One might not expect it, but the United States has experienced an increasing trend in the number of expatriates in the last decade. Each year, thousands of individual taxpayers relinquished either their U.S. citizenship or permanent resident status, peaking in 2016 with 5,405 total expatriates. Expatriates are required to comply with specific tax provisions. The Treasury Inspector General for Tax Administration (“TIGTA”) ultimately performed an audit to assess the reliability and effectiveness of the Internal Revenue Service’s efforts to ensure taxpayer (or former taxpayer) compliance.
Sections 877 and 877A, Generally
Sections 877 and 877A of the Internal Revenue Code govern the tax provisions related to expatriates. Under these provisions, certain taxpayers who relinquish their U.S. citizenship or long-term residents who terminate their U.S. residency may be subject to certain tax consequences. Specifically, such taxpayers must certify on Form 8854, Initial and Annual Expatriation Statement, their compliance with all U.S. federal tax laws for the five years prior to the date of expatriation and determine whether they are “covered expatriates.”
For purposes of Sections 877 and 877A, a “covered expatriate” is an individual who expatriated on or after June 17, 2008, and meets one of the following requirements:[1]
- Tax Liability Rule – The average annual income tax of the individual for the five years ending before the date of expatriation or termination of residency is more than a certain amount, which is adjusted for inflation (e.g., for the tax year ending December 31, 2018, $165,000);[2]
- Net-Worth Rule – The net worth of the individual as of the date of expatriation or termination of residency is $2 million or more;[3] or
- Certification Rule – The individual fails to certify under penalty of perjury on Form 8854 that he or she met his or her U.S. federal tax filing obligations for the five years preceding the date of expatriation or termination of residency.[4]
If an individual is determined to be a “covered expatriate,” he or she is subject to an “exit” tax. Generally speaking, this means the individual is deemed to have sold all of his or her worldwide property for its fair market value as of the day before expatriation, and the unrealized gain from such deemed sale is subject to federal income tax.[5] However, there are special provisions in determining the individual’s exit tax, such as net gain reductions, deferred compensation items, specified tax-deferred accounts, etc.
TIGTA’s Final Audit Report – September 28, 2020
TIGTA performed an audit of the Internal Revenue Service’s controls related to the enforcement of the relevant tax provisions to expatriates. Since the HEART Act of 2008 was enacted, a rising number of individual taxpayers have relinquished their U.S. citizenship or resident status. As a result, TIGTA set out to determine the effectiveness of the IRS’s efforts to ensure compliance.
Among its findings, TIGTA noted the following:
Expatriates are required to file Form 8854, Initial and Annual Expatriation Statement, to certify that they have been in compliance with all Federal tax laws during the five years preceding the year of expatriation. TIGTA found that the IRS database of expatriates was incomplete for 16,798 expatriates who did not file Form 8854. In addition, TIGTA found instances of potential non-filing, underreporting of income, and/or payment compliance issues by expatriates. From a sample of 26 expatriates who did not file a Form 8854, five had potential unreported income over $6 million. From a sample of 61 expatriates who filed a Form 8854, 15 had potential unreported income over $17 million. Lastly, TIGTA also found that expatriates with high net worth appear to not be paying their exit tax. Without a centralized compliance effort, Congress’s attempts to create disincentives to expatriate via Section 877A will not be effective.[6]
Moreover, TIGTA developed several recommendations with which the IRS agreed:
[The IRS should] update the Letter 2399C Failure to File – Initial Form 8854, and Letter 4135C, Failure to Respond to Initial Form 8854 Request, for compliance under the HEART Act, and develop Internal Revenue Manual procedures to use these letters to obtain Form 8854 when a Certificate of Loss of Nationality is received and no Form 8854; . . . evaluate the information reported on Form 8854 and determine what data fields should be added to the expatriate database to ensure tax compliance of taxpayers who expatriate, e.g., Form 8854, Part IV, Section B, Property Owned on Date of Expatriation; . . . develop Internal Revenue Manual procedures for transcribing Form 8854 data, correcting Form 8854 data when information as filed by expatriates is missing or incomplete, and preparing analysis as needed to determine if the expatriate is a covered expatriate and subject to tax under Internal Revenue Code Section 877A; and . . . establish a process to compile information on all expatriates whether they filed Form 8854 with their individual tax return Form 1040-NR, U.S. Nonresident Alien Income Tax Return, or filed Form 8854 with the Philadelphia Campus and use this information to identify the highest risk expatriate returns for tax compliance.[7]
For more details related to TIGTA’s audit procedures and findings, see TIGTA’s Final Audit Report.
Conclusion
Based on TIGTA’s final audit report, it is apparent that the Internal Revenue Service intends to implement new processes and procedures to ensure future compliance with expatriate tax provisions—Sections 877 and 877A. Taxpayers who intend to abandon their U.S. citizenship or permanent resident status should be mindful of their reporting requirements and potential tax obligations. In short, an overhaul in the IRS’s compliance efforts may lead to actual, cognizable disincentives for taxpayers seeking expatriation for tax reasons.
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[1] See I.R.C. § 877A(g)(1).
[2] See I.R.C. § 877(a)(2)(A).
[3] See I.R.C. § 877(a)(2)(B).
[4] See I.R.C. § 877(a)(2)(C).
[5] See I.R.C. § 877A.
[6] TIGTA, More Enforcement and a Centralized Compliance Effort Are Required for Expatriation Provisions (Sept. 28, 2020).
[7] Id.
