Your expatriation tax return when U.S. income is zero

We get questions. Some of them are answered on the weekly Expatriation Only email list (subscribe!). Here the email that went out on Tuesday. And a special thanks to reader R. W. who reminded me to get the email posted here on the blog.

Hi from Phil Hodgen.

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This Week

This week’s question asks about dual-status income tax returns.  The email list reader wants to know what the income tax return looks like for the year of expatriation:

I file the 1040 with other forms covering income up to the date of renunciation. Do I still have to file a 1040NR from the date of renunciation to the end of the year when I don't have any US source income at all for either before or after renouncing?

Unfortunately, the final year income tax return form is a little more complicated than that.  It is semi-hard to figure out whether you file Form 1040NR or Form 1040 as your tax return.  Once you have figured that you, you have to figure out what income to put on the tax return, and what income to leave off.

Here is the short answer. In the year you expatriate, you must file an income tax return with the IRS. You will either file:

• Form 1040 treating yourself as a resident for the full year;
• Form 1040NR treating yourself as a nonresident for the full year; or
• Form 1040NR treating yourself as a part-year resident and a part-year nonresident.

As the question notes, there are a bunch of other forms and schedules that are attached to the tax returns.  Don’t forget those.

If you are filing Form 1040NR, you only tell the IRS about income that is from U.S. sources.  Income you derive from foreign sources is not reported on the Form 1040NR, and is not taxed by the United States.

Now for the details.

Your Tax Year

You, as a human being, will report your income and compute your income tax on a yearly basis.  Almost every human uses the January 1 through December 31 time frame as the year for reporting income and computing income tax for the United States—resident and nonresident alike.  There are a few exceptions to this rule but let’s ignore them.

This means that when the IRS looks for your tax return for the year in which you renounce citizenship (or give up your green card) they will be looking for a tax return that covers the entire year.

It seems counterintuitive.  If you renounce your citizenship, that should cut off your tax filing requirements on that date.  Unfortunately, the answer to that is no.  All humans must use a full 12-month tax year (January 1 through December 31).  The only humans who can use a short year (January 1 through a date earlier than December 31) are dead people.  Their tax years end on the date of death.

Your Tax Return (If You Must File)

The way to figure out which tax return you must file is partly straightforward and partly not.  You look at yourself on December 31—the last day of your tax year.  What are you on that date?  Well, you are no longer a U.S. citizen, so for income tax purposes you are an “alien”.

Resident aliens are required to file Form 1040 and pay income tax on their worldwide income.  Nonresident aliens are required to file Form 1040NR, but only if they have income from U.S. sources (and sometimes not even then).

So you will need to figure out whether you are a “resident” or a “nonresident” of the United States for income tax purposes on December 31 of the year in which you expatriate.  This is unrelated to your immigration status as a resident or nonresident.

You will be a resident alien (and file Form 1040) if you spent too many days in the United States over the three year period ending with the year you renounced citizenship.  This is the substantial presence test.  Go look at IRS Publication 519 for more information.  If I write about it here you will receive a small book instead of a short email.  :-)

Note that it might be possible for you to be a resident alien (required to file Form 1040) and then convert yourself to nonresident alien status by making an election under an income tax treaty to be a resident of another country and a nonresident of the United States.  This is a complicated subject but I just want to bring your attention to it.

You will be a nonresident alien (and file Form 1040NR) if you did not spend enough days in the United States to satisfy the substantial presence test.

Not Splitting The Tax Year

If you file Form 1040NR because you make an election under the income tax treaty between the United States and your country of residence, you will be a nonresident of the United States for the entire year, and will compute your income tax as a nonresident of the United States.

Generally, that means that the United States will only tax income you receive from U.S. sources.  Income you receive from foreign sources will not be taxed in the United States.  You will, however, be required to comply with all of the terrible, horrible, very bad, not good at all paperwork that American taxpayers must suffer through when they have contact with the outside world:  FBARs, Form 5471, Form 8938, and all the rest.

Splitting The Tax Year

If you file Form 1040NR and you do not spend enough time in the United States to be a resident under the substantial presence test, then you will be what the IRS calls a dual-status taxpayer.  For part of the year you were a full-blown U.S. taxpayer (because you held U.S. citizenship or you held a U.S. green card), and part of the year you were a full-blown nonresident alien, (almost) fully out of the U.S. tax system.

For the part of the year that you held the passport or green card, you were taxable on your worldwide income.  This is from January 1 through the day before your renunciation date.

For the part of the year starting with your renunciation date until December 31, you were a nonresident alien.  This means that you were only taxable by the IRS on income you received from U.S. sources.

You can see a discussion of this in IRS Publication 519, Chapter 6.

Answering the Question, Finally

So now I (finally) come to the point where I answer the question.  :-)

The reader had no income from U.S. sources.  At all.  All of her income was from sources outside the United States.  Here is how it works:

From January 1 through the day before renunciation, income received is reportable to and taxed by the U.S.  The fact that the income was from foreign sources is irrelevant.  The power to tax this income is based on the taxpayer’s status as a passport or green card holder.

From the date of renunciation until the end of the year, only income from U.S. sources is reported on Form 1040NR.  Since the reader had no income from U.S. sources—at all—the Form 1040NR will be reporting zero income for that time period.  Essentially, the Form 1040NR is only there as a carrying mechanism to transport the income information to the IRS for the time period of January 1 through the day before renunciation.  See IRS Publication 519 for how that’s done.

The Mechanics of the Dual-Status Tax Return

I will deal with the mechanics of how to fill in the Form 1040NR as a dual status return for another time.  We are busy preparing for the second session of the webinar we are doing for expatriates, and dual status tax returns will be part of this Friday’s session.  There is enough complexity here to make “the preparation of a dual-status income tax return” its own stand-alone webinar.

Disclaimer, Waiver, Warning Shot, Pre-emptive Strike, Etc.

Now of course is a prudent moment to remind you that this is not legal advice. Get competent advice from someone. Especially for dual-status tax return preparation. The IRS is all hand-wavy 'n stuff about how to do it. Find someone experienced who can look at your situation and tell you exactly how to do it.

Next Week

Next Tuesday there will be another expatriation-related question and answer. Send yours in. Hit "Reply" and start typing. When you're done, hit "Send".

Phil.