Article Category: Expatriation

Updated March 6, 2023Posted July 22, 2014

Green card holders, treaty elections, and exit tax

Phil Hodgen

Attorney, Principal

(This is the weekly Expatriation Only email that went out on July 22, 2014 to the subscribers. Every week I answer a technical question--usually tax--in great depth about expatriation. Subscribe to the list here, or if you want to ask a question send in your questions here. I answer these either in the email newsletter or by blog posts.)

Hi from Phil Hodgen.

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This Week's Question

This week's question is going to be a mini case study. This one's long, but I hope it is useful--not only for green card holders who contemplate expatriation, but for green card holders living abroad who are considering electing to be treated as nonresidents of the United States for income tax purposes.

The question comes from an accountant in another country--someone who handles cross-border clients. Thanks, S.C., for the email. Rather than quote the email (it is long!) I will summarize the key points of S.C.'s email conversation with me.

She has a citizen of that country who happens to hold a U.S. green card. The green card was issued in February, 2009. This, of course, makes the client a U.S. taxpayer for income tax purposes, taxable on his worldwide income.

The individual lived in the United States on the green card for a year or two, but has been

living in his home country more-or-less full time for the last couple of years. I'm not sure, but it sounds like the green card holder probably does not want to live permanently in the United States in the future. He has family in the United States (children and grandchildren) so visits will happen, but in terms of "where do I live?" the answer is not the United States anymore.

Because of differences in the tax laws, a particular item of income that is tax-free in that country will be taxable to her client on his U.S. income tax return.

She is thinking of having her client make an election to be a nonresident of the United States for income tax purposes for 2013. What are the consequences of making that election?

Treaty elections to be an income tax nonresident

The United States imposes income tax on U.S. citizens and green card holders regardless of where they actually live. In other words, the precise location of your corporeal being on Planet Earth is irrelevant--you must pay U.S. income tax on all of your income, no matter where it came from.

A green card holder can make a special election and get out of this tax situation--if and only if he or she is living in a country that has an income tax treaty with the United States.

All income tax treaties have a set of rules called "tie-breaker" rules. If a person can be considered a resident of the United States (under its normal tax laws) and also a resident of another country (under its normal tax laws), then in order to prevent agony and double taxation to that person, you look at the tie-breaker rules. Apply them in sequence and sooner or later you will come to a rule that definitively says you are a resident (for tax purposes) of one country and a nonresident of the other.

These provisions are typically in Article 4 of income tax treaties. A few old treaties have the tie-breaker provisions in Article 3.

You are not required to use the treaty tie-breaker rules if you are a U.S. taxpayer. The treaty is like a trump card that you can play to defeat the Internal Revenue Code. The government cannot play the trump card against you--the IRS cannot force you to make an election to apply the treaty to your situation. Only you can play the trump card.

This means that the taxpayer gets to choose the better of the two alternatives: if the tax results are better by applying the plain old Internal Revenue Code, do that; if the tax results are better by making an election to apply the income tax treaty rules, do that.

How the treaty election works

If you make the election under an income tax treaty to be a resident of the other country (where you live) and a nonresident of the United States (where you have a green card), the results are as follows:

You compute your income tax liability to the United States as if you are a nonresident of the United States; but
For all other tax filing purposes, you are a resident.

Interpreted, this simply means you can reduce or eliminate the amount of income tax you pay to the IRS, but you still have to do all of the ridiculous paperwork. Form 8938. Form 5471. Etc. All of the intrusive and privacy-destroying paperwork you can imagine will still apply to you. All of the insane penalties that the IRS throws at you? They still apply.

How to make a treaty election

The interesting thing (for tax nerds, at least) is how the treaty election is made. You simply file a tax return that is consistent with calculating your tax according to how the income tax treaty says you should calculate it. That is how you take a tax reporting position based on the treaty.

There is a form to file, of course. Form 8833. Interestingly, if you do not file Form 8833, your treaty election is not defeated. You still are allowed to compute your income tax according to the treaty rules. The worst that can happen to you is that you pay a $1,000 penalty. Cheap! :-)

This is not to say that I recommend blowing off Form 8833. By all means file it. It prevents problems.

Questions to ask yourself

Now we get to the considerations that S.C. must analyze before filing a 2013 income tax return for her clients with a claim of nonresident status under the income tax treaty:

Will the election to be a U.S. nonresident under the income tax treaty actually save tax?
Will the client happily and eagerly do all of the rest of the tax paperwork demanded from him by the IRS for the 2013 tax year?
Will making the election to be a nonresident for income tax purposes create any immigration risks that could trigger revocation of the green card by the U.S. government? And does the green card holder care?
Will making the election to be a nonresident for income tax purposes create any exit tax problems for the green card holder?
Are there State income tax questions to consider?

I'm going to talk about the exit tax implications. The other issues must be addressed and considered carefully before filing the 2013 tax returns, but . . . well, life's tooshort for me to exhaustively analyze everything in public. Especially for free. :-)

Exit tax implications of the treaty election

Let's talk about the exit tax implications of the treaty election by this green card holder to be treated as a nonresident of the United States for income tax purposes.

Green card holders are subjected to the exit tax rules when they abandon their green card status (by filing Form I-407) with the U.S. government, or when the U.S. government revokes their visa status. Green card holders are also subjected to the exit tax rules when they make an election under an income tax treaty to be treated as a nonresident of the United States.

That second point is the one we care about--when will an election under an income tax treaty cause a green card holder to be subjected to the exit tax rules?

The answer is simple: when the green card holder has been the proud owner of a green card for a long time. This type of person is called a "long-term resident" in the Internal Revenue Code.

How long is a "long time"? It simply means that the person has held a green card "in" at least 8 of the last 15 years (including the current year).

If the person has held a green card for fewer than that magic number, then the person is not a long-term resident and the exit tax rules do not apply at all.

For the tax nerds among you, "long-term resident" is defined in Internal Revenue Code Section 877(e)(2).

For how a long-term resident is subjected to the current exit tax rules, go look at Internal Revenue Code Section 877A(g)(2)(B). This defines who is an "expatriate" or not as a long-term resident who ceases to be a lawful permanent resident of the United States within the meaning of Internal Revenue Code Section 7701(b)(6). And ceasing to be a lawful permanent resident of the United States within the meaning of Internal Revenue Code Section 7701(b)(6) is the same as making an election under an income tax treaty to be a nonresident for U.S. income tax purposes.

If you are not a "long-term resident" you cannot be an "expatriate". If you are not an "expatriate" then Internal Revenue Code Section 877A--the exit tax rules--cannot apply to you. Section 877A only applies to "expatriates" and specifically to a particular variety of expatriates--covered expatriates.

Applying facts to the law

Let's go back to S.C.'s client. He received his green card in 2009. We are now in 2014. This means he has held a green card in the calendar years 2009, 2010, 2011, 2012, 2013, and 2014.

That's six years. Six is less than eight. I had to use an extra set of fingers in order to do the math. :-)

Since S.C.'s client has not held the green card in at least 8 taxable years out of the last 15, he does not have an exit tax risk if he makes the treaty election to be a nonresident of the United States and a resident of his home country. S.C. can file Form 8833 and cause him to make the treaty election for tax year 2013 without triggering the big Section 877A tax.

The other issues

Exit tax is not a problem. The other issues are worth a quick mention, however. S.C. will need to go deep in analyzing these before choosing to file a Form 8833 treaty election for her client.

Will this save actual income tax? In this situation it is pretty clear that the client will save income tax. A particular type of capital gain was recognized on sale of an asset in 2013. That capital gain is tax-free in the home country but taxable in the United States. By electing nonresident status in the United States, the taxpayer will eliminate the possibility of income tax on that capital gain.
The other tax filings. S.C. will need to have a heart-to-heart with the taxpayer to advise him that all of his other tax paperwork is still required. In other words, he is still going to file a big brick of a tax return with the IRS. It will still be expensive to prepare that tax return. The only good news is that he will pay less tax overall in 2013.
Immigration problems. Filing a nonresident income tax return as a green card holder is a definite bad thing for visa purposes. Every immigration lawyer I have ever spoken to has said "this is a bad mark and is not good to do if you want to keep the green card". S.C.'s client should be OK if he drops the green card visa status. For him, it will be no problem to enter and exit the United States as a tourist since he comes from a country that has good diplomatic relationships with the USA. It's one of the Five Eyes countries. Hello, NSA!
State income tax. I assume (based on the amount of time that the taxpayer has been outside the United States) that no State assumes he is a resident for State income tax purposes.

Not Legal Advice

Now of course is a prudent moment to remind you that this is not legal advice. I'm probably wrong, and anyway this information is outdated ever since it was written with a quill pen while I was sailing on a clipper ship from Southhampton to Sydney, by the light of a coal oil lamp. And who knows--Congress will undoubtedly pull some election-year stunt in a shameless pandering for votes and you--an American abroad or worse yet an American giving up citizenship or resident--simply don't matter at all to a random politician in the United States.

Next Week

Next Tuesday there will be another expatriation-related question and answer. Send yours in. :-)

Phil.