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May 7, 2013 - Phil Hodgen

Expatriation if you never lived in the USA

I received a question from a reader and it is worth a blog post.

I have been reading the expatriation blog. I have a question regarding expatriation of dual nationals never having lived in the US. If they file the 5 years back + current year 2012 IRS and Treasury Dept. forms and then renounce a couple of months after, how soon can they send in the final papers? Is there any advantage to for example file the back years in November, renounce in December and then send the final forms at the beginning of 2014? I suppose this could also be done via the Streamlined program?

Who

This is all about dual-citizens (USA plus some other country) where the individual has never lived in the USA. Indeed, in my experience these people may not even have a Social Security Number.

They’ve never filed U.S. tax returns because–except for an accidental event in their lives that caused them to be U.S. citizens–they have no contact with the United States.

What They Want

Sadly, U.S. citizenship is no longer the valuable asset that it once was. Increasingly it is a liability. These dual citizens want to renounce their U.S. citizenship.

The Tax Problem

The reason they want to give up U.S. citizenship is (in my observation) driven entirely by U.S. tax considerations. The tax considerations appear to be ranked, from most important to least important:

  • The estate tax. You have lived your entire life outside the United States. You built up a business from nothing that is now worth $100,000,000. You die and leave the business to your children who are not U.S. citizens. The United States wants to impose its estate tax the value of that business. Your response? “NFW.”
  • The paperwork/penalty environment. The U.S. tax system has a well-deserved reputation for obscure paperwork requirements and harsh penalties and taxation for people who screw things up. I’m looking at you, Mr. File-Form-5471-one-day-late-and-pay-$10,000. I’m looking at you, too, Mr. Guess-What-You-Own-A-PFIC-Ha-Ha-The-Joke’s-On-You. And I’m looking at a busload of your ilk. Peh.
  • Income tax. They’ve made their lives entirely outside the USA and are making income. If they live in a country with an income tax, they’re paying tax there. They’ve never asked the USA for anything, and never will. “Black helicopters will come and save you” is BS and all you have to do is look at the recent fun ‘n games in Egypt to see how diligent the U.S. government was there.

So they want out.

But They’ve Never Filed

As usual, I digress. 🙂

These people have never filed U.S. income tax returns. They didn’t know they had to, they thought they didn’t need to. Yet in order to renounce their U.S. citizenship they need to log out of the U.S. tax system properly. That means filing Form 8854. And that, in turn, means that you tie up loose ends for the prior years.

Which brings us back to the question I received this morning.

Here’s what I think you have to do. I’m not talking about whether you are a covered expatriate or not, or anything like that. I’m talking about the tax filing strategy that allows you to achieve your primary objective. Your primary objective is to get Uncle Sam’s tax monkey off your back. Never forget that. Do all of your tax paperwork to achieve that objective. Do not give the U.S. government any excuse to come after you in the future.

What to File

With absolute certainty, you need to file a U.S. income tax return for the year in which you renounce citizenship. Do Form 8854, and do everything else that is required.

Do the prior five years of tax returns, too. On Form 8854 they ask about the five years prior to the expatriation year. I cannot imagine renouncing citizenship if you don’t do that. Just do it. You don’t need legal advice for this. Just do it.

For the years before THAT, you need to look at your financial affairs carefully and your risk exposure. This is where the problems lurk. The U.S. government has no time limits to pursue you for tax obligations if you never file the tax return. You have to file the tax return to get the clock ticking. Ordinarily the clock imposes a three year time limit. After three years, you are safe forever. In some situations, the time clock ticks longer–six year, maybe forever. So the short answer for the ancient years is “Get some advice.”

Phil’s Pacifier Principle

If you don’t file, the clock doesn’t tick. You want the government to be closed off from chasing you, according to its own rules.

This is where you need advice. How do you close the door forever on the government, using its own rules? (Hint: the legal jargon for this is “statute of limitations”.)

My tax return filing philosophy can be summed up as “The Pacifier Principle.” If you are a parent, you know how loud an infant can be. You also know the magic of a pacifier. Pop one of those things in a baby’s mouth and it is instant quiet. There is no nutrition being delivered, but the baby is happy.

It’s the same thing with tax returns. I believe that filing tax returns–even if you are not necessarily required to do so–is a good thing. Let’s say you had zero income in a particular year. File tax returns with zero reported all over it, and zero tax due. Now you have the clock starting to tick. After three years, you are safe.

Let’s say that 10 years from now the U.S. government becomes keenly interested in you, after you expatriated. They say to you, “Aha! You didn’t file tax returns for 2012. We have you now!” Now you have to shovel snow uphill in Hell in the summertime to prove that your live in 2012 consisted of zero income and therefore zero income tax liability. Where are your 10-year old bank records? How can you prove that you had zero income?

In contrast, let’s say that 10 years from now some friendly representative of the U.S. government comes knocking and asking about your U.S. income tax returns for 2012. You say “Check your own database!” and they discover you filed, and the statute of limitations ran. It is a much harder job for the government to wreak havoc at this point.

Timing

If you’re filing a bunch of tax returns late, just file them. Yes, sometimes there is a timing strategy for when to file. This is something you figure out based on each person’s situation. Sometimes it is a good idea to wait. But more often the sensible thing is “Just get it filed.” There is no clear rule in my mind for this.

If you are asking “When should I file this tax return?” I think you are forgetting your Primary Objective: to log out of the United States, cleanly and permanently. Spend all of your time making sure your tax filings are clean and bulletproof. After that, and when everything is neatly printed and sitting on the table ready to sign and send, THEN decide whether to send them in now or wait a while.

To get specific on this person’s question, yes you could wait until November to file a bunch of stuff. And you could just file it right now. In the bigger scheme of things, remember the Primary Objective and don’t try to be too clever.

Streamlined Procedure?

Look at the Streamlined Procedure for U.S. citizens abroad. The way I read the rules, it will work very well for left-handed people who are taller than 2 meters except when they’re not, and who can whistle, but only certain tunes, and only if they file in a month that has a K in it. (Translation: the rules are imprecise, and by entering the Streamlined Procedure you have put your head in the mouth of the lion and you’re hoping the lion tells the truth when he says he won’t bite.)

I know that reasonable minds differ. Michael Miller is a great tax lawyer in New York and he thinks it works. I’m kinda cranky about all of this stuff the IRS is doing penalty-wise for U.S. citizens abroad. The IRS’s ideas sound really good until you get up and walk out of your cubicle and into the real world. Von Clauswitz had some cogent advice about this. /rant

Warning

As usual, I am not your lawyer, and this is not legal advice. You’d be a damn fool to make important decisions based on the ravings of a random dude (that would be me) on the internet. Go hire someone with skills, pay for advice, and follow it.

Expatriation