March 13, 2015 - Phil Hodgen

Mentally incompetent people and renunciation; some bad solutions

Commenter badger on the blog suggested this topic:

Could you follow up with your always insightful and informative comments – this time on the related situation of those living (and many born) entirely abroad – who are prevented (lifelong) by US law from expatriating or being expatriated (by a parent or guardian) because they are deemed legally incompetent to understand citizenship and thus to voluntarily renounce or relinquish it? They therefore are bound forever as US taxable citizen persons abroad – with all the pain and burdens that entails.

This is very important – in order for families to arrange for ALL family members to renounce and have the same non-US status for simplicity sake, and to protect their legal, local, non-US disability grants, benefits and savings (ex. Canadian Registered Disability Savings Plans RDSPs) from punitive and unjust US extraterritorial taxes, FBAR, and 3520/A burdens imposed on the funds provided by non-US taxpayers, parents and governments in order to provide for the wellbeing and support of those who cannot provide for themselves – due to chronic or congenital physical, neurological, psychological or intellectual impairments which make them unable to care for and support themselves.

Short Answer

Yes, this is a problem that I have seen a few times (always with Canadians) and I don’t know what to do about it. This requires changes to the law on the citizenship side of the equation.

I suspect in the past most people in this position simply ignored the U.S. tax stuff. Now that Mr. FATCA has come to town, this may be impossible. But it strikes me as being the least bad solution to the problem. Not that I’m saying you should deliberately break the law. I will invoke Richard Nixon’s quote (mythical, perhaps): you could do that, but it would be wrong.

The Law

The problem comes about because of the law about citizenship and the requirements for giving it up.

The law requires a finding of “intent” by someone relinquishing U.S. citizenship. Mental incompetence means it is not possible for the individual to have that intent.

The State Department’s Foreign Affairs Manual, 7 FAM 1291, says (emphasis added):

  1. Because loss of U.S. nationality occurs only when a would-be renunciant or person signing a statement of voluntary relinquishment has the legal capacity to form the specific intent necessary to lose U.S. nationality, cases involving persons with established or possible mental incapacity require careful review. This includes mental disability, mental illness, developmental impairment, Alzheimer’s disease, and similar conditions. It may also include cases of substance abuse.
  2. A formal finding of mental incompetency by a court of competent jurisdiction, whether in the United States or abroad, precludes a finding that an individual has the requisite intent.

The Foreign Affairs Manual, at 7 FAM 1291(e), gives us a ray of hope (emphasis added by me):

Parents, guardians and trustees cannot renounce or relinquish the U.S. nationality of a citizen lacking full mental capacity: A guardian or trustee cannot renounce on behalf of the incompetent individual because renunciation of one’s citizenship is regarded, like marriage or voting, as a personal elective right that cannot be exercised by another. Should a situation arise of the evident compelling need for an incapacitated person to relinquish citizenship, you are asked to consult CA/OCS/L for guidance.

No Hope, I Think

But I think the hope is misplaced. It’s a “shovel snow in hell in the summertime” mission. In summary, the State Department says:

  • If a court anywhere finds the individual to be mentally incompetent, it is game over. The “intent” required by law to relinquish citizenship will simply not exist. [7 FAM 1291(e)].
  • No one else can exercise that power for the individual. [7 FAM 1291(e)].
  • Voluntary relinquishment of U.S. citizenship requires “careful review” [7 FAM 1291(a)] and you are invited to make a Federal case out of it if there is an “evident compelling need” [7 FAM 1291(e)] for the incapacitated person to relinquish citizenship.

I have not seen this happen. The door is cracked ever-so-slightly open. There may be some situations with mental incompetence where it might be possible to persuade the State Department to allow a renunciation. But the flat statement of 7 FAM 1291(b) — if a court said you are mentally incompetent, then game over — tells me that the opportunities are limited.

What To Do? My “Least Bad” Idea Number 1

What can you do in a situation like this? What happens if you have a disabled child and you need to make financial arrangement? Renunciation of U.S. citizenship is out of the question.

I think the least bad solution is to find someone to hold money and take care of the disabled child’s welfare. That arrangement can be that of a trustee (triggering a metric ton of paperwork, expense, and agony courtesy of the IRS) or it can be gifts from the goodness of that person’s heart.

You are trying to create an arrangement by which the person helping the disabled child is not a trustee, but will have the ability (and the moral integrity) to use the money in the way you would like it used. Note that you have now exchanged a tax risk for another risk entirely.

That’s not an easy decision to make. Nor is it easy to find utterly trustworthy people who will help like this.

This means that government-sponsored plans such as the RDSP are out of the window. This would raise the visibility of the beneficiary as a U.S. person, which in turn would wake up Mr. FATCA. Game over.

It also means that income on this money held for the benefit of the disabled child will be taxable rather than tax-free. And there is the complexity of getting money from your trusted friend to its intended use. That might trigger gift taxes in your country.

My “Least Bad” Idea Number 2

Weigh all of that against the compliance cost of dealing with the IRS. It may be better to simply set up a trust (or use an RDSP and forego the possibility of tax-exemption on income) and distribute the income to the disabled beneficiary every year.

You do this because (1) you figure that the income every year will be overall small enough to create minimal U.S. income tax; and (2) this strategy eliminates the accumulation distribution tax problems on accumulated income inside foreign trusts.

You would set up the system so the U.S. tax paperwork would be as robotic as possible, in order to keep overhead down.

This strategy probably plays hell with the disabled person’s ability to qualify for government benefits, and adds some thousands of dollars of overhead every year for accounting, tax return preparation, etc.

What Would Paul Biegler Do?

I do not suggest breaking U.S. tax law. I’m no Paul Biegler.