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August 11, 2015 - Phil Hodgen

Reverse time, avoid exit tax if you are a green card holder

Hi everyone, it’s Phil again and this is your regular dose of Expatriation. Happy Tuesday. You can unsubscribe by clicking the link at the bottom of this email. Alternatively, you can sign up for one of our other mailing lists.

Schedule change

I am switching to an “every other Tuesday” schedule for this email newsletter.

This week’s topic: green cards and treaty elections

This week’s topic is of special interest to green card holders who live abroad and want to stop paying income tax in the United States.

If you have a green card and live abroad (in a country that has an income tax treaty with the United States) you can choose to be taxed as a nonresident of the United States. As you might guess, this has some unpleasant trickiness when it comes to the exit tax.

I offer here an interesting thought exercise: how a patient and methodical green card holder might avoid the exit tax, even if he/she is wealthy enough to otherwise trigger covered expatriate status.

Basic tax rule for green card holders

If you have a green card visa, you are a “resident alien” for income tax purposes. The consequences are simple:

  • Render unto Caesar the IRS full income tax on your worldwide income, no matter where you live; and
  • Submit all of the tax paperwork demanded by the U.S. government.

Becoming nonresident

Every income tax treaty gives a green card holder (but not a U.S. citizen) living abroad the power to choose to be taxed as a nonresident of the United States. If you wield this power:

  • You will be taxed only on your income from U.S. sources, and income earned outside the United States will not be taxed by the United States; and
  • Your U.S. tax paperwork burden will be only marginally lighter.

You cause yourself to be a nonresident of the United States for income tax purposes by filing Form 1040NR and attaching Form 8833 to it.

Immigration status unaffected

The mere filing of Form 8833 (and causing yourself to be taxed as a nonresident of the United States) will not cause your green card to be cancelled for immigration status purposes.

However, it will be an indicator to the USCIS that you do not want to be a permanent resident. Immigration lawyers I have spoken to have not been terribly enthusiastic about making this election.

Expatriation risks

If you make the election to be a nonresident of the United States for income tax purposes, you risk triggering the exit tax.

Your risk exists if:

  • you are a “long-term resident”, which means you have held a green card in at least 8 of the previous 15 years [IRC §§877(e)(2), 877A(g)(5)]; and
  • you cease to be a “lawful permanent resident” as that term is defined for tax law purposes.

The precise trigger

There are three ways you (a “long-term resident”) can cease to be a “lawful permanent resident”:

  • give up your permanent resident visa status voluntarily (using Form I-407);
  • have your permanent resident visa status forcibly cancelled by the U.S. government; or
  • make an election — using an income tax treaty — to be a nonresident of the United States for income tax purposes.

I will only talk about the third method.

Let’s quote Notice 2009-85, Section 2(A), and pay particular attention to the part I have marked with bold font:

Cessation of lawful permanent residency. Under section 7701(b)(6), as amended by the Act, a long-term resident ceases to be a lawful permanent resident if (A) the individual’s status of having been lawfully accorded the privilege of residing permanently in the United States as an immigrant in accordance with immigration laws has been revoked or has been administratively or judicially determined to have been abandoned, or if (B) the individual (1) commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country, (2) does not waive the benefits of the treaty applicable to residents of the foreign country, and (3) notifies the Secretary of such treatment on Forms 8833 and 8854.

In other words, in order to cease your “lawful permanent resident” status for tax purposes, you must:

  • be treated as a tax resident of the country where you live (using the normal domestic tax rules of that country to determine resident status);
  • be careful to not “waive the benefits of the treaty” (whatever that means; maybe someday we will talk about this); and
  • tell the IRS about all of this in the way the IRS decided it wants to be told (Forms 8833 and 8854).

Critical insight

A long-term resident does not cease being a “lawful permanent resident” unless he/she files two pieces of paper: Form 8833 (the election to be a nonresident of the United States for income tax purposes) and Form 8854 (the exit tax paperwork).

If you do not file both pieces of paper, you are still a “lawful permanent resident” of the United States under the income tax rules.

Example: you are still a resident despite electing to be a nonresident

You have held a green card for 10 years, living in the United States all that time. You move to Ireland to live for the rest of your life.

You realize that you will be a covered expatriate if you give up your green card, so you decide that you will not file Form I-407 to formally abandon your immigrant status in the United States. (Filing Form I-407 to abandon your immigrant status would cause you to cease to be a lawful permanent resident — see the excerpt from Notice 2009-85 above — and you would be subjected to the exit tax).

But you are sick of paying income tax in the United States, so you elect to be treated as a nonresident of the United States for income tax purposes, and a resident of Ireland. You carefully attach Form 8833 to your U.S. nonresident income tax return (Form 1040NR). You carefully do not attach Form 8854 to the tax return.

As a result, you have not “ceased to be a lawful permanent resident” because you only filed one of the two required forms needed to do that. You filed Form 8833, but you did not file Form 8854.

Interesting consequence. You are still a U.S. “lawful permanent resident” and therefore are still a “resident alien” [IRC §7701(b)(1)(A)(i)] for income tax purposes. You must still pay income tax as a U.S. resident — on your worldwide income.

But here’s an idea

Remember that the exit tax rules only apply to green card holders who are “long-term residents”. And:

the term “long-term resident” means any individual (other than a citizen of the United States) who is a lawful permanent resident of the United States in at least 8 taxable years during the period of 15 taxable years ending with the taxable year during which the event described in subparagraph (A) or (B) of paragraph (1) occurs. [IRC §877(e)(2)].

(Ignore the “event described in subparagraph (A) or (B)” for now.)

Think about this as a way to defeat “long-term resident” status. Remember you are trying to avoid being a “lawful permanent resident” the “8 of the last 15 years” target. Here is how you do it.

IRC §877(e)(2) continues, saying:

For purposes of the preceding sentence, an individual shall not be treated as a lawful permanent resident for any taxable year if such individual is treated as a resident of a foreign country for the taxable year under the provisions of a tax treaty between the United States and the foreign country and does not waive the benefits of such treaty applicable to residents of the foreign country.

Interesting. You don’t count years toward the “8 out of 15” if:

  • you are treated as a resident of a foreign country under the terms of the treaty; and
  • you do not waive the benefits of the treaty.

What is interesting about this is that the definition in IRC §877(e)(2) is not the same as in IRC §7701(b)(6) when we are talking about lawful permanent resident status and treatment of such a person when an income tax treaty is involved.

Caution, this is just brainstorming (whistles)

Let’s go back to you, who held a green card for 10 years and moved to Ireland to live for the rest of your life. You did not file Form I-407 to formally cancel your green card.

Let’s talk about how a patient and methodical green card holder could get out from underneath the exit tax.

What if . . .

  • you continued to live in Ireland. You are treated as a resident taxpayer under Irish law, and by extension the income tax treaty between Ireland and the United States would treat you as a resident of Ireland as well. (Caution: carefully research this and figure out if I am right or wrong!)
  • you carefully filed U.S. income tax returns every year.
  • you figured out WTF the IRS means when they say “does not waive the benefits of such treaty applicable to residents of the foreign country”. Oh, hypothetically, you attached a statement to the back of your U.S. income tax return that says “I do not waive the benefits of the income tax treaty between the United States and Ireland that apply to residents of Ireland”, just to be doubly sure. (Caution: carefully research this and figure out if I am right or wrong!)

It seems to me that IRC §877(e)(2) would say you just created a year that does not count toward your “8 of the last 15 years”.

Let’s pretend that you do this, year after year. Eventually you will have a fifteen year period of time in which the total number of years in which you were a lawful permanent resident — as defined by IRC §877(e)(2) — is seven of the previous fifteen.

At that point, you cannot be a long-term resident as defined in IRC §877(e)(2). If you are not a long-term resident, it is impossible for the exit tax to harm you.

This might be a way for a wealthy green card holder to move abroad — and stay abroad — and wait out the application of the exit tax rules. At that point, file Form I-407, nuke the green card, and file your final U.S. income tax return, free of any risk of exit tax.

Moral of the story

You are seeing the effect of the same words (“lawful permanent resident”) being used in two different places, with two different definitions.

You will still be a “lawful permanent resident” for income tax purposes in the United States, hence a “resident alien” and subject to worldwide taxation of all of your income.

But you will be slowly reducing the number of years that are credited toward “long-term resident” status. And this is the critical thing needed for avoiding the wealth amputation that is the exit tax.

Disclaimer

This may or may not be right. If this is your situation, it will be damn well worth your while to spend money to get the specific answer that is correct. Go hire someone. This email is not legal advice at all.

See you in two weeks. (This is converting to a bi-weekly newsletter).

Phil.

Expatriation