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August 25, 2015 - Phil Hodgen

The Expatriation Chronicles of an Accidental American, Episode 3

Note from Phil:  this is the third episode of The Expatriation Chronicles, in which we follow the renunciation process from start to finish with a 17-year old Irish girl who is an Accidental American.

  • Episode 1 (Phil’s introduction)
  • Episode 2 (A’s introduction – why she wants to renounce her U.S. citizenship)

This episode went out on my biweekly Expatriation Only email letter, which you should sign up for, if you have not done so already.


Hi from Phil. This is the biweekly Expatriation Only newsletter you signed up for. If you want to unsubscribe, click on the link at the bottom of this email. We have [other mailing lists] if you are interested in other international tax topics.

The Expatriation Chronicles

This week’s newsletter is the third episode of The Expatriation Chronicles, a series about the experience of a 17-year old girl (let’s call her “A”) who, due to an accident of birth, became a U.S. citizen. She needs to renounce her U.S. citizenship because it is an impediment to her academic future.

Episode 1 and Episode 2 have already been posted to the blog.

My original discussions with her assumed that she did not have a Social Security Number. She has done some digging and discovered that she does, indeed, have a Social Security Number. You can read all about it in Episode 2 on the blog.

What to do when you do not have a Social Security Number?

But for those of you who are in a similar position and do not have a Social Security Number, here is a quick discussion. You need to make a strategic decision. You must choose between these two approaches:

  • Get a Social Security Number first, then renounce U.S. citizenship; or

  • Renounce U.S. citizenship, then get an Individual Taxpayer Identification Number.

Why it matters

There are two reasons why this strategic decision matters:

  • Timing. Is it important, for external, non-tax reasons, to shed the U.S. citizenship as soon as possible?

  • Taxes. Not having a U.S. taxpayer identification number makes it impossible to be fully compliant with U.S. tax requirements, and that means potential covered expatriate status (because of failing the certification test).

Timing considerations (renunciation for minors)

Just as an aside, A may or may not have a hard time getting a renunciation appointment before her 18th birthday. Go read the State Department’s Foreign Affairs Manual (warning, PDF) for more information on this.

We shall see how this plays out in the real world, because A is working on this right now. This is a matter of discretion for the consular official. She might be told to go away and come back when she is 18. We shall see.

Taxpayer Identification Numbers

“Taxpayer Identification Number” is the genus, encompassing a number of species of identification numbers used by the Internal Revenue Service for tax purposes.

  • A Social Security Number is a taxpayer identification number used for humans who are entitled to receive a Social Security Number.

  • An Individual Taxpayer Identification Number is a taxpayer identification number used for humans who are not entitled to receive a Social Security Number. Use Form W-7 to get this.

I will not bother to explore identification numbers in depth. Here is what is important to remember:

  • As long as you are a U.S. citizen, you are entitled to receive a Social Security Number. This means you are not entitled to receive an Individual Taxpayer Identification Number.

  • As soon as you renounce and are no longer a U.S. citizen, you cannot get a Social Security Number, so you must apply for (and receive) an Individual Taxpayer Identification Number for any U.S. tax filings you are required to do.

The tax risk: covered expatriate status

I find it useful, when making strategic choices, to identify the precise risk that exists. Here, having a Social Security Number (or not) has the power to cause A to avoid covered expatriate status.

Being a covered expatriate means two things:

  • A potential income tax liability is triggered by the act of renunciation; and

  • Gifts or bequests to U.S. persons will trigger a tax liability for the recipient.

Risk #1: no income tax will be payable

A is 17 and has not yet entered university. She has no assets and has earned no income.

Therefore, the exit tax (“pretend you sold everything you own on the day before you renounced U.S. citizenship”) (disclaimer: certain conditions, exceptions, and baroque modifications apply) does not matter to her.

She cannot possibly owe any money to the U.S. government.

This is a non-issue. If you are in this position, too, then you will not fear the exit tax. There are other reasons why you might not fear the exit tax as well. If you are in a position of wanting to expatriate but you do not have a U.S. Social Security Number, you should analyze this to your own satisfaction.

Risk #2: tax on U.S. recipients of gifts, bequests improbable

So the only potential tax problem that that someone like A would face is the second factor. If you are in that position, you must ask yourself: “Someday, somehow, will I make a gift to a U.S. person, or when I die will I leave an inheritance to a U.S. person?” If the answer is “Yes,” then there will be a tax payable by the recipient — at the highest gift tax rate in existence at the time of the transfer.

The most likely scenario for this? Someday you have children, and your children are U.S. citizens.

It is difficult to make predictions, especially about the future. (Origin of this quote: unclear.)

However, if you ask A, she would likely dismiss this eventuality (having U.S. citizen children someday, or leaving large chunks of money to U.S. persons under any circumstances) as being at laughably-less-than-lottery-ticket level probabilities.

In my experience in working with others, the possibility of their children becoming U.S. persons is remote, and they dismiss the risk out of hand.

This is usually a non-issue.

Conclusion: no fear of covered expatriate status

For someone like A, there is no fear of covered expatriate status. No (tax) harm can happen if the U.S. tax system, for some reason, categorizes her as a covered expatriate.

But . . . no filing requirement, no covered expatriate status

The certification test says you are a covered expatriate if you do not certify that you are fully compliant with all of your U.S. tax paperwork obligations and tax payment obligations for the five calendar years before the year you renounce your U.S. citizenship.

By definition you cannot file any tax paperwork if you do not have an identification number to put on the forms.

This means that a U.S. citizen who does not have a Social Security Number will by definition be a covered expatriate when he or she renounces U.S. citizenship, because that person could never have filed a tax return and paid any tax.

Unless, of course . . .

. . . that person, like A, had no requirement to file tax returns or pay tax to the United States.

A’s income (zero dollars per year) was well below the level that triggers a requirement to file an income tax return with the Internal Revenue Service. She could not possibly owe any income tax to the United States. Zero income multiplied by any tax rate you can think of is still zero dollars of tax liability.

As a result, A can say with a high degree of certainty that she passes the certification test. She can answer that magic question at the bottom of page 2 of Form 8854 by ticking the “Yes” box. She does not need to file U.S. tax returns to make this happen.

There are a number of reasons why you might not have a U.S. tax return filing requirement (or a U.S. income tax liability) as a U.S. citizen. Check this out for yourself. You might not be a covered expatriate even though you never filed an income tax return.

Get an identification number later for the 2015 tax filings

So far, we have come to a tentative conclusion that it is possible to renounce U.S. citizenship first, then apply for an Individual Taxpayer Identification Number later, and deal with the tax paperwork later. It is possible to do this without being a covered expatriate.

What about the tax filings required for the year of renunciation? If, for instance, you have no Social Security Number and renounce your citizenship in 2015, you will have U.S. tax filings to do, and you will need a taxpayer identification number to do that. Since you are no longer a U.S. citizen, you will need to get an Individual Taxpayer Identification Number (use Form W-7) to use for your tax filings.

As we walk through the whole process with A (which will be, ermmm, chronicled in The Expatriation Chronicles), we will talk about what she needs to file for the year of expatriation (hint: probably just Form 8854). Your situation might be similar, or you might need to file an income tax return as well.

The critical thing to know is the filing deadline for the 2015 tax forms you must file — and figure out whether you have time to get an Individual Taxpayer Identification Number in time to file everything correctly.

Short answer: yes.

For someone renouncing U.S. citizenship in 2015, the tax filing deadline will be 15 June 2016.

On (well, actually, before) that day, you need to have a properly completed Form W-7 in hand. It will be attached to the tax forms that you file.

In order to complete Form W-7, you will need your (other) passport certified at the U.S. Embassy/Consulate. In order to do that, the consular official (even if it is the same person who administered the renunciation oath to her) will almost certainly require you to show your Certificate of Loss of Nationality.

So. The sequence of events is:

  • renounce citizenship,

  • wait a while,

  • get your Certificate of Loss of Nationality,

  • go get a photocopy of your other passport authenticated at the Embassy,

  • attach it to a filled-in Form W-7, and

  • attach that Form W-7 to the tax return or Form 8854 or whatever you are filing.

As long as you get your Certificate of Loss of Nationality in plenty of time before 15 June 2016, you will be able to file everything on time.

Strategy decision time

OK, with all of that background, here is how the analysis ends up for someone who has no Social Security Number and wants to renounce U.S. citizenship. A is fortunate — she discovered that she does, in fact, have a Social Security Number that was presumably issued to her at birth. But for the rest of you, make your strategy decision as follows:

  • If you need a Certificate of Loss of Nationality for “real life” reasons (A will have problems with enrolling in University if she has a U.S. passport; you might have problems with your bank as an American citizen), the preference is expatriate now, get an Individual Taxpayer Identification Number later.

  • If you have no risk of being a covered expatriate by failing the certification test (e.g., your income was so low that you were not required to file tax returns or pay income tax), then you are safe from unpleasant tax blow-back. Preference: expatriate now, get an Individual Taxpayer Identification Number later.

  • If you will be a covered expatriate (by failing the certification test because you should have — but did not — file U.S. tax returns for the previous five years), look to see the real cost of this. If your exit tax will be zero or close to it, and if you are unlikely to ever have to worry about the taxation of gifts or bequests to U.S. persons by a covered epatriate, then no harm can befall you, taxwise. Preference: expatriate now, get an Individual Taxpayer Identification Number later.

  • Unless the Embassy is stunningly inept (and it does happen!), you will have a Certificate of Loss of Nationality in two or three months, maximum. If that is enough time for you to return to the Embassy and get your (real) passport certified and file a Form W-7 on or before 15 June 2016, then the tax filings will be on time. Preference: expatriate now, get an Individual Taxpayer Identification Number later.

In conclusion, people with no Social Security Number issued can sometimes renounce their U.S. citizenship in a fairly expedited process. They can deal with the U.S. tax mess (including getting an Individual Taxpayer Identification Number) later.

Disclaimer

This, of course, is not legal advice to you. Go hire someone. Get some help on this stuff. This discussion was just to illustrate some ideas here, and how to approach making decisions on expatriation strategies.

Keep watching the blog for updates as we track this expatriation all the way through from “I’ve been thinking about this” to “Done.”

See you in two weeks.

Phil.

Expatriation Expatriation Chronicles of an Accidental American