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March 15, 2012 - Phil Hodgen

Expatriates failing the certification test create trouble for themselves

Reader (G)ee posted a comment with follow-up questions on expatriation if you’ve never filed tax returns on my post “The Exit Tax Paperwork for People Who Have Never Filed.”  That post was triggered by her question, too.  🙂

Question #1

I want to put her questions in a blog post or two because, well, it will make it easier to find and collect these thoughts rather than just putting an answer in the comment thread.

Thanks for posting my question as a blog.  This has brought significant clarity thus far.  

However, in regards to your comments regarding leaving “Unnecessary Open Loops”, I have a couple of further questions.

First, doesn’t being subject “to the exit tax” on the basis of “failing to certify” compliance close the loop because the individual is no longer a US citizen because they have both renounced and filled out the 8854 form as a “covererd expatriate” as the law requires?  

Why would the option to be a “covered expatriate” be offered to a “failed to certify” dual at birth unaware citizen if it did not adequately deal with the final exiting process?  Are they not coming into compliance by being subject to the “exit tax”?  In some cases, filing 5 years of 1040’s (with no tax owing) may expose the dual/born abroad to various reporting penalties even if they never owed the US any real tax monies.

Fail Certification Test? You’re a Covered Expatriate

You (not (G)ee but the “you” who is the would-be expatriate trying to figure out what to do) can fail the certification test for two reasons:  you don’t certify you’re up to date and paid up on your last five years of income tax, or you DO certify that you’re up to date, but you file the paperwork (Form 8854) late.

That makes you a “covered expatriate.”

That treats you as if you sold all of your stuff on the day before you cancelled the passport.  You decanted all of your IRAs.  If you have pensions, etc., you have to do whatever Section 877A tells you do to with them.  Ditto for beneficial interests in foreign trusts.

You have that status no matter what your net worth.  If all you have in the world is a peanut butter and jelly sandwich, the IRS wants it to be marked to market and capital gain calculated.

The Resulting Open Loop:  “Hit Me Here.  In the Jaw.  Hard.”

Your life now has an open loop.

The open loop here is an unsatisfied (and probably uncalculated) tax liability to the U.S. Treasury Department.  They know you cancelled your citizenship.  They know you are a covered expatriate (you filed Form 8854, remember?).  They know you didn’t file tax returns for the prior years.

So what is a government to do?  Answer:  rain on your parade.

Just filing that exit year tax return and Form 8854 and saying “Sorry, Uncle Sam, in fact I haven’t filed tax returns for the prior five years” will make you technically comply with the exit tax paperwork filing requirements.  But it shines a gigantic searchlight on a gaping hole in the rest of your life’s work — filing of annual tax returns going back.  In other words, you showed up and said “Guilty, Your Honor.”  On paper.

You haven’t filed tax returns.  Therefore the statute of limitations is still open for all of the years. The government can pursue you as far and as hard as it chooses.  The government will (sooner or later) make up an imaginary number of what they think you had in taxable income, assess a very real tax liability based on their imaginary income number for you, and tell you to pay or die.

You can solve the problem by running away and never coming back to the United States as a tourist or anything else.  As long as you live in a place that is not too thrilled to help the U.S. government collect U.S. taxes, you’re probably safe.  Or you will solve the problem by going to the IRS and dealing with the mess.

Question #2

A second question:  what did you mean by “if you want to re-enter the USA”?  Are you referring to whether one would  ever want to establish a residency in the US as a now alien or are you referring to just crossing the border?

I mean “crossing the border.”  The immigration people at the border are even grumpier than the IRS.  Why put your head in the lion’s mouth?

Question #3

A third question:  even if the US changes the expatriation process once again, thus changing the rules for the now non US citizen “covered expatriate”, can this be done retroactively, re-exposing a now ex US citizen to future risk?

In general the Constitution is supposed to protect against retroactive application of laws.  What you think is legitimate under the Constitution may be very different from what Congress thinks is legitimate, and what the Supreme Court thinks is legitimate.

E.g., under the old expatriation rules, you could give up your passport but until you filed all of  your paperwork, the IRS considered you to be a U.S. taxpayer.  So if you gave up your passport in 2005 and you never filed Form 8854, as far as the U.S. government is concerned you’d be a U.S. taxpayer out of compliance with everything.  Even though you’re not a citizen.  Although this is not “apply the law backwards in time” I give you this example to show how the U.S. government cheerfully assumes it owns you.

Proving the contrary would require hundreds of thousands of dollars litigating constitutional issues in Federal Court.  If you lose, you risk total financial destruction or imprisonment.

Yesterday, the Senate passed a bill which — if the House agrees and President Obama signs it — will give the government the power to cancel your passport if you owe $50,000 or more in tax.

Own your own life.

Expatriation