Archive for 'Income taxation of nonresidents'

Electing Resident Alien Status Under Section 7701(b)(4)

[Note:  I am preparing the course materials for an all-day program I am teaching for the California Society of Certified Public Accountants on the taxation of multinational families.  This is a portion of the handout I am writing.]

You do not have a green card, and you were not in the U.S. enough days to meet the substantial presence test.  You want to be a U.S. resident for income tax purposes.  Here is how you do it, by making a special election under Section 7701(b)(4) of the Internal Revenue Code.

Why

This election is used by nonresident aliens who become residents of the United States after the middle of the year, and do not hold a green card.  Therefore they will not qualify as a U.S. resident under either the substantial presence test or the green card test.

As a nonresident alien, the taxpayer will not be able to claim an itemized deduction for mortgage interest or property tax.  Or perhaps there are some foreign losses in the current year that could be taken on Form 1040 that cannot be taken on Form 1040NR.  By making the election described here, the taxpayer becomes a resident alien and will be able to take these deductions and thereby reduce his or her Federal income tax liability.

As you read the description of this election—and what is required to qualify for it—you will probably wonder whether the effort is worth the expected tax savings.

The requirements to satisfy are, like many things in tax law,  unnecessarily complicated.1  In order to make the election for a particular tax year, you must know certain things about the past, and you must accurately predict certain things about the future.  Then there are complicated rules for what you do in the current year.

Prior Year: Be a Nonresident Alien

First, you must have been a nonresident alien in the prior year.  To be precise, you must not have been a resident alien under the definitions found Internal Revenue Code Section 7701(b)(1)(A) for the prior year.2

Current Year: Be a Nonresident Alien

Second, you must be a nonresident alien for the current year.3  This means that you fail both the green card test and the substantial presence test for the current year.

Current Year: 31 Consecutive Days in the United States

Third, you must be in the United States for 31 consecutive days in the current year.4  This means you are physically present5 in the United States on every day for 31 days in a row.6  You cannot be out of the country, even for a day.

These days in the United States do not count toward the “31 days in a row” requirement:

  • If you are in the United States but you are an exempt individual7 because you have a specific type of visa status;8
  • If you are present in the United States because you have a medical condition and cannot travel;9
  • If you are in the United States solely because you are in transit between two foreign places;10 or
  • If you are in the United States because are a regular commuter for employment purposes into the United States from Mexico or Canada.11

Current Year: At Least 75% Time in the United State

Fourth, you must be in the United States for a period of continuous presence, starting with the first day of the 31 day period described above.12  That phrase—“a period of continuous presence”—needs a definition.13

It means that you start counting on the first day of the 31-day period of continuous presence.  From that day until December 31, you determine whether you were physically present14 in the United States at least 75% of the time.  This is harder than it looks.  You are instructed to include some days that you are outside the United States, and to exclude some days that you are inside the United States.  And you have extra work to figure out the correct “Day 1” to use to compute whether you satisfy this requirement or not.

In calculating whether you were “in the United States” for at least 75% of the time, you can count days abroad as if you were in the United States If you are out of the United States for fewer than five days—only for purposes of determining whether you satisfy the “period of continuous presence” requirement.15  The moral of this story is clear: do not leave the United States, or if you do, make very brief trips abroad.

Conversely, some days that you are physically within the borders of the United States are not counted toward the 75% test of the “period of continuous presence.”  These are the same types of days that are excluded for the “31 days in a row” requirement:

  • If you are in the United States but you are an exempt individual16 because you have a specified type of visa status;17
  • If you are present in the United States because you have a medical condition and cannot travel;18
  • If you are in the United States solely because you are in transit between two foreign places;19 or
  • If you are in the United States because are a regular commuter for employment purposes into the United States from Mexico or Canada.20

It gets worse.  Consider the possibility (because the author of the Treasury Regulations considered it) that your hapless taxpayer has more than one “31 days in a row” period of presence in the United States.  For satisfying the “period of continuous presence” requirement, you must figure out a starting date.  Which of the 31-day periods do you use as Day 1 for the “period of continuous presence” requirement?

It’s easy.21  Look at each 31-day period, and figure out whether the taxpayer satisfied the “period of continuous presence” requirement by being in the United States for at least 75% of the days between the starting point of each 31-day period and the end of the calendar year.

  • If you satisfy the “period of continuous presence” requirement for all of the 31-day periods, you use the first of those 31-day periods.22
  • If you do not satisfy the “period of continuous presence” requirement for the first of the multiple 31-day periods but you do satisfy it for a later 31-day period, then you use the starting date of the earliest of those later 31-day periods to satisfy the “period of continuous presence” requirement.23

Next Year: You Meet the Substantial Presence Test

Fifth and finally, you must be in the United States for a sufficient number of days in the NEXT calendar year to satisfy the substantial presence test.24  It does not matter whether you are treated as a resident alien because you a green card or not.25  Indeed, it would seem that becoming a citizen will not satisfy this requirement. You must be physically present in the United States for a sufficient number of days in the following year to be a resident alien under the substantial presence test.

Effective Date for the Election

If you meet all of the requirements,26 you may elect to be treated as a resident of the United States for the current year.27)  The effective date for the election—the first day on which you are treated as a resident of the United States—is the first day of the “period of continuous presence” that applies to you. 28  That is, it is the first day of the “31 days in a row” in the United States that kicks of the “period of continuous presence” in which you were physically in the United States for at least 75% of the days between that first day of the 31-day period and December 31.

First Ask for an Extension

Actually making the election to be treated as a resident alien in the current year is tricky, because you do not qualify for the election until you meet the substantial presence test for the following year.29

The election is made by filing a statement on Form 1040 for the year for which you want to make the election.30  However, you cannot make the election until you have satisfied the substantial presence test for the following year.31  This guarantees you will miss the filing deadline for the current year, of course.

As a result, the Regulations allow you to apply for an extension of time to file your current-year income tax return.  You will get enough time to accrue enough days to satisfy the substantial presence test in the following year, plus a “reasonable period”.32  You must apply for this extension of time prior to the due date for filing the tax return for the year in which you want to make the election (i.e., the usual April 15 deadline).  You do not include extensions—even if you file Form 4868 and get an extension until October 15, you must still apply for the extension of time for purposes of this particular election before the April 15 filing deadline.

There is no form for this election, and no specific instructions exist for how to make the election for resident status under Section 7701(b)(4).  As a result, we look to the default rules under the Regulations for guidance on how and where to make the election.  These rules tell you to make the request for extension in the form of a letter.33  The letter must “clearly set forth” information about the tax return for which a filing deadline extension is requested,34 and enough facts to allow the examining officer to figure out whether to grant the extension or not.35  Presumably, providing all of the information required under the Section 7701(b)(4) regulations would satisfy this requirement.

The extension request is sent to the place where you would be required to file your income tax return.36  This should be the place where you would file your Form 1040, assuming your application for resident status under Section 7701(b)(4) is successful.

Interestingly, the default rules for granting extensions of time to file returns have time limits that are at odds with the specific rules for the extension of time under Section 7701(b)(4).  The default rules say that the Commissioner may grant a “reasonable” amount of time as an extension.37  However, “reasonable” is limited by a flat prohibition on extensions greater than six months.38  We have a collision between a six month limit in the general Regulations about extensions of time,39 and an open-ended amount of time allowed under the specific Regulations for making the Section 7701(b)(4) election.40  Go with the open-ended authorization and ask for enough time for you to guarantee that you satisfy the substantial presence requirement for the year following the year for which you wish to make the election.

In addition to filing the extension request at the right time, you must make an estimated tax payment.  The payment is computed as if you are a nonresident alien for the entire election year.41

Election for Dependent Children

If you are making the election for yourself, you can also make the election for a dependent child.42

The Election Statement

Once you have satisfied the substantial presence test for the following year, you will file your Form 1040 for the year for which you want to make the election to be treated as a resident alien.  The information required in this statement is specified in the Regulations:43

  • Your name and address;44
  • A statement that you were not a resident of the United States in the immediately preceding tax year;45
  • A statement that you are a resident alien under the substantial presence test in the year following the election year;46
  • The actual number of days of presence in the United States that you had in the year following the election year;47
  • The starting and ending date of the 31-day period of presence in the United States for the election year;48
  • The starting and ending dates of the period of continuous presence in the United States for the election year;49 and
  • If you were out of the United States for five or fewer days during the period of continuous presence in the election year (so that those days are in fact treated as if you were in the United States, even though you were not),50 those dates are identified.51

The statement must be a “signed declaration” that you are making the election.52  If you are making the election for a dependent, you must include all of that information for the dependent as well.53  Although the Regulations do not require it, I suggest you attach a copy of the extension correspondence to your Form 1040.

Conclusion

These rules are astonishingly complex.  The likely tax benefit to an individual making the election will probably be outweighed by the cost of professional fees incurred in making the election.  If the taxpayer makes the election himself or herself, the opportunity cost and brain damage incurred is likely to yield an economic benefit slightly lower than the Federal minimum wage.  Why bother?

 

 

  1. Internal Revenue Code Section 7701(b)(4)(A). []
  2. Internal Revenue Code Section 7701(b)(4)(A)(4)(ii); Treasury Regulations Section 301.7701(b)-4(c)(3)(i)(A).  The three ways to become a resident alien, as specified in Internal Revenue Code Section 7701(b)(1)(A), are to have a green card, meet the substantial presence test, or make an election to be a resident alien. []
  3. Internal Revenue Code Section 7701(b)(4)(A)(i); Treasury Regulations Section 301.7701(b)-4(c)(3)(i). []
  4. Internal Revenue Code Section 7701(b)-4(A)(iv)(I); Treasury Regulations Section 301.7701(b)-4(c)(3)(i). []
  5. Treasury Regulations Section 301.7701(b)-4(c)(3)(ii). []
  6. Treasury Regulations Section 301.7701(b)-4(c)(3)(iii). []
  7. Internal Revenue Code Section 7701(b)(3)(D)(i); Treasury Regulations Section 301.7701(b)-3(a)(1). []
  8. Treasury Regulations Section 301.7701(b)-4(c)(3)(iv).  Form 8843 is used to report exempt individual status. []
  9. The medical condition rules are found in Internal Revenue Code Section 7701(b)(3)(D)(ii); Treasury Regulations Section 301.7701(b)-3(a)(2).  The exclusion of these days from the “30 days in a row” requirement is found in Treasury Regulations Section 301.7701(b)-4(c)(3)(iv). []
  10. Treasury Regulations Section 301.7701(b)-3(a)(3) describes the concept of transit; Treasury Regulations Section 301.7701(b)-4(c)(3)(iv) excludes those transit days from the “31 days in a row” requirement. []
  11. Treasury Regulations Section 301.7701(b)-3(a)(4) describes the commuter exception; Treasury Regulations Section 301.7701(b)-4(c)(3)(iv) excludes those commuter days from the “31 days in a row” requirement. []
  12. Internal Revenue Code Section 7701(b)-4(A)(iv)(II). []
  13. Treasury Regulations Section 301.7701(b)-4(c)(3)(iv). []
  14. Treasury Regulations Section 301.7701(b)-4(c)(3)(ii). []
  15. Treasury Regulations Section 301.7701(b)-4(c)(3)(iv). []
  16. Internal Revenue Code Section 7701(b)(3)(D)(i); Treasury Regulations Section 301.7701(b)-3(a)(1). []
  17. Treasury Regulations Section 301.7701(b)-4(c)(3)(iv).  Form 8843 is used to report exempt individual status. []
  18. The medical condition rules are found in Internal Revenue Code Section 7701(b)(3)(D)(ii); Treasury Regulations Section 301.7701(b)-3(a)(2).  The exclusion of these days from the “period of continuous presence” requirement is found in Treasury Regulations Section 301.7701(b)-4(c)(3)(iv). []
  19. Treasury Regulations Section 301.7701(b)-3(a)(3) describes the concept of transit; Treasury Regulations Section 301.7701(b)-4(c)(3)(iv) excludes those transit days from the “period of continuous presence” requirement. []
  20. Treasury Regulations Section 301.7701(b)-3(a)(4) describes the commuter exception; Treasury Regulations Section 301.7701(b)-4(c)(3)(iv) excludes those commuter days from the “31 days in a row” requirement. []
  21. This, of course, is flat-out sarcasm. []
  22. Treasury Regulations Section 301.7701(b)-4(c)(3)(iv). []
  23. Treasury Regulations Section 301.7701(b)-4(c)(3)(iv). []
  24. Internal Revenue Code Section 7701(b)(4)(A)(iii); Treasury Regulations Section 301.7701(b)-4(c)(3)(i)(B). []
  25. Internal Revenue Code Section 7701(b)(4)(A)(iii); Treasury Regulations Section 301.7701(b)-4(c)(3)(i)(B). []
  26. Internal Revenue Code Section 7701(b)(4)(A). []
  27. Internal Revenue Code Section 7701(b)(4)(B []
  28. Internal Revenue Code Section 7701(b)(4)(C); Treasury Regulations Section 301.7701(b)-4(c)(3)(i). []
  29. Treasury Regulations Section 301.7701(b)-4(c)(3)(i)(B). []
  30. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(A). []
  31. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(A). []
  32. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(A). []
  33. Treasury Regulations Section 1.6081-1(b)(1). []
  34. Treasury Regulations Section 1.6081-1(b)(1)(i). []
  35. Treasury Regulations Section 1.6081-1(b)(1)(ii). []
  36. Treasury Regulations Section 1.6081-1(b)(1). []
  37. Treasury Regulations Section 1.6081-1(a). []
  38. Treasury Regulations Section 1.6081-1(a). []
  39. Treasury Regulations Section 1.6081-1(a). []
  40. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(A). []
  41. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(A). []
  42. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(B). []
  43. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C). []
  44. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C). []
  45. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C)(1). []
  46. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C)(2). []
  47. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C)(3). []
  48. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C)(4). []
  49. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C)(4). []
  50. Treasury Regulations Section 301.7701(b)-4(c)(3)(iv). []
  51. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C)(5). []
  52. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C). []
  53. Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C). []

Form 1040NR Filing, Tax Payment Deadlines

I received an email from a CPA friend of mine today. She and another person in her office disagreed on a seemingly simple question. They were preparing a Form 1040NR for a nonresident alien and wanted to get an extension of time to file the tax return. They both agreed that Form 4868 should be filed before June 15 to get the extension of time to file a timely tax return. But they disagreed on making the tax payment: is the tax payment due on April 15 or June 15?

I was about to reflexively answer her question when I thought to myself, “Hang on. Let’s look at the Code.” I’m glad I did. My reflexive answer would have been conservative, safe, and wrong. (Hint: I would have said “Pay the tax by April 15, file Form 4868 by June 15. That’s wrong. But it’s safe!)

This blog post will now explain the rules entirely without using IRS Publications, instructions to various forms, or other similar unreliable and lazy crutches. This is totally an Internal Revenue Code plus Treasury Regulations boondoggle. The Board of Accountancy should award you bonus CPE credits for reading this blog post. :-)

Since this post is written in response to a CPA’s question (and she will read this), you should approach it as if you are a CPA. Basic terminology will not be explained.

TL;DR

A nonresident alien who has U.S. taxable income and must file a U.S. income tax return (Form 1040NR) must do so on or before June 15.

The nonresident alien can get an extension of time to file a tax return by filing Form 4868. This will extend the filing deadline to December 15.

If the nonresident alien owes U.S. income tax, the payment deadline is June 15.

The rules are cheerfully and needlessly different for a nonresident alien who has wage income subject to U.S. income tax withholding. For these folks, the filing deadline is April 15. An extension of time will run to October 15. The payment deadline is April 15 for any tax liability.

Filing Deadline

I am going to ignore nonresident aliens who have wage income subject to U.S. income tax withholding. Let’s just talk about my friend’s client, who has rental income from U.S. real property and must file Form 1040NR to report the income and pay the income tax.

Internal Revenue Code Section 6072(c) contains the rule:

Returns made by nonresident alien individuals (other than those whose wages are subject to withholding under chapter 24) . . . under section 6012 on the basis of a calendar year shall be filed on or before the 15th day of June following the close of the calendar year and such returns made on the basis of a fiscal year shall be filed on or before the 15th day of the 6th month following the close of the fiscal year.

(Section 6012 of the Internal Revenue Code is the basic rule that says humans and other sentient and non-sentient beings must file income tax returns in the United States).

I am going to ignore fiscal year taxpayers. Rare indeed is the nonresident alien who has the presence of mind to claim a fiscal year for a tax year on his or her U.S. income tax return. Plus it is well known that fiscal year accounting (and the accrual method, for that matter) cause brain damage. It’s true! You can look it up.

So the nonresident alien who is using the calendar year as his or her tax year has a filing deadline of June 15.

There are the usual rules for pushing the filing deadline forward if June 15 falls on a weekend or public holiday. In 2013, for instance, June 15 falls on a Saturday, so the actual filing deadline will be the first business day after that, which is Monday, June 17, 2013.

You can find the filing deadline information easily enough in the Instructions to Form 1040NR.

Extension of Time to File Tax Return

A nonresident alien (again we are talking about someone with no wage income subject to U.S. income tax withholding)) who wants more time to file a tax return can apply for an extension. This is done with the normal Form 4868.

A properly and timely-filed Form 4868 extends the filing deadline for our nonresident alien to file his Form 1040NR until December 15. You want to know why? Here you go.

The time prescribed for filing the tax return is June 15. Internal Revenue Code Section 6072(c). The taxpayer can get an automatic six month extension of time from the time prescribed for filng the tax return. Treasury Regulations Section 1.6081-4(a) says:

(a) In general. An individual who is required to file an individual income tax return will be allowed an automatic 6-month extension of time to file the return after the date prescribed for filing the return if the individual files an application under this section in accordance with paragraph (b) of this section. In the case of an individual described in §1.6081-5(a)(5) or (6), the automatic 6-month extension will run concurrently with the extension of time to file granted pursuant to §1.6081-5.

The last sentence does not apply to a nonresident alien. An individual described in Treasury Regulations Section 1.6081-5(a)(5) or 1.6081-5(a)(6) is a U.S. citizen or resident living abroad. A nonresident alien is not that.

The method for getting the automatic six month extension is spelled out in Treasury Regulations Section 1.6081-5(b). In plain English? File Form 4868.

Time to Pay Tax

Now we know when the nonresident alien must file an income tax return that is treated as filed “on time”. What if the taxpayer has a tax liability? What is the payment deadline for the tax payment?

The general rule is that income tax is due and payable at the time and place fixed for filing the tax return. Internal Revenue Code Section 6151(a) says:

Except as otherwise provided in this subchapter, when a return of tax is required under this title or regulations, the person required to make such return shall, without assessment or notice and demand from the Secretary, pay such tax to the internal revenue officer with whom the return is filed, and shall pay such tax at the time and place fixed for filing the return (determined without regard to any extension of time for filing the return).

As is common in the Internal Revenue Code, we are invited to go on a treasure hunt. “Except as otherwise provided in this subchapter” is the magic incantation that sends us on our quest. “This subchapter” refers to Title 26, Subtitle F, Chapter 62, Subchapter A of the United States Code. (Title 26 of the United States Code is colloquially referred to as the “Internal Revenue Code” and it is where Federal tax law lives). Subchapter A includes Sections 6151 through 6159. Trust me. There is no exception lurking in Sections 6151 through 6159 of the Internal Revenue Code that would apply to our nonresident alien.

Therefore, we conclude that a nonresident alien individual who must file Form 1040NR must — if tax is due — pay that tax on or before June 15.

An extension of time to file a tax return does not extend the time for payment of the tax due. Internal Revenue Code Section 6151(a); Treasury Regulations Section 1.6151(a)(1).

Note that the normal rules for estimated payments of tax will apply. If you make a big lump sum payment on June 15 and you should have made quarterly estimated payments, expect a little letter from the IRS asking you to shed some blood in penance.

Nonresidents with Wage Income Tax Withholding

Finally, I will just wave a flag here. My friend the CPA did not have this problem so I did not look at it. But if the nonresident alien taxpayer had received wage income on which withholding was imposed under “Chapter 24″ (i.e., Title 26, Subtitle F, Chapter 24 of the United States Code), then all of this would not apply.

Alimony Payments to Nonresidents

[I am preparing course materials for an upcoming presentation at the 2012 CalCPA Family Law Conference (01 Nov 2012 in Los Angeles, 02 Nov 2012 in San Francisco; the San Francisco event will be webcast) on the international tax aspects of divorce. This is a piece of what I am working on. It is a draft version, so please forgive mistakes. People who attend the live show will get the final version of this, along with the other topics I will cover.]

Introduction

Alimony payments to nonresidents can be tricky.  The tax rules are similar enough to purely domestic situations to encourage complacency, but with withholding, paperwork, and penalty risks for the complacent.

Read more…

Property you acquired before coming to the USA

This is a quick little blog post to answer a recurring question for many people out there.  It came up in the course of some work I am doing right now.

Situation

You are a nonresident of the United States.  Thirty years ago you bought a piece of land in your home country for US$10,000.  Now it is worth US$200,000.

You immigrate to the United States, then sell the land for its current value — US$200,000.

Question

Do you pay U.S. capital gain tax on the entire $190,000 of capital gain?

Answer

Yes.

Why

Just because you change status from nonresident to resident of the United States, you don’t change the U.S. tax laws that apply to your transaction.  Unfortunate but true.  You calculate your U.S. tax results using U.S. tax law, despite the fact that you were a nonresident when you bought the property.

From 1998 FSA LEXIS 402:

In several cases, the Tax Court has determined the adjusted basis of property acquired by a U.S. taxpayer outside the U.S. before becoming a U.S. resident. The court has assumed as the starting point the taxpayer’s appropriate basis under U.S. tax principles. Compare Gutwirth v. Comm’r, 40 T.C. 666 (1963) (1939 Code) and Benichou v. Comm’r, T.C. Memo 1970-263 (taxpayer’s basis was initial cost) with Reisner v. Comm’r, 34 T.C. 1122 (1960) (taxpayer’s basis was fair market value upon inheritance). In general, the taxpayer’s cost basis for purchased property has been determined to be the initial expenditure in the foreign jurisdiction.n5 See Heckett v. Comm’r, 8 T.C. 841 (1947).

The same idea is true if you acquired the property by inheritance.  Your acquisition basis (and therefore the starting point for calculating capital gain) is the date of death value for property.  (Date of death = the date the person from whom you inherited the property died).

But I digress . . .

The Reisner v. Commissioner case contains an interesting little tidbit of information for those of you handling World War II restitution cases.  (Yes, I still run into this every so often, most recently in an OVDI case).  There a gentleman was forced to sell property in Berlin in 1937.   He had inherited the property in 1926 from his parents.  After the war he recovered the property under an order of restitution — Order No. 49 by the Allied Berlin Kommandatura.  The legal effect of this order told the Tax Court everything it needed to know about calculating the basis of the buildings in the hands of the taxpayer.

The order said that anyone receiving restitution under the order would be treated as if he had an unbroken chain of title — that the property had always been his.

This gave the Tax Court an easy way to determine the basis of the buildings in the hands of the taxpayer — date of death valuation in 1926 plus the cost of capital improvements.

It is rare that you find a non-tax fact so clear as that postwar order.  Usually these World War II restitution cases are messy in the extreme.

I’m back now

And the results of this case give us clear guidance on how you should handle your capital gain tax for the year of sale.  This gentleman was deemed to have acquired the property by inheritance while a nonresident of the United States.  He got the 1926 acquisition cost (calculated under U.S. tax law).

Exception for exit tax

There is a weird little exception for people who expatriate.  Green card holders.  I will write a blog post about this later.  If you come to the United States, stay long enough with a green card, then leave the country and are subjected to the exit tax (Section 877A; go see Form 8854), you can use the “date of entry” value to calculate your capital gain for purpose of the mark-to-market gain.

All gibberish for those of you who don’t live inside the Holy Temple of Exit Tax, I’m sure.  Here’s an example.

You are a nonresident of the United States.  Thirty years ago you bought a piece of land in your home country for US$10,000.  Now it is worth US$200,000.

You immigrate to the United States, stay for 10 years, and then say “Oh, (blankety blank blank).  I’m outta here!” and relinquish your green card.  You still have the land.  At that point it is worth $300,000.

For exit tax purposes (assuming you are a “covered expatriate”) you are deemed to have sold the land at fair market value on the day before you gave up your green card.  So you’re treated as selling at $300,000.  Lucky for you, though, you get to use the value of the property on the day you came into the USA — $200,000 — to calculate that exit tax.  So you only pay tax on $100,000 of capital gain.  Make-pretend capital gain.  Lucky you.

Yeah

We need more unnecessary complexity.  Please Congress — write more ill-conceived tax laws charmingly devoid of common sense and jet-fueled by partisan lobbyists and Poli Sci majors burnishing their resumes with three years of work on the Hill, all with an ideological ax to grind and a pocket to stuff with government largesse.  (Who by the way couldn’t spell “If A, then B” if you handed them both letters).  (Both parties offend me; spare me your tortured outrage.  I’ve received too many emails saying “How COULD you??? Are you one of THEM?????” emails).  (But I’m not bitter.)

Sigh.

Nonresidents’ U.S. bank interest earned to be reported to IRS

The IRS came out with their Regulations which tell banks that they must report interest earned by nonresidents.  Up to now, this was not done.  If a nonresident opened a bank account in the United States, the interest earned was not reported to the U.S. government.

The bank interest itself is not taxable in the United States.  These new Regulations do not change that.  These new Regulations merely force the bank to tell the U.S. government how much interest was earned, and the identity of the nonresident bank account holder.

Why?

The IRS is trying to force every foreign bank in the world to report the accounts of U.S. persons.  It wants information from other countries shared with the IRS.  In that way, the IRS believes it can reduce tax evasion by U.S. persons.

If the IRS wants banks in Mexico to share information with the United States, it is reasonable that Mexico would ask for information about Mexicans with U.S. bank accounts.  Oh, wait.  

Up to now, the U.S. government has not had any information to share.  If the IRS wants to play the game of “Let’s share information on each other’s taxpayers!” then the IRS needs stuff to share.  These Regulations make that happen.

Logic Box

This move by the IRS makes complete sense, within the government’s tiny logic box.  The IRS Commissioner would be laughed out of the Diplomat Club as a hypocrite if information sharing was a one-way affair.  The U.S. government has not been shy about strong-arming other countries into changing their laws to serve the purposes of the United States.  This cannot go on forever.  The U.S. has to make a pretense at being even-handed.

The Regulations will stand.  Diplomats will junket amongst themselves happily and solemnly.  Treaties and Agreements will be signed.  Press releases will be released.  Everyone will be happy.  Within the logic box.

Outside the box

For those living outside the logic box, we know of the concept of “perverse incentives” and “unintended consequences.”  We understand that humans are not static.  New situations trigger new behavior.

The movement of capital out of U.S. banks to other countries is an obvious one.  (What are the effects to the U.S. economy?)  This has been resoundingly and repeatedly rejected by the IRS.  We now get to watch and see whose prediction is right.

The IRS will acquire a lot of information about interest earned by nonresidents.  Will this information be valuable?  Will it be useful in acquiring the reciprocal information that the U.S. government hopes to get?  Or will other governments find ways to resist the coquettish “come hither” blandishments of the U.S.?  My guess is that the government will get rather less use out of the information than expected.  This is a hypothesis that unfortunately cannot be tested rigorously because the data (if it is collected) will be inside the belly of the beast, and not available to impartial outsiders.

The IRS probably expects this to be an incentive that drives future voluntary income reporting by U.S. taxpayers with bank accounts abroad.  Maybe.  Again, the data to prove/disprove this hypothesis will lie deep inside the government, immune to truth serum.  Equally plausible is that this will continue to accelerate expatriations (we get calls daily for this).

Comment

The U.S. government launched itself on an aggressive course of rooting out and punishing U.S. tax evaders.  The hallmark of this quest was continued pressure to get information from other countries.  Once launched, the course of action must continue to its logical conclusion despite the best efforts of many to point out its flaws.

FATCA bomb