U.S. brokerage accounts after you expatriate
I did the second webinar today for a limited group of people–all about expatriation. Everyone had a chance to send in questions ahead of time–and I got a lot of them. And there were plenty of questions during the webinar. The show ran for almost three hours: well past the 90 minutes scheduled. Now you know why I limit the number of people in the webinars.
We will do another webinar on expatriation soon. This one will be scheduled at a time convenient to people in Asia. Contact us if you are interested in getting on the list.
But I digress.
One of the questions that came up today is worth blogging about. (What am I talking about? One question only? No way. I have pages of great questions stored in Evernote as blog fodder. But I digress.)
Let’s say a husband and wife have a normal investment account of U.S. stocks and bonds at a place like Charles Schwab or Merrill Lynch. They expatriate. What should they do about the investment account–leave it in place or move everything outside the United States?
Let’s assume the brokerage company will allow them to stay on as customers (not necessarily the best assumption in the world) and will allow them to invest freely in all types of assets (definitely not true at all!). What should they do?
The Deciding Factors
The two tax considerations are:
- U.S. income tax; and
- U.S. estate tax.
Income Tax Considerations
Let’s keep it simple. The husband and wife keep the same account that they had before. They will each give the brokerage company a Form W-8BEN to notify the company that they are now nonresident aliens for U.S. income tax purposes.
The default U.S. income taxation treatment of their portfolio will be:
- Dividends are taxed at 30%, unless an income tax treaty allows a lower tax rate;
- Interest should almost certainly be exempt from Federal income tax;
- Capital gains will be free of Federal capital gains tax–short term or long term; and
- There will be no State income tax at all (they aren’t residents of any States).
This sounds pretty good. The full result is hard to determine without knowing where our expatriating couple will live, and what the local income tax rules are in that country. Only by knowing the combined tax hit for the U.S. and their country of residence will we know whether it is better (from an income tax perspective) to leave the assets in the United States or move them to the country of residence. But all in all, the U.S. government more or less keeps its hands out of the pocket of nonresident investors.
Estate Tax Considerations
The problem lies with the U.S. estate tax. When nonresidents own U.S. stocks and bonds, they run the risk of getting hit with the estate tax. These assets are treated as “located” in the United States and if the individual dies, they are going to be subjected to estate tax. The first $60,000 of U.S. assets are not taxed. But above that, expect to pay some tax, and pay for the expense of an estate tax return.
The worst example I saw of this situation was a husband and wife who had $65,000 in a Schwab account. They both died. Schwab froze their account until the IRS issued a letter saying “all of the U.S. tax liabilities for these people have been fully satisfied.” That meant an estate tax return (Form 706NA). It meant over a year of waiting. And it meant a trivial amount of tax collected for the U.S. government–far, far less than the professional fees to get Schwab to loosen its grip on the account and turn over the money to the couple’s daughter.
So, when people expatriate I recommend that they move all of their financial assets out of the United States. Why go through the pain and agony of dealing with the U.S. estate tax system? Invest your money elsewhere.
Many countries do not have an estate tax at all. If you expatriate and live in one of those countries, why would you leave assets in the United States where they will definitely be taxed when you die?
Many countries have an estate tax of their own. It is probable that these countries have a tax credit system–if your heirs had to pay estate tax in the United States, they will allow a credit against your home country estate tax for the U.S. taxes paid. But that doesn’t avoid the cost of dealing with the U.S. tax bureaucracy
Borg system. The work involved in preparing and filing a Form 706NA is substantial and costly.
A few countries have estate tax treaties with the United States to soften the blow of the U.S. estate tax. If you live in one of these countries, you might have things a little easier. Perhaps the treaty eliminates the tax entirely. But it will not eliminate the requirement to prepare and file an array of U.S. tax paperwork.
All in all, the U.S. estate tax is an excellent reason to NOT invest in U.S. stocks and bonds.
Note that this holds true if you have a brokerage account in another country. If that brokerage account holds U.S. stocks and bonds, you are at risk of the U.S. estate tax just as much as if you had the assets in a domestic Schwab account.
A Solution: Use a Corporation
There is a solution. It is not for everyone, and it is not cheap. But it works.
The problem is the U.S. estate tax. Here is how we solve it. You form a foreign corporation. This might be formed in your home country, or it might be formed in a tax haven jursidiction. Bahamas. British Virgin Islands. You and your wife are the shareholders. Put your money into that corporation. Then use the corporation to open up a brokerage account at Schwab, Merrill Lynch, or anywhere in the world. The corporation then invests its money in U.S. stocks and bonds.
The same income tax results I described above will apply. Dividends will get taxed by the United States at 30%. (If you use a tax-haven country corporation you will not have any ability to use income tax treaties to reduce that rate). Interest will be tax-free, as will capital gains.
The difference lies with the estate tax. If you and your wife die, the U.S. estate tax system asks the first question: what did they own at the time of death? The answer is that you and your wife owned stock in a foreign (from the U.S. perspective!) corporation. That stock is considered to be located outside the United States. A nonresident owned assets outside the United States. The estate tax cannot apply to those assets, so there is no U.S. estate tax.
This is not necessarily a good idea from the perspective of home country tax systems. Many countries have complex systems in their tax laws that are designed to attack holding companies as I have described. In the U.S. system they are called “controlled foreign corporations” if owned by U.S. persons. There is another set of rules called the “personal holding company” rules that penalize the use of corporations that have too much cash in them. Then of course there is the “passive foreign investment company” rules.
Your country of residence might have similar types of rules. If so, a brilliant strategy from the U.S. tax perspective will make you look like a dunce from your home country’s perspective.
The Simplest Solution
The simplest solution, though, is to close out the U.S. brokerage account and pull the money out of the United States. Then, invest the money anywhere you want, but do not buy U.S. stocks, bonds, or mutual funds.
The world is a very large place, with many opportunities for investment. The U.S. government has yet to learn this simple fact. The U.S. government is fat on hubris and the supposed strength of the U.S. dollar.
Winter is coming.
Expatriation and the Expiring Green Card
For the webinar coming up on November 19, I invited people to email me their hardest questions ahead of time so I could answer them. Here’s one that came in and I figured it would make a good blog post.
I’ve heard some people say that long-term green-card holders (i.e., those who’ve had their green card for 8 of the last 15 years and are therefore subject to the exit tax) can “inadvertently” expatriate and trigger the exit tax if their green card expires or if they stayed out of the U.S. long enough to be considered to have abandoned their green card. However, I thought that a green-card holder didn’t officially become an NRA again until they took an intentional action to relinquish their green card—thus, the obligation to file U.S. tax returns continues, and the exit tax is not triggered, until that “official relinquishment date.” What’s the correct position? I haven’t had this particular fact scenario come up on my practice yet, and I’d like to be ready for it when it does!
This happens a lot. People have green cards. They leave the country and stay out of the United States so much that they might be considered to have abandoned their permanent immigrant status. Or the green card expires.
Neither of these events have any meaning for exit tax purposes. The only thing that matters is the fat lady singing–the United States government has to tell you, the green card holder, that yes, your permanent resident status is kaput.
In order for the exit tax to apply, the taxpayer must be an expatriate. A green card holder is an expatriate when he or she “ceases to be a lawful permanent resident of the United States (within the meaning of [Internal Revenue Code] Section 7701(b)(6)).”1
The way a person becomes a lawful permanent resident is:
- You have the correct visa status under the immigration laws,2 and
- That immigration status has not been revoked and has not been determined to have been abandoned (by administrative or court action).3
In the example given (a green card holder leaves the United States and never returns, or the green card expires), that second requirement has not been satisfied. The immigration status has not been revoked (that would require some sort of official action by the U.S. government). And the immigration status has not been abandoned. All of the facts exist to show that the individual abandoned the intention to live in the United States, but the government (via administrative action or court proceedings) has not said “Yes, you have abandoned the green card.”
Let’s look first at the “revoked” language in Code Section 7701(b)(6)(B). The Treasury Regulations don’t use the word “revoke” because why bother with consistency? The word used in the Regulations is “rescission” or “rescind”.4 Let’s agree that “revoke” == “rescind”. We’re all friends, right?
Resident status (as evidenced by your green card) is considered to be rescinded:
if a final administrative or judicial order of exclusion or deportation is issued regarding the alien individual. For purposes of this paragraph, the term “final judicial order” means an order that is no longer subject to appeal to a higher court of competent jurisdiction.”5
In other words, in order to have green card status “revoked” the fat lady must sing–there is an official order kicking you out of the country, and you cannot appeal that order to any court. Just sitting quietly in another country is not enough to revoke (or “rescind” as the Regulations call it) your green card.
Resident status is deemed “abandoned” when it is “administratively or judicially determined to have been abandoned.”6 The Regulations tell us how this is done.
First, the Regulations say that either the individual or the government can start the process of abandonment.7 On the government’s side, a consular official or the USCIS can start the process. (T. Regs. § 301.7701(b)-1(b)(3).))
If the USCIS or a consular official launches the procedures for abandonment of green card status, then the date that resident status ceases is when there is a final administrative order of abandonment. The individual can appeal that to a court, and if that happens, then the date is when there is a final court order that can no longer be appealed.8
Again, the fat lady must sing–the government must issue a piece of paper saying that your green card status is finished.
If the individual initiates the abandonment proceedings, it is done in one of two ways:
- File Form I-407; or
- Send a letter stating the intent to abandon status and enclose your green card.9
Merely sitting quietly in another country will not cause an abandonment of green card status. You, the individual, must file some piece of paper with the government. The effective date of abandonment is the date you filed the paperwork.10
OK. On to the final point. What if the green card expires and you do not renew it? Surely this means you abandoned your permanent resident status. Nope. Remember that the Regulations say the government must issue an order–administrative or judicial.11 Something simply hitting its expiration date is not an order issued to you.
What This Means
I regularly talk to people who had green cards and moved abroad 10 or 15 years ago. They stopped filing U.S. tax returns under the assumption that they were no longer U.S. residents.
You are still a lawful permanent resident in the eyes of the U.S. government and should be filing income tax returns.
For someone who is sitting outside the United States and wants to make a clean break with the IRS, this will mean going through the expatriation process. It will mean filing the paperwork required to formally abandon the green card status (usually Form I-407). It will also mean preparing income tax returns going back in time to fix the failure to file problem. How far back will be determined on a case by case basis. Not doing so will make you a covered expatriate.
- Internal Revenue Code Section 877A(g)(2)(B). [↩]
- Internal Revenue Code Section 7701(b)(6)(A). [↩]
- Internal Revenue Code Section 7701(b)(6)(B). [↩]
- T. Regs. § 301.7701(b)-1(b)(1). [↩]
- T. Regs § 301.7701(b)-1(b)(2). [↩]
- T. Regs. § 301.7701(b)-1(b)(1). [↩]
- T. Regs. § 301.7701(b)-1(b)(3). [↩]
- T. Regs. § 301.7701(b)-1(b)(3). [↩]
- T. Regs. § 301.7701(b)-1(b)(3). [↩]
- T. Regs. § 301.7701(b)-1(b)(3). [↩]
- T. Regs. § 301.7701(b)-1(b)(3). [↩]
Community Property and Form 8854′s Balance Sheet
I received a question by email this morning from a CPA I know in New York:
I have a [Country X] couple who were Long Term Residents. They had their green cards for more than [a bunch of] years. They are at a joint, net worth level, that puts them over the $2,000,000 threshold. However, their net worth is about $4,000,000. [Country X] is a community property country. Do you ever apply community property rules when you complete a Form 8854?
Interpreting the insider jargon for you guys, my CPA friend is saying that the husband and wife have had green cards long enough to be “long term residents” for purposes of Section 877A–the exit tax rules. She does not want her clients to be treated as covered expatriates when they abandon their green cards. (If the husband and wife are treated as covered expatriates, then there will be mark-to-market tax imposed on their assets, IRAs will be treated as distributed in full, etc. etc. All the bad stuff.)
One way that an individual achieves “covered expatriate” status is by being rich. “Rich” is defined by the IRS as having more than $2,000,000 in net worth. There are other ways to become a covered expatriate but they are not important for the purposes of this blog post. The couple in question has a net worth above $2,000,000 but less than $4,000,000. They will both abandon their green cards.
If they can successfully argue that they are precisely 50/50 owners of all of their assets, then each of them will report a net worth of under $2,000,000, and will escape the United States without tax. The only headache will be that of my CPA friend has messy tax returns to file. If the net worth of $4,000,000 must be reported for each individual (or jointly), then they have a problem.
Two Form 8854 Filings
When you prepare the balance sheet on Form 8854 to prove to the IRS that you are (or are not) a covered expatriate, you put your own assets on the balance sheet. In this case, the husband and the wife will each file a final U.S. income tax return using the filing status “Married Filing Separately” because on December 31, 2013 both will be nonresident aliens–their green cards will have been cancelled.
Each of them will prepare a Form 8854 showing his and her assets and liabilities, and this will be attached to the separate tax returns. The Form 8854 is not a combined husband-and-wife form.
Jointly-Owned Property and Form 8854
How do you deal with jointly owned property? Simple–divide it among the owners in the correct percentage. If there are three co-owners and one expatriates, then one-third of the assets are reported on the expatriating person’s Form 8854.
Community property is particularly easy. Every asset, no matter what, that has been acquired during marriage will be considered equally owned by the husband and the wife–by law. It does not matter who holds title to the asset. Community property rules vary from country to country, so sometimes you need to do a bit of archeology into the other country’s specific community property rules to see what they say. But in general, this is how things work.
So at first glance, the answer to my CPA friend’s question is simple. Take the heroic position that the community property laws of Country X mandate that all of their assets should be treated as owned equally by the spouses, no matter whose name is on title.
Alas, nothing is simple. Country X happens to have two types of marriages. When couples get married they can choose to have their property rights governed under one of two different systems. One is a classic community property set of rules as I have described. The other system is . . . different from the community property rules.
You don’t want to become an expert in Country X marital property laws just for the purpose of getting a nice couple cleanly out of the United States via a correctly-prepared Form 8854.
Sledgehammers Fix Everything
A younger version of me was a factory worker. There I learned to revere the five pound sledgehammer. It fixed everything, and was referred to with a certain reverence up and down the line. (Custom van fabrication–take an empty van, put carpet, stereo, pimpin’ swivel seats, etc. etc. in them. Also a breakfast cereal factory, making corn flakes ‘n stuff.)
These life lessons remain useful to those of us who practice tax law. There are a few blunt instruments we can use to cudgel and bludgeon facts until magic occurs.
The first method for achieving the desired result is a spousal agreement. Husband and wife agree amongst themselves that no matter what the law of Country X might say, they agree that all assets are community property. Every country I have ever seen (well, except for Indonesia) allows community property rules to be trumped like this. I am going to refer to this as a transmutation agreement, because that is what California calls it. You are transmuting the character of separate property to community, or vice versa.1
Such an action–transmuting the character of an asset from separate property under Country X law to community property under Country X law–might trigger a taxable gift from one spouse to the other. If there is a $1,000,000 asset that Country X would call the husband’s separate property, then converting it to community property will be a $500,000 transfer to the wife. Transfers to noncitizen spouses are not eligible for the marital deduction, so for transfers above $143,000 (the number in 2013; it adjusts annually for inflation) there will be a taxable gift.
This would assume that the IRS:
- has someone actually look at the Form 8854 balance sheets;
- asks critical questions;
- finds the underlying situation as a matter of Country X law prior to the transmutation agreement and compares it to the balance sheet after the transmutation agreement;
- engages in the extremely exciting exercise of retaining Country X expert lawyers to advise on the laws related to this transfer; and
- decides to send the taxpayers a little letter requesting a love offering to the United States Government’s Bucket ‘o Booty.
Unlikely. But we don’t live in the world of probabilities. We live in the world of certainties. Or we do as much as we can, anyway.
Here’s the deal. If all of that happens, H and W just file the appropriate gift tax returns (late) and report the taxable gift and use up some of their unified credit. No tax. Paperwork only. Easy.
This suggests an even easier solution. Since the couple is leaving the United States never to return, they can burn their unified credits like gangsta pyromaniacs. They can make gifts to each other, file Form 709s as needed, and be done with it.
Result and Recommendations
Note what has happened here. We used a simple agreement between the spouses (not filed anywhere, but be sure to follow all the formalities in case you are audited by the IRS) to cause the couple to have an equal split of assets. They can exit the country and report the assets on Form 8854 truthfully and correctly. Each has a net worth of under $2,000,000. Neither is a covered expatriate.
My suggestion–if this strategy is followed–is to file gift tax returns. Remember that when you sign Form 8854 you are saying to the U.S. government “all my tax filings are up to date and on file with you”. If gift tax returns should have been filed but weren’t, they that statement is false, and you are a covered expatriate.
Since a gift tax return is prudent anyway, my next suggestion is to just cook up whatever gift tax returns are necessary to equalize the asset ownership between the spouses and file them. The husband and wife are leaving the USA forever so they don’t care about the unified credit.
A lot of this is overkill. The likelihood of the IRS coming in to challenge a married couple’s allocation of all assets as 50/50 between themselves is negligible. But the Service loves excessive overkill. Just look at the penalties built into the Code. With a bit of paperwork you can prevent potential blowback.
Or just run with it.
- I like the word “transmutation” because it sounds vaguely theological. You might recall that I recently read Will and Ariel Durant’s volume on the Reformation, so all of this “angels dancing on the head of a pin” stuff is still resonating with me. [↩]
Second Webinar on Expatriation–Get On The Wait List
We had the first webinar on expatriation yesterday. I had a good time and we went overtime to answer everyone’s questions. Some of them were hard, hard questions.
We have a wait list already, and are thinking of scheduling a second webinar for next week. The people on the wait list have first priority and you will be added to the wait list.
If you are interested in attending, please send an email to Olivia Park — at olivia.park (at) hodgen.com.
See the description of yesterday’s webinar here.
Any questions? Hit us up on the Contact Us page.
UPDATE: Here is a comment from someone who attended yesterday’s session. (Clue: I went from 8:00 a.m. to noon, answering ALL of the questions.)
Just wanted to say thanks for the great webinar yesterday. It was well worth the money, and after receiving four hours of useful information I felt like the coach passenger that got a free upgrade to first class. My compliments.
Expatriation webinar is full; add a second one?
The webinar on November 12, 2013 is full. I have received some emails asking if there is a bit more room. Sadly, no. I want to keep the limit to 10 people so I can answer questions completely and fully.
Another Webinar? Email me
If you missed out and are interested in attending the webinar, please email me using the Contact page of the website, or just guess my email address — it is “phil” at the domain name of my last name “hodgen” then .com at the end of it.
If we get enough people I will schedule another webinar.
Again, it will be highly limited for attendance so everyone gets individual attention. This one will probably be set at a different time of day and possibly on a weekend, in order to find a time that is better for people in Asia/New Zealand/Australia.
For People Attending Tomorrow
Please email your hardest questions. Trust me, I have received some big hairy questions already! I want to be prepared. If I know the questions ahead of time I can give them some thought and you will get better answers.
I want you to leave tomorrow’s webinar with confidence that you can make the right decision on expatriation. The way I can help you with this is by exploring all of the edge case problems that the expatriation tax laws throw at us.