Telling the IRS that Elvis has left the building

Webinar - April 24, 2015 - Noncovered Expatriates

Just a reminder. My webinar for noncovered expatriates is coming up on April 24, 2015. Get more information and sign up here.

This week's question

This week's question is not for U.S. citizens. It is for noncitizens who are U.S. tax residents, and who terminate their resident status in one way or another – maybe by expatriation, maybe in some other way.

The topic is about a little-known requirement for attaching a statement to the last tax return you filed in the United States, and came from a couple of sources.

First, a person who has held a green card for a few years (not enough to create an exit tax problem) emailed me wondering how to tell the IRS that she was leaving the USA–what does she tell The Borg so that she is known to be a former U.S. taxpayer?

Then, a CPA friend asked a more specific question:

Are you familiar with the residency termination rule in the Regulations under section 7701(b) that states that unless one attaches a residency termination statement to the income tax return, the default residency termination date is December 31st of the year one leaves the US?

The tax rules for the final year of U.S. residency require that the individual attach a statement giving the IRS all of the details needed to establish a residency termination date. This is a residency termination statement.

Residency termination date = December 31

For noncitizens who are terminating their U.S. resident status, the default rule is that your last year of resident status is December 31:

An alien individual who is a United States resident during the current year but who is not a United States resident at any time during the following calendar year will cease to be a resident for tax purposes on the individual's residency termination date. Generally, the residency termination date will be the last day of the calendar year.²

This applies to people who are not U.S. citizens but are residents (for tax purposes) because they hold green cards, or they spend too much time in the United States, or they make an election to be a U.S. resident for tax purposes.

Earlier residency termination date

For a green card holder who cancels that visa status, it is possible to have an earlier residency termination date than December 31:

[T]he residency termination date for an alien who meets the green card test is the first day during the calendar year that the alien is no longer a lawful permanent resident if the individual establishes that, for the remainder of the calendar year, his or her tax home was in a foreign country and he or she maintained a closer connection to that foreign country than to the United States.³

There are special rules for figuring out the residency termination date for people who are tax residents because of spending too much time in the USA (the substantial presence test), and for people who are tax residents because they had a green card AND spent too much time in the United States. We will cheerfully skip that stuff.

“Prove it!” (the residency termination statement)

If you want the IRS to know that you are no longer a U.S. resident for tax purposes, you have to tell them. This is done with a residency termination statement.

Anyone who wants to establish a residency termination date (that's you!) is required to file such a statement:

A statement must be filed by an individual who is seeking to establish … [a] residency termination date.⁴

So. You're filing Form 8854, perhaps. You're filing a dual status tax return for the final year of your residency status. You might be filing a Form 8833 with an election under an income tax treaty to declare yourself a nonresident of the United States for tax purposes. You might even have done one of those quaint anachronisms, the sailing permit (Form 1040-C). Here is another requirement.

The residency termination statement, dissected

Here is what's involved in putting one of these statements on your tax return.⁵

All about you

You do this on a piece of paper attached to the back of your tax return. Put your name, the year, the form you are filing (Form 1040NR, presumably), and your Social Security Number on the paper. Do this in the top left corner (this is my preference, not a rule), like so:

• Fred Flintstone
• Form 1040NR (2015)
• SSN 123-45-6789

If your piece of paper ever becomes a free floater inside the IRS, they know where to send it to reunite it with the tax return from whence it came.

Heading

Make a heading that says:

Residency Termination Statement - T. Regs. Section 301.7701(a)-8

Center it, bold it, do whatever you want. Go wild.

What to include

Here is the full set of information requirements for the statement. The list of information requirements is for your purposes (establishing a residency termination date) plus other purposes. Pick and choose whatever is relevant to your situation.

The statement shall contain the information described in paragraphs (b)(1) (i), (ii) and (iii) of this section … .⁶

Here is what that requires:

• Paragraph (b)(1)(i) - This is for people who are trying to use the closer connection test (see Form 8840) to eliminate U.S. resident status. It requires you to file Form 8840. This item does not apply to you, the person giving up a green card.
• Paragraph (b)(1)(ii) - This is for tax returns due before December 31, 1997. You can safely ignore this item.
• Paragraph (b)(1)(iii) - There is no such provision. It is gone, a casualty of some earlier revision of the Treasury Regulations that left a little stub of a cross-reference behind after it left. Ignore this.

The requirements then continue:⁷

… and the following information (as applicable)--

(i) The first day that the individual was present in the United States during the current year;

(ii) The last day that the individual was present in the United States during the current year;

(iii) Dates of de minimis presence that the individual is seeking to exclude from his or her residency starting or termination dates; [note - this probably does not apply to a person canceling a green card]

(iv) Sufficient facts to establish that the individual has maintained his or her tax home in and a closer connection to a foreign country during a period of de minimis presence; [note - this probably does not apply to a person canceling a green card]

(v) Sufficient facts to establish that the individual has maintained his or her tax home in and a closer connection to a foreign country following the individual's last day of presence in the United States during the current year or following the abandonment or rescission of the individual's status as a lawful permanent resident during the current year;

(vi) Date that the individual's status as a lawful permanent resident was abandoned or rescinded; and

(vii) Sufficient facts (including copies of relevant documents) to establish that the individual's status as lawful permanent resident has been abandoned or rescinded.

Signed under penalty of perjury

The statement you attached must be signed and dated:

The statement filed by an individual described in paragraph (a)(3) of this section shall be dated, signed by the individual seeking to … establish a residency termination date, and verified by a declaration that the statement is made under the penalty of perjury.⁸

Here is a sample of what you can use:

Under penalties of perjury, I declare that I have examined this statement, and, to the best of my knowledge, believe it to be true and correct.

______________ (signature) ________________ (date)

Penalties for failure

For a green card holder who gives up the permanent resident visa, the failure to attach a residency termination statement has limited pain attached to it. Two things happen:

• You cannot use the closer connection exception (Form 8840) to prevent U.S. resident status. That is no big deal, because regardless of the days of presence in the United States you still are a resident for tax purposes because you hold a green card.
• You lose some exceptions for excluding days under the substantial presence test for figuring out the last day of your residency period under the substantial presence test. One exception applies to professional athletes,⁹ another to people in the United States due to medical conditions.¹⁰ These are of minor importance. The one that does matter is the disallowance of the exception for minor return trips to the USA after you have formally terminated your resident status.¹¹ This means that the very last day you are in the United States in your last year – that will be your best case termination date for resident status.
• You can still use income tax treaties to control your U.S. resident/nonresident status.

Specifically, the penalty for failing to file the residency termination statement on time is:

(1) General rule. If an individual is required to file a statement pursuant to paragraph … (a)(3) of this section and fails to file such statement on or before the date prescribed by paragraph © of this section, the individual will not be eligible for the closer connection exception described in § 301.7701(b)-2 and will be required to include all days of presence in the United States (calculated without the benefit of §§ 301.7701(b)-3(b)(5), 301.7701(b)-3©, and 301.7701(b)-4©(1)) for purposes of the substantial presence test and for determining the individual's residency starting and termination dates. If an individual is considered to be a resident because of this paragraph and the individual is also a resident of a country with which the United States has an income tax convention pursuant to that convention, the individual shall be treated in the manner provided in § 301.7701(b)-7(a) (relating to the treatment of individuals who are dual residents).¹²

Strategy

Usually when you are looking at the residency termination statement you are looking at ways to terminate your resident status on a day earlier than December 31. Frankly, this does not seem to be a big problem, with or without the required statement.

And in some cases you actually would prefer to have your final year of tax residency run until December 31. It makes the tax return preparation much easier (saving you money), and in the case of someone who lives in a country with high tax rates you don't pay any extra tax – because of the foreign tax credit. It also (as my CPA friend noted in our conversation) allows you one final year to file a “Married Filing Jointly” income tax return.

So my only meta-advice is to think a moment as you plan for the answer to the question “What is the last day I am a U.S. taxpayer?” Sometimes the answer is a counterintuitive one.

Disclaimer

Richard Wagner would tell you to ignore email newsletters when making complex financial or legal decisions. He is right. Go find a competent tax advisor and get things sorted out properly.

Until next week

Until next week, keep cool and have fun. Me, I'm going to take Thursday and Friday off – there is a birthday for me on Thursday! Anyone want to hike the Mount Wilson Trail to Orchard Camp? :-)

See you next week.

Phil