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May 24, 2016 - Phil Hodgen

The Dual Citizen Exception to Covered Expatriate Status

Hello everyone. It’s Phil Hodgen, and welcome to Expatriation Only, the email newsletter that I send out every other Tuesday.

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Dual Citizen Exception

This week, let’s look at the dual citizen exception to covered expatriate status.

When you renounce your U.S. citizenship, you will be characterized as a “covered expatriate” — or not. It is better to not be a covered expatriate. Covered expatriates will probably pay some tax for the privilege of leaving the U.S. tax system behind them.

There are three reasons why you would be characterized as a “covered expatriate”. Two reasons are financial (you are rich, says the IRS), and one is paperwork-driven (your tax returns are not filed or correct for the prior five years).

People who are dual citizens of the United States and another country will be exempt from the financial reasons for being viewed as covered expatriates. They can renounce U.S. citizenship tax-free, regardless of how wealthy they are.

I will not discuss the financial criteria that can potentially make you a covered expatriate, because the objective is to make these criteria irrelevant to you.

Remember: there is a third way in which someone may become a covered expatriate. This is called the certification test. You must have your tax returns filed for the prior five years, and your tax liabilities to the U.S. must be fully paid up. While the dual citizen exception eliminates the financial criteria for becoming a covered expatriate, you will still need to make sure everything is correct for the certification test.

Dual Citizen Exception — What Is Required

The dual citizen exception says that you will not be treated as a covered expatriate because of the financial criteria if three things are true:

  • You became at birth a citizen of the United States and a citizen of another country;
  • On the day you renounce your U.S. citizenship, you “continue” to be a citizen of, and be taxed as a resident of, that other country; and
  • Using special rules, you have been a U.S. resident for 10 or fewer years out of the previous 15 years (counting the year you renounce your U.S. citizenship).

See IRC §877A(g)(1)(B)(i).

Requirement Number 1: Dual Citizen at Birth

Nothing has been published here by the IRS, but my belief is that you would satisfy this requirement if you automatically become a citizen of both countries, under the laws of the two countries involved (the United States and your other country of citizenship).

Thus, for example, if your parents were in the United States going to college when you were born, you would acquire U.S. citizenship because you were born within the boundaries of the USA. And probably under the laws of your home country, the fact that your parents are citizens of that country made you automatically a citizen — even though you were born outside that country.

Note: this requirement means that naturalized citizens cannot use the dual citizen exception to covered expatriate status.

Requirement Number 2: “Continues to be a Citizen and Is a Tax Resident of Another Country”

The second requirement is clumsily written. It requires that someone who qualifies as a dual citizen:

became at birth a citizen of the United States and a citizen of another country and, as of the expatriation date, continues to be a citizen of, and is taxed as a resident of, such other country[.]

See IRC §877A(g)(1)(B)(i)(I).

I read that to say that the word “continues” applies only to citizenship, not to tax residence.

Citizenship

This means that you cannot have had a lapse in citizenship status for the other country. I have not seen this happen, but in theory it could. In the real world, this point should not cause you difficulty.

“Taxed as a Resident”

You must be, as of your renunciation date, taxed as a resident of your other country of citizenship.

This means that a dual France/U.S. citizen cannot successfully use the dual citizen exception if, on the renunciation date, she is taxed as a resident of Italy.

It also means that a dual France/U.S. citizen cannot successfully use the dual citizen exception if, on the renunciation date, she is taxed as a resident of the United States.

The more interesting question is the one that faces people who live in countries that do not have an income tax. How can you be “taxed as a resident” of another country if it has no income tax?

I leave that for your amusement, though it is my opinion that the correct interpretation is that “if that country had an income tax, you would be a resident for that purpose”.

Alternatively, you can look to alternate taxes that are imposed on residents (e.g., zakat in Saudi Arabia and other countries) as proof that you are “taxed as a resident”.

Requirement Number 3: The “10 of the Last 15 Years” Calculation

The final requirement involves math.

The Rule

You will qualify for the dual citizen exception if you have:

“. . . been a resident of the United States (as defined in section 7701(b)(1)(A)(ii)) for not more than 10 taxable years during the 15-taxable year period ending with the taxable year during which the expatriation date occurs[.]”

See IRC §877A(g)(1)(B)(i)(II).

This means that up to 10 years out of the last 15 years can be spent as a U.S. resident. Or put another way, as soon as you can count five of the prior 15 years as a nonresident, you are safe and can use the dual citizen exception.

What It Means

Here is how I do it:

  • Look for a time period consisting of 15 “taxable” years. The last year of this time period is the “taxable” year in which you renounce your U.S. citizenship.
  • Figure out whether you were a U.S. resident in any of those “taxable” years. To figure this out, use the rules that they tell you to use.
  • Count the number of “taxable” years that you were a U.S. resident (under those special rules) during the time period consisting of 15 “taxable” years.
  • If the number of years in which you were a U.S. resident (under those special rules) is 10 or fewer, you qualify for the dual citizen exception.

“Taxable Year” Defined

A “taxable year” is the taxpayer’s annual accounting period. IRC §441(b)(1). The calendar year is required for individuals except in extremely unusual situations. See IRC §441(g). For the extremely unusual situations, see Regs. §1.441-1(c)(1).

For our purposes, whenever you read “taxable year” simply substitute “calendar year” in your head.

Resident Years

We know that out of the 15 year period, ten or fewer years must be years in which you were a U.S. resident. Or, you must have NOT been a U.S. resident for five or more years out of the last 15 years.

The method for deciding if you have been a resident of the United States is exactly the same method that is used nonresident aliens to decide whether they have spent sufficient time in the United States to become a resident — by counting the day using a three-year weighted average formula. This is called the “substantial presence test”. IRC § 7701(b)(3).

  • Starting with the year of your expatriation, count the number of days of physical presence in the united States in each calendar year.
  • Go back in time until you have fifteen years of day-counting accomplished.

Next, for each of those 15 years, you need to do some math:

  • Number of days of physical presence in the United States for that year, plus
  • Number of days of physical presence in the United States for the first preceding year, divided by three, plus
  • Number of days of physical presence divided by six.

If the sum of those three numbers is 183 or more in a calendar year, you are a resident of the USA for that year.

Example

Here is an example. Let’s pretend that through 2011 you were a full-time resident of the United States. Starting in 2012, you were a resident of your other country of citizenship, and spent only a few days in the United States each year.

Year This Year Last Year Year Before Total Resident?
2011 365 365/3 365/6 >183 Yes
2012 183 365/3 365/6 >183 Yes
2013 30 183/3 365/6 151 5/6 No
2014 9 30/3 183/6 52 No
2015 44 9/3 30/6 49 1/2 No
2016 30 44/3 9/3 46 1/6 No
2017 0 30/3 44/6 17 1/3 No

 

If you successfully stay out of the United States in 2017 for a sufficient number of days, the fifth year in which you will be a nonresident during the 15 year time period starting in 2003 through 2017 will be 2017. You will have been a resident of the United States in 10 or fewer of those fifteen years.

This means that the first year that you can successfully renounce U.S. citizenship while using the dual citizen exception will be 2017.

Years With 30 Days or Fewer In the USA?

Some of you might be saying (because you know your tax law) that an individual is a automatically nonresident if the number of days of presence in the United States for any year is 30 or fewer. IRC §7701(b)(3)(A)(i).

True.

Unfortunately, for the dual citizen exception, the computation method for the “10 of the last 15 years” explicitly points to “just the math” in IRC §7701(b)(3)(A)(ii), and tells you to use that method.

It does not point to the substantial presence test generally, which is at IRC §7701(b)(3)(A). The substantial presence test contains both the “30 days or fewer in a calendar year makes you a nonresident automatically” rule and the “weighted average of the current and two prior years” rule.

Therefore, we cannot use the “30 days or fewer” rule of IRC §7701(b)(3)(A)(i) to establish nonresident status for the dual citizen exception. You will need to do the math for all fifteen years in order to figure out whether you can successfully use the dual citizen exception and renounce your U.S. citizenship without being a covered expatriate.

Remember the Certification Test

Remember, the dual citizen exception means that the net worth text and the net tax liability test will not apply to you in deciding whether you are a covered expatriate. The certification test, however, will continue to apply to you. Be sure that for the five prior years your tax returns are filed, are correct, and your tax is fully paid up.

Disclaimer

As usual, do not rely on an email from me as being legal or tax advice. Go hire someone, go do your own research, but for God’s sake do not make life-altering decisions based on reading this email.

See you in a couple of weeks.

Phil.

Expatriation