Are you U.S. citizen or resident? Have you ever just wanted to leave the whole U.S. federal tax system behind? Well, you can . . . try at least. But there’s a cost.
The Problem
U.S. citizens and residents are subject to federal income tax on their worldwide income.[1] They’re subject to federal estate tax based on all assets wherever located upon death.[2] And, they’re subject to gift tax on the transfer of all property, whether it be real or personal, tangible or intangible.[3]
Noncitizens-nonresidents, on the other hand, are subject to federal income tax only on certain U.S. source income and income that’s effectively connected with the conduct of a U.S. trade or business.[4] They’re subject to federal estate tax only with regards to assets situated within the United States upon death.[5] And, they’re generally subject to gift tax only when the gift is real estate or tangible personal property located in the United States at the time of the gift.[6]
Plus, there are those pesky U.S. information reporting requirements that apply to U.S. citizens and residents, including but not limited to the:
- FinCEN Form 114 (Report of Foreign Bank and Financial Accounts (FBAR));
- Form 8938 (Statement of Specified Foreign Financial Assets);
- Form 5471 (Information Return of U.S. Persons With Respect To Certain Foreign Corporations);
- Form 8858 (Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs));
- Form 8865 (Return of U.S. Persons With Respect to Certain Foreign Partnerships);
- Form 3520 (Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts);
- Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation);
- Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund); and
- information gathering requirements imposed on foreign financial institutions regarding U.S. account holders under the Foreign Accounts Tax Compliance Act of 2010.[7]
The Solution
Given the tremendous burden that the federal tax system places on U.S. citizens and residents compared to its relatively light touch on noncitizens-nonresidents, you might start wondering—what if I just stopped being a citizen or resident?
The Cost
Unfortunately, Congress appears to have realized that creating different U.S. federal tax treatment for citizens and residents on the one hand and noncitizen-nonresidents on the other may incentivize some folks to do just that. That’s why ever since this different treatment was put in place there have been provisions of the Internal Revenue Code aimed at making it more difficult for citizens and residents to escape the clutches of U.S. taxation.[8]
Section 877A
Currently, that provision is mainly Section 877A. This section generally causes certain folks who renounce their U.S. citizenship or cease to be a long-term U.S. resident (a.k.a., “covered expatriates”) to be treated as if they sold or exchanged all their property on the date that they renounced their citizenship or residency.[9] This means that covered expatriates would be taxed on the gain or loss on each of these assets as of that date. Covered expatriates can elect to defer payment of the tax until the due date for the return in which the property actually is disposed of, but they will have to provide the IRS with adequate security and file an annual Form 8854 until the deferred tax and interest is paid.[10]
In order to be caught in Section 877A’s web, the statute provides that an individual has to owe average net income tax of more than $124,000 for the five tax years preceding the loss of citizenship or residency, a net worth of $2,000,000 or more as of that date, or the individual must have failed to have certified under penalties of perjury that they have complied with federal tax law for the preceding five tax years.[11] The $124,000 dollar amount has been adjusted annually for inflation since 2004.[12] And, any gain on the deemed sale or exchange is first reduced by $600,000 (also adjusted for inflation).[13]
Section 2801
While Section 877A does the lion’s share of the work in policing the boundaries taxwise between U.S. citizens and residents and noncitizens-nonresidents, Section 2801 also plays its part. Section 2801 imposes a tax at the highest applicable estate tax rate on citizens and residents who receive gifts bequests over the gift tax annual exclusion from an expatriate covered by Section 877A.[14] Thus, Section 2801 basically penalizes expatriates who try to give money or property by gift or bequest to people who are still under the sway of the U.S. tax system.
Section 6039G
And then the shame game comes into play. All persons who lose their U.S. citizenship in each calendar quarter are required to be listed in the federal register.[15] To add insult to injury, former citizens also may be bounced from coming back to the United States if they renounced their citizenship for some reason relating to tax.[16]
Final Thoughts
So, there’s a lot to think about when it comes to expatriating from the United States. If you want someone to talk with about any of these issues, we’re here to help.
********
[1] 26 C.F.R. §§ 1.1-1(b), 1.871-1(a). A U.S. citizen is somewhat circuitously defined as “[e]very person born or naturalized in the United States and subject to its jurisdiction as a citizen.” Id. § 1.1-1(c). A resident is broadly defined as:
[a]n alien actually present in the United States who is not a mere transient or sojourner is a resident of the United States for purposes of the income tax. Whether he is a transient is determined by his intentions with regard to the length and nature of his stay. A mere floating intention, indefinite as to time, to return to another country is not sufficient to constitute him a transient. If he lives in the United States and has no definite intention as to his stay, he is a resident. One who comes to the United States for a definite purpose which in its nature may be promptly accomplished is a transient; but, if his purpose is of such a nature that an extended stay may be necessary for its accomplishment, and to that end the alien make his home temporarily in the United States, he becomes a resident, though it may be his intention at all times to return to his domicile abroad when the purpose for which he came has been consummated or abandoned. An alien whose stay in the United States is limited to a definite period by the immigration laws is not a resident of the United States within the meaning of this section, in the absence of exceptional circumstances.
Id. § 1.871-2(b). Fortunately for those who value something a little more concrete, an alien individual is a resident for U.S. tax purposes if:
- the individual is lawfully admitted for permanent residence;
- the individual is physically present in the United States for a total at least 183 days during the current year and preceding two years after applying the applicable multiplier (current year = 1; first preceding year = 1/3; second preceding year = 1/6); or
- the individual has elected to be treated as a resident under certain circumstances.
26 U.S.C. § 7701(b)(1), (3), (4).
[2] 26 U.S.C. §§ 2001(a), 2031(a).
[3] 26 U.S.C. § 2501(a), 2511(a); 26 C.F.R. § 25.2511-1(a).
[4] 26 U.S.C. § 872(a).
[5] 26 U.S.C. §§ 2101(a), 2103.
[6] 26 U.S.C. §§ 2501(a), (b), 2511; 26 C.F.R. §§ 25.2511-1(b), –3(a).
[7] See 26 U.S.C. §§ 1298(f), 1471, 1472, 6038, 6038B, 6038D, 6039F, 6046, 6048; 31 U.S.C. § 5314; 31 C.F.R. §§ 1010.306(c), 1010.350(a), (b).
[8] See The Foreign Investors Tax Act of 1966, Pub. L. No. 89-809, 80 Stat. 1551 (Nov. 13, 1966).
[9] See 26 U.S.C. §§ 877(a)(2), 877A(a), (g)(1), (2), (3). The terms “covered expatriate” doesn’t cover an expatriate that 1) became a U.S. citizen and citizen of another country at birth, continues to be a citizen of and is taxed as a resident of that other country on the date of expatriation, and hasn’t been a U.S. citizen for more than ten out of the preceding fifteen taxable years; or 2) 26 U.S.C. § 877A(g)(1)(B).
[10] See 26 U.S.C. §§ 877A(b), 6039G; I.R.S. Notice 2009-85, 8.C.
[11] See 26 U.S.C. §§ 877(a)(2), 877A(g)(1).
[12] See 26 U.S.C. § 877(a)(2), 877A(g)(1).
[13] 26 U.S.C. § 877A(a)(3).
[14] 26 U.S.C. § 2801(a).
[15] 26 U.S.C. § 6039G(d).
