Death as an exit tax avoidance strategy, part 1

This Week

This week's question comes from Daniel Hayden, a German tax lawyer I know. He is a fountain of interesting ideas. :-)

Hi Phil,

Here is another question, that – as far as I remember – has not been covered in your question-of-the-week-emails:

Is there any exit tax, if a green card holder, who returned to his country, but never returned the green card, dies (probably because he heard the latest FATCA news)?

If he surrenders his green card during his lifetime, I assume he would be subject to the exit tax. But is there also an exit tax upon death? Since he has no U.S. situs assets (and no U.S. citizen heirs), there would be no inheritance tax.

Would it make a difference, if his return to his home country happened a long time ago? I am thinking of the “at least 8 taxable years during the period of 15 taxable years”-language in § 877(e) IRC here…

I am looking forward to your answer, whenever it is suitable for you.

Thank you very much for your great newsletter.

Dan, you are right that I have never answered this question, because it did not occur to me until now.

My answer: I think you can take the position that there is no exit tax imposed when a green card holder (who never surrendered the green card visa) dies. But this is not clear as a legal matter. And if you take that position, there is a price that might -- or might not -- ever be paid.

This answer is a two-part answer. This week I go through the exercise of identifying the precise legal issue that Daniel's question calls into play. Next week I answer it.

Long-Term Resident + Event = Expatriate

The exit tax rules only apply to "expatriates". Once you are an "expatriate", you have a paperwork problem to solve, but not necessarily a "I have to pay some money to Uncle Sam in order to get out of here" problem. Only special types of expatriates -- "covered expatriates" -- have that problem.

In the situation that Daniel describes, the green card holder never becomes an expatriate, and therefore never triggers the exit tax rules. Let's follow the trail through the Internal Revenue Code and see why.

"Expatriate" = Was "Lawful Permanent Resident", then Not

A green card holder becomes an "expatriate" by being a "long-term resident" and then ceasing to be a "lawful permanent resident". Is that clear? I thought not. Quoting from the Good Book, at Section 877A(g)(2)(B):

The term "expatriate" means . . . any long-term resident of the United States who ceases to be a lawful permanent resident of the United States (within the meaning of section 7701(b)(6) [26 USC § 7701(b)(6)]).

Emphasis added. A "long-term resident" is defined in Section 877A(g)(5), which simply tells you to go look in Section 877(e)(2), which says:

[T]he 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.

A "long-term resident" (a tax definition found in Section 877(e)(2)) is someone who is a "lawful permanent resident" (another tax definition) who has held that status for a specified period of time. We will assume that Daniel's green card holder meets the time test. What is a "lawful permanent resident"? The Collected Works of Timeless Tax Wisdom, at Section 7701(b)(6), says:

[A]n individual is a lawful permanent resident of the United States at any time if—

(A) such individual has the status of having been lawfully accorded the privilege of residing permanently in the United States as an immigrant in accordance with the immigration laws, and

(B) such status has not been revoked (and has not been administratively or judicially determined to have been abandoned).

An individual shall cease to be treated as a lawful permanent resident of the United States if such individual 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, does not waive the benefits of such treaty applicable to residents of the foreign country, and notifies the Secretary of the commencement of such treatment.

This is badly written. What Congress meant to say was:

You become a lawful permanent resident (for income tax purposes) by getting the appropriate visa, and you keep that status until one of three things happens. The three things are:

(1) the government revokes your visa;

(2) you give up your visa and it is final for administrative and court appeal purposes; or

(3) you start being a nonresident of the United States for tax purposes because of a tax treaty.

We are now, FINALLY, at the point where we can start to answer Daniel's question. Here we go, one point of logic at a time:

• (Law) An expatriate is someone who is a lawful permanent resident for a long time and then loses that status. Section 877A(g)(2)(B).
  
• (Law) A lawful permanent resident is someone who got a green card, still has it (i.e., it wasn't revoked by an action of the U.S. government and it wasn't given up by the green card holder), and furthermore that person has not gone to nonresident status for income tax purposes in the United States by virtue of an income tax treaty. Section 7701(b)(6).
  
• (Fact) We agree that Daniel's hypothetical green card holder received a green card.
  
• (Fact) We agree that the "for a long time" requirement is satisfied, because otherwise we would be here all day.
  
• (Conclusion) Daniel's green card holder is a lawful permanent resident unless we can find that one of the three ways to terminate that status has occurred.
  
• (Explanation) If none of the three ways of terminating lawful permanent resident status occurred, then Daniel's green card holder cannot be an expatriate, because the only way of being an expatriate is by having lawful permanent resident status terminated.
  
• (Fact) The U.S. government has not formally revoked the green card.
  
• (Fact) Daniel's green card holder has not formally abandoned the green card. He has not filed Form I-407 to do so.
  
• (Here's the Crux, People) That means the only way that Daniel's green card holder could cease being a lawful permanent resident (within the required methods of doing so, as stated in Section 7701(b)(6)) is that flush language at the end, where it talks about income tax treaties.

The Pivot/Fulcrum/Crux/Whatever

Two out of three ways to lose lawful permanent resident status have been eliminated. But we still have the third way to lose lawful permanent resident status -- The Way of the Flush Language.

We have finally identified the pivotal piece of tax law that, when answered, will tell us whether Daniel's green card holder is exempt from the exit tax or is not exempt from the exit tax:

• If the flush language of Section 7701(b)(6) causes Daniel to terminate his lawful permanent resident status, then he has triggered the exit tax rules and he must pay the exit tax if he is a covered expatriate.
  
• If the flush language of Section 7701(b)(6) does not cause Daniel to terminate his lawful permanent resident status, then he can live outside the United States until he dies without triggering the exit tax.

Tune In Next Week For the Conclusion of This Exciting Episode

The next thing we must analyze is what Section 7701(b)(6) says, exactly. I'm going to do that next week.

You will get next week's episode on December 23, 2014 while I am sitting in lovely Anguilla. It will be an analysis of the flush language of Section 7701(b)(6) and it will be difficult to write without using potty-mouth words, but I promise a Fully Expurgated Edition of Expatriation Tuesdays next week.

And next week's episode will name the price that must be paid if exit tax is avoided. It isn't necessarily financial.

Disclaimer

Routine disclaimer coming now. Water is wet, gravity sucks and, as you might guess:

Remember, kids. This is not legal advice to you. This stuff is dangerous to your wallet and you're supposed to do all the things that the Internal Revenue Code says. Go get yourself some professional help to figure this out.