As a tax practitioner assisting taxpayers with expatriation issues, I sometimes see a question arise in cases when the taxpayer has not sought my advice prior to expatriating—for example, before renouncing U.S. citizenship or surrendering a green card held for at least eight tax years. The question is: When must an individual meet what tax professionals call the “tax compliance test” to avoid “covered expatriate,” or C.E., status? Is it at the time of expatriation, or when the final tax return together with Form 8854 is signed?
U.S. Expatriation Tax Rules in a Nutshell
The U.S. “expatriation tax” provision rules apply only to certain U.S. citizens or long-term residents who have given up their U.S. status. Long-term residents are generally those holding a green card for eight of the past 15 years and have properly ended their U.S. resident status for tax purposes.
Under the expatriation rules contained in IRC section 877(a)(2), an individual will be treated as a C.E. if any one of the following tests applies (quoting the statutory text):
(A) the average annual net income tax (as defined in section 38(c)(1)) of such individual for the period of five taxable years ending before the date of the loss of United States citizenship is greater than $124,000 [$172,000 for 2021],
(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 five preceding taxable years or fails to submit such evidence of such compliance as the Secretary may require.
If any one of these tests is triggered, the individual is a C.E., subject to the “Exit Tax” regime. Generally, all property owned by the C.E. worldwide is treated as sold for its fair market value on the day before the expatriation date. This “pretend” gain is then taken into account for the tax year of the deemed sale and subject to tax, usually at capital gains rates. An exception exists for a certain amount of gain, but it doesn’t apply to all assets, and is calculated in a very specific way. In short, it’s complicated—get the best tax advice.
In addition to the Exit Tax, U.S. recipients of any gift or bequest at any time in the future from the C.E. must pay a special transfer tax—currently 40% of the value of the gift or inheritance.
Full “Tax Compliance”
So, back to the question: Assuming the taxpayer does not trigger either the net worth or tax liability test, when must the taxpayer be fully tax compliant? If the taxpayer is not tax compliant at the time of expatriation but later achieves full compliance by the due date of the final tax return with the accompanying Form 8854—signed under penalty of perjury and checking the “yes” box to Part II Question 6—is this sufficient to prevent C.E. status?
As a tax practitioner, I always try to avoid potential issues and have the individual be fully tax compliant when the taxpayer expatriates. Sometimes, however, the individual has already expatriated and is not compliant before coming to see me. However, full tax compliance is achieved before the due date of the timely filed final return and Form 8854. It appears to me one can argue that this taxpayer should not be treated as a C.E.
Deep Dive into section 877(a)(2)(C)
Under a strict reading of the statute, C.E. status can result if “such individual fails to certify under penalty of perjury that he has met the requirements of this title for the five preceding taxable years…" The focus of the tax statute is on the act of certification. As a practical matter—although I will not belabor this point—the statutory certification language has been expanded by the IRS to mean “actual tax compliance.” Certification is accomplished only by signing and filing Form 8854, which are simply not done on the expatriation date, and, as discussed below, are often impossible to do on the expatriation date.
Taking a deep dive into the text of the statute itself, one can see that it is simply not possible to meet the tax compliance certification test if it is interpreted to mean a taxpayer must be fully tax compliant as of the expatriation date. Remember the statute requires certification of compliance “for the five preceding taxable years"—though the IRS and Form 8854 apparently use five preceding calendar years and not taxable years.
Here is an example: Taxpayer expatriated on Jan. 25, 2021, taking the oath of renunciation on that date. The five preceding “taxable years” are the short taxable year Jan. 1, 2021-Jan. 24, 2021, and the full calendar years 2017-2020. The taxpayer’s final income tax return for 2021 will be a so-called dual-status tax return, reflecting U.S. and non-US status—generally, it is due June 15, 2022. It is impossible for the taxpayer to file the short-year tax return by the expatriation date of Jan. 25, 2021.
Additionally, the taxpayer cannot be compliant on that date for the tax year 2020 since the tax season did not start, and the taxpayer cannot file the 2020 tax return. The only date that makes any sense whatsoever for certifying tax compliance is the date that the taxpayer signs Form 8854.
There are additional arguments against the view that tax compliance as of the expatriation date is required.
First, the statute does not specifically state when the individual must be tax compliant, although the statutory language “fails to certify under penalty of perjury” arguably indicates compliance must be met at the time the taxpayer so certifies. No Treasury Regulations have ever been issued.
Second, 12 years ago, the IRS issued Notice 2009–85, which is the only official expatriation guidance currently available. The Notice itself does not make clear when full tax compliance is required—see Sections 2A and 8C of the Notice.
I had occasion some years back to informally speak to Bill Yates, the IRS attorney who was a principal author of Notice 2009–85. His view is that the Notice should be interpreted to mean tax compliance must be met on the expatriation date. I pointed out to him that the Notice and Form 8854 and its instructions do not clearly say that. By comparison, the tax law and Form 8854 are quite clear about when to measure the value of the taxpayer’s assets—the day before expatriation. On the certification test, neither the law nor the IRS is explicit.
By analogy, one can look to the normal income tax return—how does the taxpayer certify under penalty of perjury that everything is accurate? As of what moment is the taxpayer making that certification? Clearly, the answer is at the time the taxpayer signs the tax return. The tax compliance certification can be similarly viewed—the relevant point for full compliance is when Form 8854 is signed.
I would also point out that the IRS currently has certain relief procedures in place to help individuals who fail to file Form 8845 and expatriate—even those with a U.S. tax filing history—as well as those who failed to file Form 8854 and are not fully tax compliant. If a taxpayer can use the procedure, it will mean relief from toxic C.E. status and its very harsh tax consequences.
If the tax law was abundantly clear on the issue that full tax compliance had to be met as of the date of expatriation, these IRS Relief Procedures would be beyond the permissible scope of the statute. However, the law is not clear. These Procedures confirm it and indicate that the IRS itself does not have a fixed and clear stance on the issue.
As many are aware, expatriation is a hot area for IRS audits, and since June 2019, it has been an active IRS “compliance campaign.” I understand from reputable tax colleagues that expatriation audits have been happening, with the IRS taking the position that tax compliance must be met at the time of expatriation.
This area of tax law is a mess, and maybe it will be resolved only through litigation.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
With over 35 years of U.S. tax and international experience, Virginia La Torre Jeker has been a member of the NYS Bar since 1984. Virginia has been practicing U.S. tax overseas since 1986. After spending 15 years in Hong Kong, she has been in Dubai since 2001. She provides expert insight into the latest changes in American tax laws and outlines the U.S. tax obligations of American expats and foreign individuals with U.S. connections.
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