (a) the net worth test, (b) tax liability test, or (c) the certification test (IRC Section 877(a)(2)(C)). The government alleges he met the net worth test.
The indictment charges that he met the net worth test and IRS Form 8854 (COUNT TWO) and IRS Form 1040 (COUNT ONE) were false. False, the indictment alleges (COUNT ONE), since he did not reflect his deemed “mark to market” gains from his property that he owned in 2013 at the time he became a “covered expatriate” on his income tax return. The indictment uses “technical tax” language calling such a “gain” as arising from a “constructive sale.”
The relevant portion of the indictment as to Form 8854 (COUNT TWO: 26 U.S.C. § 7206(1) -Making and Subscribing A False Document or Statement) provides –
On or about April 15, 2014, in the Northern District of California, and elsewhere, the defendant, OLEG TINKOV, a/k/a Oleg Tinkoff, did willfully make and subscribe a Form 8854, Initial and Annual Expatriation Statement, for the calendar year 2013 (the “Expatriation Statement”), which was verified by a written declaration that it was made under penalties of perjury and which defendant TESfKOV knew was not true and correct as to every material matter. The Expatriation Statement, which was prepared, signed, and which TINKOV caused to be prepared and signed, in the Northern District of California and was filed with the IRS, (1) falsely reported on Part IV, Section A, Line 2, that TINKOV’s net worth as of his expatriation date was$300,000; (2) fraudulently failed to report any property in Part IV, Section B; and (3) falsely stated that to the best of TINKOV s knowledge and belief, the Expatriation Statement was true, correct, and complete, whereas TINKOV knew and believed his net worth as of his expatriation date was greater than $300,000, and that he was required to list property and report information related to such property on the Expatriation Statement, in violation of Title 26, United States Code, Section 7206(1).
It is curious that no further charges were brought, such as tax evasion ((26 U.S.C. § 7201) and there were no Title 18 crimes charged. The indictment alleges he under-reported his total income (not including the “mark to market” gains from the IRC § 877A(1)) and therefore it would seem to be ripe for a tax evasion charge? Interestingly, while the indictment uses the language “constructive sale” that term is found nowhere in the statute or the regulations. Instead, the statute uses the language “mark to market” and provides that –
(1) Mark to market§ 877A(1)
The term “constructive” or “deemed” (e.g., “deemed sale” or “constructive distribution” or “constructive ownership”) are terms commonly used by U.S. tax professionals and the federal tax law throughout. It refers to a “legal fiction”, since there is no actual transaction that must occur; such as a sale, distribution or some type of actual ownership. Therein lies the “legal fiction.” Importantly, nowhere is “constructive” or “deemed” used in the specific expatriation language of IRC §§ 877 or 877A. The statute uses instead the terminology “mark to market” that treats the U.S. taxpayer (i.e., the “covered expatriate”) “as if” all of their property was ” . . . sold on the day before the expatriation date for its fair market value. . . .” Herein is the legal fiction in these tax expatriation rules since no sale actually occurs.
There is important case law that supports the argument that the government cannot impose taxation until an actual sale or exchange of property occurs. For an excellent review of the 1920 U.S. Supreme Court’s decision of Eisner v. Macomber, see the article prepared by Professor Henry Ordower at Saint Louis University – School of Law –
The Expatriation Tax, Deferrals, Mark to Market, the Macomber Conundrum and Doubtful ConstitutionalityPittsburgh Tax Review, Vol. 15, No. 1, 2017, Saint Louis U. Legal Studies Research Paper No. 2018-3
Maybe the U.S. Attorney’s office did not charge tax evasion ((26 U.S.C. § 7201) in the Tinkov case, because of their concerns that the “mark to market” tax imposed by statute may not even be Constitutional? Maybe they did not want to try to pursue a criminal charge on a tax, the very essence of it, which could be challenged by applying the realization principles set forth by the U.S. Supreme Court?
Legal Question of the Day: FBAR Penalties for USCs and LPRs Residing Outside the U.S. Is the IRS Website correct as a matter of law?
The IRS website has a specific statement on their website titled Delinquent FBAR Submission Procedures
Importantly, the website provides the following comforting statement:
The IRS will not impose a penalty for the failure to file the delinquent FBARs if you properly reported on your U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs, and you have not previously been contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted.
The question is the following:
Is the IRS bound by their own statement on their website as a matter of law?
In other words, can they go ahead and assess FBAR penalties notwithstanding the statement set forth above on their website?
USCs are necessarily subject to U.S. taxation on their worldwide income because they are defined as “United States persons” under title 26, Section 7701(a)(30)(A). See, The U.S. Civil War is the Origin of U.S. Citizenship Based Taxation on Worldwide Income for Persons Living Outside the U.S. ***Does it still make sense?
Lawful permanent residents (“LPRs”) may, but are not necessarily defined as “United States persons” under title 26, Section 7701(a)(30)(A) by application of an applicable tax treaty and the flush language of Section 7701(b)(6). See, Timing Issues for Lawful Permanent Residents (“LPR”) Who Never “Formally Abandoned” Their Green Card and see the IRS practice unit discussion, Determining Tax Residency Status of Lawful Permanent … – IRS.gov
Now, this is all relevant to know and understand, in order to determine who exactly has a filing obligation under Title 31: regarding FBARs. See, Why Most U.S. Citizens Residing Overseas Haven’t a Clue about the Labyrinth of U.S. Taxation and Bank and Financial Reporting of Worldwide Income and Assets
Assuming you do have an FBAR filing requirement, e.g., residing in your country of residence with financial accounts in your own country or in other financial institutions outside the U.S.; can the IRS assess a penalty against you for a delinquently filed FBAR? What if you have properly reported on your U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs?
The answer may surprise you. It will be addressed in a subsequent post.
Incidentally, to date, there have been more than 200 FBAR civil penalty cases filed in U.S. federal courts. The Federal District Courts have seen approximately 200+ civil penalty cases and the Court of Federal Claims, much less popular venue, has seen 5 cases thus far.
Additional Time for Tax Return Filing – Extension until December 15th for USCs Residing Overseas: “Avoiding the Acceleration of the ‘Repatriation’ Tax”
A prior post explained how a USC can avoid the acceleration of the 965 Repatriation tax for a USC residing outside the U.S., by timely filing an extension. See, the following comment regarding the relief granted by the IRS –
- a timely election under Section 965(h)(1) needs to have been made, which is typically extends the return due date until October 15, 2018 (USCs residing outside the U.S., the extension due date was June 15th, 2018 and requires the filing of a specific automatic extension form (IRS Form 4868) by that date); and . . .
Also, the IRS provides in its Questions and Answers to Reporting Related to Section 965 – Q16 in relevant part as follows:
Q16: If an individual fails to timely pay his or her first installment of tax due under section 965(h), will the IRS assess an addition to tax for failure to pay? Will the taxpayer’s requirement to pay all subsequent installments be accelerated under section 965(h)(3)?
. . . the IRS has determined that, if an individual’s net tax liability under section 965 in the individual’s 2017 taxable year is less than $1 million, the individual makes a timely election under section 965(h), and the individual did not pay the full amount of the first installment by the due date under section 965(h)(2), the failure to make the payment will not result in an acceleration event under section 965(h)(3) so long as the individual pays the full amount of the first installment (and its second installment) by the due date for its 2018 return (determined without regard to extensions).
The only way to make a timely election, is to do so prior to the due date of the tax return. For USCs residing outside the U.S. (who already properly filed an extension by June 15th, 2018 with IRS Form 4868, the due date of the election and return filing is days away – due October 15, 2018.
There is a way to further extend the due date from October 15th for USCs residing overseas until December 15th.
Treas. Reg. Section 1.6081-1(b)(1) allows USCs residing overseas to request an additional extension until December 15th, provided
. . . A taxpayer desiring an extension of the time for filing a return, statement, or other document shall submit an application for extension on or before the due date of such return . . . ; however, taxpayers may apply for an extension in a letter that includes the information required by this paragraph. . . . the taxpayer should make the application for extension to the Internal Revenue Service office where such return . . . is required to be filed . . . the application must be in writing, signed by the taxpayer or his duly authorized agent, and must clearly set forth—
1.6081-1(b)(1)(i) – The particular tax return, information return, statement, or other document, including the taxable year or period thereof, for which the taxpayer requests an extension; and
1.6081-1(b)(1)(ii) – An explanation of the reasons for requesting the extension to aid the internal revenue officer in determining whether to grant the request.
A sample letter requesting an additional extension might look like this – with the foreign address of the USC reflected on the top of the letter:
Taxpayer 1 (USC) & Taxpayer 2 (USC)
No. 807 Address Foreign Street
Foreign City, Foreign Country, Codigo 87903-187
October 3, 2018
Department of the Treasury
Internal Revenue Service Center
Austin, TX 73301-0215
VIA CERTIFIED MAIL
Re: Additional Extension of Time to File IRS Form 1040: Taxpayer 1 (USC – SSN ***-**-7497) & Taxpayer 2 (USC SSN ***-**-4916)
Dear Sir or Madam:
We previously filed Form 4868 to extend our 2017 personal tax return. We live overseas outside of the good old US of A. Pursuant to Treas. Reg. §1.6081-1 (b), we are requesting an additional 2 months extension so that we can accurately file complete and accurate returns.
We are shareholders of certain foreign companies (in our country of residence, and the records are kept in Foreign Country and are in foreign currency and in Foreign Language. Additional time is required for the complex international information recording requirements on our tax returns, including IRS Forms 8865 and 8938 (which we know you would like to assess us penalties of US$10,000 for each form that you might argue are substantially incomplete in their presentation).
Please confirm this is approved. All taxes due were paid when we requested the extension in June, 2018.
_________________________Signature Taxpayer 1 (USC)
__________________________Signature Taxpayer 2 (USC)
For some additional guidance in layman’s terms, you might want to look at the IRS website that is somewhat helpful and titled: Frequently Asked Questions (FAQs) About International Individual Tax Matters
14th Annual University of San Diego School of Law – Procopio International Tax Institute (Oct. 31, Nov 1 & 2)
The international tax conference will be held October 31 through November 2 on campus.
Topics will address * the U.S. federal international tax reform, * cross border tax implications of the new “NAFTA II”-USMCA Agreement, * passport revocations, * FBAR penalty strategies in light of Colliot, Wadhan and Norman, *FDII, *GILTI, * lessons from cross border tax policy government leaders, among many other international tax topics.
Joan B. Kroc Institute for Peace and Justice, Alcalá Park, San Diego, California
A particularly interesting panel for readers of Tax-Expatriation, Matters of U.S. Citizenship Renunciation – Relinquishment & LPR Abandonment is
The IRS Director of Collection Policy, Ms. Kristen Bailey will be discussing passport revocation issues on the panel – U.S. Passport Revocations for “Seriously Delinquent Taxpayers” – IRC §7345 & Role of the DOJ, IRS, U.S. District Court and U.S. Tax Court
Taxpayer’s Advocate (TAS) and Passport Revocations – Unconstitutional Restriction on Right to Travel Internationally?
As the State Department starts rolling out more letters denying U.S. passport renewals and initial applications on the backs of IRS Notices CP 508C to U.S. citizens (USCs); USC taxpayers are highly motivated to address their “seriously delinquent tax debts.” What rights do USCs have vis-a-vis these government allegations in their tax certifications?
See, Part II: Example of United States Department of State – Letter Denying Passport Renewal – The Time has Really Come: Revocation or Denial of U.S. Passports as IRS Begins Issuing Notices to U.S. citizens
For a deep dive into a range of issues that USCs need to consider, if they find themselves on the side of an unfortunate IRS Notices CP 508C – see the TAS’s excellent Interim Guidance Memorandum dated April 26, 2018. One key point made by the TAS memo is:
The right to travel internationally is a fundamental right, protected by the Due Process Clause of the Constitution. Under the Universal Declaration of Human Rights, adopted in 1948 by the United Nations after a unanimous vote (including the United States) “[e]veryone has the right to leave any country, including his own, and to return to his country.” The National Taxpayer Advocate expressed concerns that the IRS’s implementation of the passport program fails to protect taxpayers’ right to travel as well as their rights promised under the Taxpayer Bill of Rights. See the National Taxpayer Advocate’s blog and the Fiscal Year 2018 Objectives Report to Congress.
The U.S. Supreme Court, in an opinion penned by retired Justice Souter in Sosa v. Alvarez-Machain (2004), has some interesting observations about the Universal Declaration of Human Rights (which is cited above by the Taxpayer Advocate) limiting its application in the Alvarez-Machain case. This is a fascinating case to read, as it arises out of the tragic torture and murder of a DEA agent, Enrique Camarena-Salazar in 1985 in Mexico. Physician Alvarez-Machain was subsequently indicted in the U.S. as part of the torture and murder scheme and the DEA hired private Mexican nationals to seize Alvarez and bring him to the United States in a private plane to stand trial.
Alvarez-Machain was ultimately granted motion for a judgement of acquittal on the criminal charges.
In response, Alvarez-Machain then sued the federal government under the Federal Tort Claims Act and the Alien Tort Statute.
The Supreme Court opined (on these tort action claims and the application of international law as to U.S. federal tort statutes) as follows:
. . . To begin with, Alvarez cites two well-known international agreements that, despite their moral authority, have little utility under the standard set out in this opinion. He says that his abduction by Sosa was an “arbitrary arrest” within the meaning of the Universal Declaration of Human Rights (Declaration), G. A. Res. 217A (III), U. N. Doc. A/810 (1948). And he traces the rule against arbitrary arrest not only to the Declaration, but also to article nine of the International Covenant on Civil and Political Rights (Covenant), Dec. 19, 1996, 999 U. N. T. S. 171,22 to which the United States is a party, and to various other conventions to which it is not. But the Declaration does not of its own force impose obligations as a matter of international law. See Humphrey, The UN Charter and the Universal Declaration of Human Rights, in The International Protection of Human Rights 39, 50 (E. Luard ed. 1967) (quoting Eleanor Roosevelt calling the Declaration “ ‘a statement of principles … setting up a common standard of achievement for all peoples and all nations’ ” and “ ‘not a treaty or international agreement … impos[ing] legal obligations’ ”).23 And, although the Covenant does bind the United States as a matter of international law, the United States ratified the Covenant on the express understanding that it was not self-executing and so did not itself create obligations enforceable in the federal courts. . . [emphasis added]
Section 7345(e) provides for judicial review of the IRS’s certifications of “seriously delinquent tax debts” as follows:
(e)Judicial review of certification
After the Commissioner notifies an individual under subsection (d), the taxpayer may bring a civil action against the United States in a district court of the United States or the Tax Court to determine whether the certification was erroneous or whether the Commissioner has failed to reverse the certification.
Surely, the U.S. Tax Court and Federal District Courts will have much more to say about the rights of USCs who have their U.S. passports revoked or renewals denied by application of 26 U.S.C. 7345. Will the Universal Declaration of Human Rights be meaningful to the Courts applying Section 7345?
How many errors will the IRS make in issuing certifications of “seriously delinquent tax debts” to USCs around the world?
22. Article nine provides that “[n]o one shall be subjected to arbitrary arrest or detention,” that “[n]o one shall be deprived of his liberty except on such grounds and in accordance with such procedure as are established by law,” and that “[a]nyone who has been the victim of unlawful arrest or detention shall have an enforceable right to compensation.” 999 U. N. T. S., at 175—176.
23. It has nevertheless had substantial indirect effect on international law. See Brownlie, supra, at 535 (calling the Declaration a “good example of an informal prescription given legal significance by the actions of authoritative decision-makers”).
Part II: Example of United States Department of State – Letter Denying Passport Renewal – The Time has Really Come: Revocation or Denial of U.S. Passports as IRS Begins Issuing Notices to U.S. citizens
Earlier posts have addressed Section 7345 of Title 26 and how the U.S. Department of State (DOS) will deny the renewal of passports.
See, The Time has Come: Revocation or Denial of U.S. Passports as IRS Begins Issuing Notices to U.S. citizens and Revocation or Denial of U.S. Passport: More on new section 7345 (Title 26/IRC) and USCs with “Seriously Delinquent Tax Debt”
The IRS has purportedly issued tens of thousands of IRS Notices CP 508C to U.S. citizen (USC) taxpayers during the first part of this year, 2018.
We have now started seeing examples of the letters issued by the DOS. They are harsh and direct.
See here such a letter, with identifying information redacted.
The letter from the DOS says it is obliged to comply with the letter from the Department of Treasury’s Internal Revenue Service (IRS) certifying the USC has a “seriously delinquent tax debt.” The letter goes on to say that it has no actual information concerning the “seriously delinquent tax debt” and it is the IRS who must be contacted.
The DOS essentially “washes its hands” of this legal issue, by simply saying the USC taxpayer must resolve the issue within ninety days directly with the IRS.
Only after “”these arrangements” have been made with the IRS, can the USC taxpayer contact the National Passport Information Center according to the letter.
There are a host of legal issues and practical problems that USC taxpayers face in these circumstances. Many of these will be covered in later posts.
. . . more to come . . .
Is it too late to comply with the “965 Hammer” (aka the “Transition” or “Repatriation” Tax) for USCs Residing Overseas?
For more background on how Section 965 works, please see, The “965 Hammer” (aka the “Transition” or “Repatriation” Tax) for USCs Residing Overseas, which explains how U.S. citizens (USC) residing overseas may owe U.S. federal income tax on “phantom income”. I call it phantom income as it does not need to be received (nor does the USC) need to have any right to it for it to be taxed.
The tax is calculated with reference to (1) the type of assets held in the USC’s foreign corporation (cash or not), and (2) the previously un-taxed earnings of the foreign corporation owned by the USC.
The IRS has a dedicated page on their website to the Section 965 Transition Tax that provides a basic overview. The rules are complex and the IRS addressed a set of Q&As to help taxpayers understand how they must report on their tax return; see, Questions and Answers about Reporting Related to Section 965 on 2017 Tax Returns
Normally, USCs combined with other “U.S. persons” need to have greater than 50% of the shares of the foreign corporation to be subject to the 965 Hammer/Repatriation tax. The following example shows how U.S. individuals combined to own 51% cause the foreign corporation to be a “controlled foreign corporation” (CFC) and therefore a “specified foreign corporation” (SFC) that causes the USCs to be subject to the tax on “phantom income” to the extent the company has previously un-taxed earnings.
In contrast, a USC that owns 10% (or 21% or 30%) should not be subject to this tax, as long as the foreign corporation is not a CFC and/or there is no U.S. corporate shareholder that owns 10% or more of the foreign corporation. The following example (Example 2) shows how a USC that owns 15% and another USC who owns 20% of a foreign corporation, will not be subject to the 965 Hammer, since it is neither a CFC or a SFC.
Compare that scenario to the following example (Example 1) that shows the somewhat “capricious” nature of how a USC that only owns 10% in a different fact pattern of ownership, can still be subject to the 965 Hammer repatriation tax. This is true, even when other U.S. owners have a mere 11% ownership (but in this case it is a U.S. corporate owner with >=10%), causing it to be a SFC and therefore triggering the 965 Hammer/repatriation tax:
In this last example, the USC owns only 10% of the shares of the foreign corporation, but since a U.S. corporate shareholder owns at least 10% of the shares of the same foreign corporation, all U.S. shareholders are subject to the 965 Hammer/repatriation tax.
There are some silver linings to this tax.
First, the tax rate applicable (8% in the case of non-cash assets) can be much lower than the normal statutory rate on dividend distributions.
Second, since the tax is mandatory (hopefully at a lower rate as cash and cash equivalents carry out a 15.5% higher tax rate), it can provide an opportunity to restructure and/or repatriate profits of the foreign corporation. This can give liquidity in the hands of the USC shareholder who was otherwise deterred from making actual dividend distributions or investing in U.S. property (which is in itself normally deemed a dividend to the USC shareholder) for foreign corporations that are “CFCs.”
Maybe USCs residing overseas will want to restructure their business operations to obtain specific tax advantages from the federal tax reform (e.g., 21% or 13.25% corporate tax rates that can be applicable for U.S. corporate taxpayers)?
Third, the statute allows the taxpayer to make a timely election (under Section 965(h)(1)) to defer the payment of the tax over many an eight (8) year period as follows:
There are no circumstances where a USC would not want to defer the payment of the tax over time? Why pay for something today, when you can pay it tomorrow without an interest carrying charge?
For instance, if the total 965 Hammer/repatriation tax is US$200,000 for a USC, why would she not want to pay only 8% or US$16,000 in 2017/2018 and defer the rest of the US$200,000 tax payments over time?
The payments are “back-loaded” in later years and do not carry an interest charge.
Also, the IRS granted further relief for individuals who owe less than US$1M of 965 Hammer/repatriation tax. This relief allows the payment/deferral of the first installment otherwise due in 2017 until 2018 (and will not trigger the full amount immediately due), provided all of the following are satisfied:
- a timely election under Section 965(h)(1) needs to have been made, which is typically extends the return due date until October 15, 2018 (USCs residing outside the U.S., the extension due date was June 15th, 2018 and requires the filing of a specific automatic extension form (IRS Form 4868) by that date); and
- pays the first installment by the due date of of the 2017 tax return, without regard to extensions (which will typically be June 15th, 2018 provided the USC is residing overseas).
Bottom line: a USC who has timely filed an extension to file their IRS Form 1040 individual income tax return by June 15th, still has time to timely file the election under Section 965(h)(1) to defer the payment of the 965 Hammer/repatriation tax.
Incidentally, the Treasury published proposed regulations at the beginning of last month on Section 965 – Treasury Announces Guidance on One-Time Repatriation Tax on Foreign Earnings
Small businesses around the world commonly operate through companies established in their country of operation. According to the U.S. Tax Foundation, with admittedly outdated information from the year 2014, there were 1.7 million traditional C corporations, compared to 7.4 million partnerships and S corporations; even more sole proprietorships operating in the U.S.
I could not find similar data for other countries around the world, which is where Section 965 takes us.
USCs who live outside the U.S. and operate a business through a corporate entity in their country of residence (e.g., Canada, Mexico, UK, France, South Africa, Japan, Brazil, Hong Kong, Sweden, etc.) can be shocked when they learn how the new tax provision of IRC Section 965 works.
People read about the Administration and Congress’s goal to tax mega-technology companies such as Google, FaceBook, Microsoft and the like on their accumulated overseas profits in low tax jurisdictions. See, for instance, U.S. companies will pay billions in tax on offshore cash piles from CNN Money (by Alanna Petroff) and Apple Leads These Companies With Massive Overseas Cash Repatriation Tax Bills from FORTUNE (by Lisa Marie Segarra, January 18, 2018).
Hence, new IRC Section 965 imposes a one-time mandatory repatriation tax on accumulated earnings and profits of foreign corporations. The tax is paid by the U.S. shareholder. This makes policy sense, if the goal is to tax U.S. based taxpayers, especially mega companies with billions or 100s of millions of dollars of offshore un-taxed cash. In the past, much of these offshore profits could avoid U.S. taxation indefinitely as long as they were not actually repatriated in the form of dividends to the U.S. shareholder(s).
However, most people at the time were not expecting that this same repatriation tax would befall USCs living overseas arising from their local business operations.
Probably Congress and the Administration did not contemplate the fallout to these USC taxpayers. They were focusing on a different group of taxpayer. Nevertheless, Section 965 imposes immediate U.S. individual taxation on the “phantom income” (i.e., when no dividends are distributed to the USC shareholder) of the USC shareholder.
The next few posts will be dedicated to trying to explain in plain English how the “965 Hammer” (as I am affectionately calling it) applies to USCs residing in their home country with a business or investment assets held in a corporation.
The due date under the statute for paying this 965 tax has “come and past”; however, the IRS has granted certain extensions of time. These will be discussed in subsequent posts.
Importantly, a timely election under Section 965(h)(1) must be made by the due date (including extensions) for filing the return for the relevant year. For USCs residing outside the U.S., that due date was June 15th, 2018 and hopefully all USCs filed an automatic extension (IRS Form 4868) by that date, which would extend your due date to October 15, 2018 and the time to file the 965(h)(1) election.
Q&A 16 of the IRS website (Questions and Answers about Reporting Related to Section 965 on 2017 Tax Returns) addresses key provisions here –
Q16: If an individual fails to timely pay his or her first installment of tax due under section 965(h), will the IRS assess an addition to tax for failure to pay? Will the taxpayer’s requirement to pay all subsequent installments be accelerated under section 965(h)(3)?
. . . However, the IRS has determined that, if an individual’s net tax liability under section 965 in the individual’s 2017 taxable year is less than $1 million, the individual makes a timely election under section 965(h), and the individual did not pay the full amount of the first installment by the due date under section 965(h)(2), the failure to make the payment will not result in an acceleration event under section 965(h)(3) so long as the individual pays the full amount of the first installment (and its second installment) by the due date for its 2018 return (determined without regard to extensions). . .
A USC’s extensions and elections are very important here. A later post will explain how a USC residing outside the U.S. can obtain an additional extension at the discretion of the IRS. This can extend the due date of the 2017 income tax returns (IRS Form 1040) from the extended October 15th date to a further extended date of December 15th, 2018; for which the 965 election must be correctly made by the USC individual shareholder of a non-U.S. corporation.