On Sept. 6, 2019, the Internal Revenue Service announced an important new procedure to enable certain non-compliant U.S. citizens who relinquish their U.S. citizenship to become U.S. tax compliant.
- Primary Targets. “Accidental Americans” who were unaware of their U.S. tax obligations.
- Eligibility and Filings. In general, (1) past compliance failures were non-willful, (2) past tax liability not in excess of $25,000 for the five years prior to, and the year of, expatriation, and (3) less than $2 million in net assets as of expatriation date. Eligible taxpayers must file U.S. tax returns, including all required schedules, international information returns, and Foreign Bank Account Reports (FBARs), for the five years preceding and the year of expatriation.
- Benefits and Takeaway. Qualifying taxpayers become compliant without having to pay any past due U.S. taxes, penalties, or interest and avoid classification as a “covered expatriate,” a designation that could result in extremely detrimental tax consequences. For qualifying expatriates, the new procedure provides a taxpayer-friendly pathway to U.S. tax compliance, thereby avoiding potentially detrimental U.S. tax consequences and adverse reputational risk.
In the “Relief Procedures for Certain Former Citizens” and accompanying FAQs, the Internal Revenue Service (IRS) provides a simplified pathway for certain non-compliant U.S. citizens who expatriated after March 18, 2010, to become U.S. tax and reporting compliant.
In short, under this new procedure, U.S. citizens who expatriated, were non-willful in their failure to file U.S. income or gift tax returns and associated international information returns, owed a limited amount of back taxes (not in excess of $25,000), and had net assets of less than $2 million can remediate their non-compliance by filing outstanding U.S. tax returns, required schedules, information returns and Foreign Bank Account Reports (FBARs).
Provided a non-compliant, non-willful expatriate satisfies the eligibility requirements to utilize the new procedure and submits the necessary information for the five years prior to the year of expatriation and the year of expatriation, the expatriate will become U.S. tax and reporting compliant and will not be liable for any unpaid taxes, interest, and penalties for the six years (or any previous years) and, most importantly, will not be a “covered expatriate” for purposes of the harsh expatriation tax provisions of the tax code.
A U.S. citizen who expatriated on or after June 17, 2008, would be a “covered expatriate” if:
(1) the expatriate’s annual net income tax for the five years ending before the date of expatriation or termination of residency is more than a specified amount ($155,000), adjusted for inflation (the Income Tax Liability Test;
(2) the expatriate’s net worth is $2 million or more on the date of expatriation (the Net Worth Test); or
(3) the expatriate failed to certify on IRS Form 8854 that he or she has complied with all U.S. federal tax obligations for the five years preceding the date of his or expatriation.
If any of the foregoing rules apply, then generally the expatriate is a “covered expatriate” and subject to immediate and detrimental income tax consequences (principally the “exit tax,” which is a mark-to-market tax); viz. the covered expatriate generally will be deemed to have sold all of his or her worldwide assets at their fair market value on the day before expatriation; in addition, there are detrimental gift and estate tax consequences if the expatriate makes gifts or bequests to U.S. persons other than his or her spouse or to a charitable institution.
U.S. citizens are subject to taxation on their worldwide income based on citizenship and not residency, which is the common standard globally. The U.S. worldwide taxation regime and associated tax compliance is complicated and burdensome for U.S. taxpayers, particularly those living abroad. Thus, for many “Accidental Americans,” e.g., citizens of foreign countries who also are U.S. citizens because:
(1) they were born in the U.S. while their foreign parents were in the U.S. but shortly after birth returned to the home country of their parents;
(2) they were born outside the U.S. while their American parent(s) were living abroad; or
(3) a U.S. expat became a naturalized citizen of another country and incorrectly believed that his or her U.S. citizenship ended.
The enactment in 2010 of the Foreign Account Tax Compliance Act (FATCA), may have been the tipping point in their decision to expatriate. After FATCA was enacted, expatriations increased significantly.
The IRS, cognizant of the increase in the number of expatriations, announced a new compliance campaign focusing on non-compliance in the expatriation area on July 19, 2019.
An overview of the requirements of the new procedure and its associated FAQs is provided below.
Items Subject to Remediation
- Income tax returns, including Form 8854 (Initial and Annual Expatriation Statement)
- Gift tax returns
- International Information Returns, such as IRS Form 8938 (Statement of Foreign Financial Assets)
- FBARs (Foreign Bank and Financial Accounts, FinCEN Form 114, formerly Form TD F 90-22.1)
- Procedure limited to individual U.S. citizens who expatriated or intend to expatriate, but non-compliant expatriate only can file under the new procedure after expatriation.
- Past compliance failures non-willful (i.e., conduct due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law).
- U.S. citizenship relinquished after March 18, 2010, the FATCA enactment date. For U.S. citizen expatriations, the expatriation date is generally determined by reference to U.S. Department of State Certificate of Loss of Nationality, Form DS-4083.
- Taxpayer has no tax filing history as a U.S. citizen or resident (i.e., individuals who have not filed U.S. tax returns as U.S. citizens or residents).
- Note: if an expatriate filed IRS Form 1040 NR (U.S. Nonresident Alien Income Tax Return) under good faith belief that he or she was not a U.S. citizen, the procedure may still be used.
- Taxpayer did not exceed the average annual net income tax threshold for the period of five tax years ending before the date of expatriation (see the Income Tax Liability Test).
- Taxpayer’s net worth is less than $2 million at the time of expatriation and at the time of making the submission under this procedure (see Net Worth Test).
- Taxpayer’s aggregate total tax liability is $25,000 or less for the five tax years preceding expatriation and in the year of expatriation, determined after application of all deductions, exclusions, exemptions, and credits (to include foreign income tax).
- Note: for purposes of the $25,000 limitation, (1) U.S. withholding taxes are not treated as an offset; (2) the tax code’s expatriation tax, commonly referred to as the “exit tax” is not considered; and, (3) neither are penalties or interest.
- Note: if a taxpayer reports foreign mutual fund distributions as ordinary income but does not apply the passive foreign investment company (PFIC) excess distribution rules and fails to include IRS Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund), the taxpayer still qualifies, which is a favorable rule.
- Note: foreign income taxes imposed on a taxpayer can be used as an offset without limit, as would ordinarily be the case under the foreign tax credit limitation provisions.
- The submission of all required federal tax returns for the six tax years at issue, including all required schedules and information returns.
- Importantly, if a taxpayer does not have a Social Security Number (SSN), a taxpayer may still make a submission under the procedure. Unlike the Streamlined Foreign/Domestic Offshore Procedures, it is not necessary to obtain an SSN for purposes of this procedure. If a taxpayer mistakenly applied for, and received an Individual Taxpayer Identification Number (ITIN), the ITIN should be provided.
Benefits of Participation in Procedure
- No payment of omitted tax for six years at issue and prior years
- No imposition of penalties
- No payment of interest
Additional Key Points
- This procedure does not have a specific termination date. The IRS will inform taxpayers prior to terminating the procedure.
- All eligibility criteria must be strictly met.
- If a taxpayer is not eligible to make a submission but makes a submission, the IRS will process the returns using normal examination procedures, and the taxpayer will be liable for all taxes, penalties and interest associated with the submission.
- No preclearance procedure or prior approval requirement applies.
- Taxpayers cannot contact the IRS to request a “placeholder” for an anticipated submission.
- After reviewing the submission to confirm the eligibility criteria, the IRS will send the taxpayer a letter notifying that the submission was received and complete. It may take the IRS at least two months to review submissions for eligibility and completeness.
- Once a submission is made, there is no ability to retract a submission, although taxpayers usually can file amended returns. The only exception is if the Department of State were to vacate its finding of loss of U.S. citizenship.
- Returns submitted under this procedure will not automatically be subject to an IRS examination, but returns may be subject to examination or to verification procedures to confirm the accuracy and completeness of submission.
- The IRS has established a help line at +1.267.466.0020.
This procedure, while limited in application, is an extremely favorable way for non-compliant U.S. citizen expatriates to come into compliance, thereby eliminating not only “covered expatriate” status but also potentially detrimental and costly taxes, interest and penalties for past non-compliance.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Alan Winston Granwell is of counsel in the Washington office of Holland & Knight LLP; Andrea Darling de Cortes is a partner in the Tampa office; and William M. Sharp, Sr. is a partner in the Atlanta, San Francisco, and Tampa offices.