The U.S. has income tax treaties with multiple countries.  My post from yesterday briefly explains how a LPR living in one of these countries may become a “covered expatriate” if the three conditions of the statute, IRC Section 7701(b)(6) that was added into the law in 2008 are satisfied.  See, 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. Posted on April 28, 2014

Importantly, a LPR who resides in one of these countries where he or she has income tax residency in the treaty country, can inadvertently “expatriate” for U.S. federal income, estate, gift and inheritance taxes.  See, Oops…Did I “Expatriate” and Never Know It: Lawful Permanent Residents Beware! International Tax Journal, CCH Wolters Kluwer, Jan.-Feb. 2014, Vol. 40 Issue 1, p9

The list of those countries with income tax treaties are as follows and can be reviewed at IRS website:

A

Armenia
Australia
Austria
Azerbaijan

B

Bangladesh
Barbados
Belarus
Belgium
Bulgaria

C

Canada
China
Cyprus
Czech Republic

D

Denmark

E

Egypt
Estonia

F

Finland
France

G

Georgia
Germany
Greece

H

Hungary

I

Iceland
India
Indonesia
Ireland
Israel
Italy

J

Jamaica
Japan

K

Kazakhstan
Korea
Kyrgyzstan

L

Latvia
Lithuania
Luxembourg

M

Malta
Mexico
Moldova
Morocco

N

Netherlands
New Zealand
Norway

P

Pakistan
Philippines
Poland
Portugal

R

Romania
Russia

S

Slovak Republic
Slovenia
South Africa
Spain
Sri Lanka
Sweden
Switzerland

T

Tajikistan
Thailand
Trinidad
Tunisia
Turkey
Turkmenistan

U

Ukraine
Union of Soviet Socialist Republics (USSR)
United Kingdom
United States Model
Uzbekistan

V

Venezuela

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.

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

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.

Why expats are ditching their U.S. passports

By Sophia Yan (11 March 2014)

Reading the personal stories of some of these individuals demonstrates the complexities of living as a U.S. citizen overseas.   As a group, they are all intelligent, highly educated and in one way or another very negatively impacted by the U.S. citizenship based taxation system the U.S. has had since the U.S. Civil War.

See the summary of current law below:

U.S. taxation of citizens has a long history going back to 1861 and the Civil War.⁴  The concept of citizenship based taxation was upheld by the U.S. Supreme Court in the 1920s.⁵  See Cook v. Tait,⁶  where a U.S. citizen resided permanently and was domiciled in Mexico City with his Mexican citizen wife and the Court found that U.S. taxation of his Mexican source income was indeed constitutional. Notwithstanding the long history of U.S. citizenship based taxation, the authors view it as an anachronism in the 21st century since it is particularly difficult to administer and cannot be enforced effectively overseas.⁷

The complete proposal can be read at  “Tax Simplification: The Need for Consistent Tax Treatment of All Individuals (Citizens, Lawful Permanent Residents and Non-Citizens Regardless of Immigration Status) Residing Overseas, Including the Repeal of U.S. Citizenship Based Taxation,”  by Patrick W. Martin and Professor Reuven Avi-Yonah, 2013.

 

 

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The U.S. worldwide taxation system of U.S. citizens and LPRs causes much confusion.  It is unique in the world as most all other countries only impose worldwide taxation on their residents.  See, . “Tax Simplification: The Need for Consistent Tax Treatment of All Individuals (Citizens, Lawful Permanent Residents and Non-Citizens Regardless of Immigration Status) Residing Overseas, Including the Repeal of U.S. Citizenship Based Taxation,”  by Patrick W. Martin and Professor Reuven Avi-Yonah, 2013.

These U.S. citizens and LPRs living outside the U.S. have (at least prior to FATCA) little third party reporting of income directly to the IRS.  There are numerous government reports that demonstrate that when third parties (e.g., banks, tenants, securities brokers, credit card companies, real estate sales transactions, etc.) report the income of a particular transaction to the government, the voluntary compliance of taxpayers increases significantly.  See, OECD FORUM ON TAX ADMINISTRATION: COMPLIANCE SUB GROUP

and the U.S. GAO-12-342SP: General government: 44. Internal Revenue Service Enforcement Efforts   which highlights that the ” . . . where IRS can improve its programs which can help it collect billions in tax revenue, facilitate voluntary compliance, or reduce IRS’s costs. These include pursuing stronger enforcement through increasing third-party information reporting . . .  Expanding third-party information reporting improves taxpayer compliance and enhances IRS’s enforcement capabilities. The tax gap is due predominantly to taxpayer underreporting and underpayment of taxes owed. At the same time, taxpayers are much more likely to report their income accurately when the income is also reported to IRS by a third party. By matching information received from third-party payers with what payees report on their tax returns, IRS can detect income underreporting, including the failure to file a tax return.”

The current trend of worldwide reporting of assets and income via FATCA and the OECD programs is designed to accomplish just this;  increase information reporting by third party payers (e.g., principally from foreign financial institutions) directly to the IRS and tax revenue authorities around the world to deter U.S. citizens and LPRs living outside the U.S. from under-reporting or not reporting at all their income on their U.S. income tax returns.

Traditionally, there were limits on the law and the jurisdictional authority the U.S. government had to require non-U.S. institutions to report non-U.S. source income directly to the IRS.  This has changed significantly now with FATCA, which started in earnest this year, in 1 January 2014.  See,

Probably the most misunderstood concept in the U.S. tax expatriation law provisions is Section 877(a)(2)(C) for several reasons.

1.  People of modest means with modest to little income and little to no assets can fall into this category.

2.  Most individuals think the mark-to-market tax upon expatriation is only applicable to rich, wealthy or otherwise individuals with high levels of income.  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

3.  Lawful permanent residents (“LPRs”) can inadvertently fall into this category without doing anything, other than living principally in a country outside the U.S., which has a U.S. income tax treaty. See, Oops…Did I “Expatriate” and Never Know It: Lawful Permanent Residents Beware! International Tax Journal, CCH Wolters Kluwer, Jan.-Feb. 2014, Vol. 40 Issue 1, p9.  At the end of this post is a list of the countries with U.S. income tax treaties.

4.  Few individuals understand exactly what must be included and reported in IRS Form 8854 to be able to satisfy the certification requirement above.  For more details, see What are the consequences of becoming a “covered expatriate” for failing to comply with Section 877(a)(2)(C)?

The relevant provisions of Section 877(a)(2)(C) are highlighted 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.

Failure to certify truthfully about compliance with U.S. tax law for 5 years, as set forth above in the statute, means the individual necessarily will be a “covered expatriate.”   Does this mean that if a U.S. citizen who renounces citizenship or a LPR who abandons their green card, will necessarily be a “covered expatriate” if they fail to follow IRS Notice 2009-45 “Guidance for Expatriates Under Section 877A”?

What steps will the IRS take if someone intentionally does not comply with the certification requirement?  Will they become a target of a criminal investigation, and under what circumstances?  What could be the focal point of IRS Criminal Investigations of Former U.S. Citizens and Lawful Permanent Residents?

There are many pending and open questions not answered by current law, as the U.S. Treasury has yet to publish regulations under Section 877A, 877 or 2801.

APPENDIX – Countries with Income Tax Treaties with the United States

This is a very important question for purposes of the “tax-expatriation” rules that can apply to LPRs who leave the U.S. and live predominantly in another country.  This is particularly important if the individual lives in a country with a U.S. income tax treaty.

See the article – Oops…Did I “Expatriate” and Never Know It: Lawful Permanent Residents Beware! International Tax Journal, CCH Wolters Kluwer, Jan.-Feb. 2014, Vol. 40 Issue 1, p9.

For statistical information of LPRs and their country of origin, see, Rytina, Nancy; Estimates of the Legal Permanent Resident Population in 2012, Office of Immigration Statistics (July 2013). p 3.

Country of Birth

Mexico was the leading country of origin of the LPR population in 2012 (see Table 4). An estimated 3.3 million or 25 percent of LPRs came from Mexico. The next leading source countries were China (0.6 million) and the Philippines (0.6 million), followed by India (0.5 million) and the Dominican Republic (0.5 million). Forty-two percent of LPRs in 2012 were born in one of these five coun-tries. The 10 leading countries of origin, which also include Cuba, Vietnam, El Salvador, Canada, and the United Kingdom, repre-sented 55 percent of the LPR population.

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Should the IRS modify its offshore voluntary disclosure program for U.S. citizens residing overseas?  IRS is reconsidering the effectiveness of its offshore voluntary disclosure program.  Should it be modified?

According to Tax Analyst’s “The IRS is reexamining its offshore voluntary disclosure program and considering making modifications to it, according to Michael Danilack, deputy commissioner (international), IRS Large Business and International Division.”

U.S. citizens who have lived most all of their lives overseas should not be subject to the same scrutiny and inflexibility that currently exists for U.S. taxpayers residing in the U.S.  Important differences exist, mostly because of the lack of U.S. citizens residing overseas to understand the complex U.S. tax law system applicable to them; in addition to the country’s tax laws and requirements in their country of residence.

The de-facto U.S. income tax residency regime is a residence based regime for several reasons.  First, the National Taxpayer Advocate estimates there are between 5-7 million U.S. citizens residing overseas.  Second, only a small portion of these taxpayers apparently even file U.S. income tax returns.  The IRS taxpayer statistics office showed that only 334,851 U.S. taxpayers filed a foreign earned income exclusions (for the year 2006, which is the latest year available from the IRS office of tax statistics).   How many of these taxpayers are not even U.S. citizens? The details of U.S. tax returns filed with foreign earned income exclusions can be read here.

Each country’s filings are set out below (notice only 6,112 returns were filed from Mexico, where the largest number of U.S. citizens reside in any particular country; with Canada as the second most populated with U.S. citizens):

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