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April 20, 2015 - Phil Hodgen

Out of the (taxpaying) frying pan . . . and back in again?

“Noncovered Expatriate” seminar this Friday, April 24, 2015

A quick reminder: I am doing a 90 minute online seminar on Friday, April 24, 2015 at 8 a.m. Pacific Daylight Time. That is:

  • 11 a.m. EDT, 24 April 2015
  • 3 p.m. GMT, 24 April 2015
  • 11 p.m. Singapore, 24 April 2015
  • 1 a.m. Sydney, 25 April 2015 (so sorry!)

You can see the topics that will be covered in the tentative agenda, and you can sign up here.

This week’s question

This week’s question come from W, who is a CPA. She asks about the income tax return that must be filed in the year of expatriation:

I would dearly love to participate in your webinar, but I will be on vacation next week (without a computer).

Anyway I have 1 question that seems obvious, but I cannot find the answer. When a US person expatriates and becomes an alien (I love the terminology here!), there is a dual status year. If the event happened in October, and X was a US person for >183 days in the year X expatriates, does he (it?) need to file a Form 8840 for the part of the year that he was an alien?

Thanks for your help on this – it seems to be a popular trend these days to expatriate! (and I do not wonder why)

Short answer

You can expatriate yet be a “resident alien” afterwards.

The point raised by W is true:

  • do not assume that your expatriation date is the first day of the rest of your life, free of the U.S. tax system; and
  • you might have extra paperwork to do (e.g., the Form 8840 she refers to) in order to establish the cutoff date for when you stopped being a U.S. taxpayer.

What makes an alien?

A person who is subjected to the full brunt of U.S. income tax laws will be one of two things:

  • A U.S. citizen; or
  • A “resident alien”.

An “alien” is simply a person who is not a U.S. citizen. This means that a “resident alien” is simply a noncitizen who somehow becomes a “resident” of the United States.

There are three ways you can become a “resident alien”.

  • One way is by getting a green card visa; we will ignore this method because someone who expatriates by definition is shedding this type of visa.
  • Another way is by spending too much time in the United States over a three-year time period.
  • A third way is by deliberately choosing to become a U.S. taxpayer.

You are taxable on all income if you are a citizen or resident alien. You are only taxable on your U.S. income if you are a nonresident alien.

Deliberate choice

Take the situation of a U.S. citizen married to another U.S. citizen. One of them decides to renounce U.S. citizenship.

Yet the expatriate can elect to be a U.S. taxpayer again after expatriation. An election is available to those who are nonresident aliens on December 31, and are married to a U.S. citizen or resident. See 26 U.S.C. §6013(g)(2), which says:

This subsection shall be in effect with respect to any individual who, at the close of the taxable year for which an election under this subsection was made, was a nonresident alien individual married to a citizen or resident of the United States, if both of them made such election to have the benefits of this subsection apply to them.

People do this so they can continue to file a joint income tax return. There are some other cool tricks that the election allows you to do, too. (One of these involves nonrecognition of capital gain for interspousal transfers of property under Internal Revenue Code Section 1041. Saves tax and brain damage for U.S. citizens married to noncitizens.)

Anyone making this election is deliberately intending to dive head-first into the pool and become a U.S. taxpayer. There is no mystery here about which tax return to file and what is taxable.

The substantial presence test

The second way to become a resident alien after expatriation is to use the “too many days” method. The IRS calls this the “substantial presence test”. Let us say that you are a U.S. citizen and you are in the United States until October 31, 2015. You fly out and renounce your citizenship the next day.

You have overstayed the “number of days” you can be in the USA and are a resident alien. For the early part of the year (until October 31, 2015) you were a U.S. taxpayer because you were a citizen AND you met the substantial presence test. After October 31, 2015, you are a U.S. taxpayer only because of the substantial presence test.

What that means for someone who is expatriating in 2015 is simple: in order to truly know what tax return you are going to file in 2015 when you expatriate (Form 1040 or 1040NR), you will need to look at the number of days that you are physically in the USA in 2013, 2014, and 2015.

Here is the formula. Take the 2013 days in the USA and divide by six. Take the 2014 days in the United States and divide by three. Add these two numbers to the number of days you are in the United States in 2015. Is the total 183 or more? Then you are a resident alien for at least part of calendar year 2015 — the year you renounce your citizenship or give up your green card.

Some counterstrikes

It isn’t quite that simple, however. Your final day of resident status in the United States for tax purposes might not be December 31. There are special rules hard-wired into the Internal Revenue Code for you to look at before you can predict with certainty what your last day of resident alien status will be. Look at these rules in the Code to see what you can do:

  • Internal Revenue Code Section 7701(b)(2)(B), which describes a way to establish a cut-off date as of your last day of physical presence in the USA or the last day you held a green card;
  • Internal Revenue Code Section 7701(b)(2)(C), which allows you to disregard some days of presence in the USA;
  • Internal Revenue Code Section 7701(b)(3)(C), which completely trumps the substantial presence test if you go over the magic number of 183 when doing the math over three years, but you were in the USA for under 183 days in the current year;

There is another method, not in the Internal Revenue Code, that might work. Look for an income tax treaty. Can you claim nonresident status in the United States under the provisions of the income tax treaty between the USA and your home country? If so, use Form 8833 to make this happen.

MOTS

The Moral of the Story is simple. For those of you who expatriate and have few or no days of presence in the United States in the current and two prior years, life is simple. The expatriation date is almost certainly going to be the first day of nonresident status for U.S. income tax.

But for those of you who have spent a lot of time in the United States, it will be important for you to understand the full impact of the rules so you know whether you are filing Form 1040 or Form 1040NR, or if you are filing a dual status tax return (part Form 1040NR, part Form 1040). And if you are filing a dual status tax return, you will need to compute the magic date on which you flipped from resident to nonresident status.

Hint, hint

I am going to spend some time on the topic of dual status tax returns in the webinar I am doing in April 24, 2015. W cannot attend, but you can. Sign up!

Disclaimer

Not legal advice. Don’t rely on it. Get your own advice or do your own analysis, etc.

Have fun and see you next Tuesday.

Phil.

Expatriation