The current iteration of the exit tax rules were enacted in June, 2008. At this point, nearly 10 years later, I am working with people who expatriated and now want to become residents and citizens of the United States again.
When Covered Expatriates Come Back
This sometimes creates interesting tax problems. An accountant friend, K. N., sent me this interesting situation he is working on now, specifically involving the Section 2801
When a covered expatriate makes a gift or leaves an inheritance to a U.S. person, the recipient must pay a tax of 40% of the amount received from the covered expatriate. That’s the effect of Internal Revenue Code Section 2801.
What happens when that covered expatriate becomes a U.S. resident or citizen again? Will the Section 2801 tax still apply? What about the other exit tax rules that continue to apply U.S. taxation to covered expatriates after they have left the United States?
Is there a break for these people? Or is it a case of “once a covered expatriate, always a covered expatriate,” and changed circumstances be damned?
Lightly edited, K. N.’s email gives the following facts:
The individual was born a NRA, moved to the United States and got a green card. Nothing unusual so far. Moved back to the original country, and abandoned the green card. Again, normal. But the individual did not get advice, and ended up being a covered expatriate. The out of pocket cost was small, luckily.
But the individual is married to a U.S. citizen and files jointly. And they are now moving back to the U.S., likely permanently (the NRA will get a new green card).
So. What will happen to this individual who returns to the U.S. with his wife, then makes gifts or leaves inheritances to U.S. persons? What does Section 2801 say?
Who is a Covered Expatriate?
Let’s start from the beginning. A covered expatriate is someone who:1
- Is an “expatriate” (a former U.S. citizen or long-term resident of the United States); and
- Meets one of three tests to determine if the person is rich enough (net worth or amount of Federal income tax paid over the previous five years) or bad enough (tax obligations are not up to date for the prior five years).
Once a Covered Expatriate, Always a Covered Expatriate
There are no tax rules for removing covered expatriate status. Once you are tagged as a covered expatriate, you will be a covered expatriate until you die. It’s worse than a tattoo.
Temporary Break for Covered Expatriates Who Are Citizens or Residents
Fortunately, covered expatriates who return to the United States as residents or citizens are spared further application of the exit tax rules:
- The special exit tax rules for deferred compensation are not enforced;
- The special exit tax rules that apply to beneficiaries of nongrantor trusts are not enforced; and
- The Section 2801 tax rules are not enforced.
From Section 877A(g)(1)(C):
In the case of any covered expatriate who is subject to tax as a citizen or resident of the United States for any period beginning after the expatriation date, such individual shall not be treated as a covered expatriate during such period for purposes of subsections (d)(1) and (f) and section 2801.
Here you can see the way the Internal Revenue Code is written. A covered expatriate is always a covered expatriate, but if he or she becomes a U.S. taxpayer again, the special exit tax rules will not apply.
Leaving the United States again, of course, will cause covered expatriate status to resume, unsheltered by Internal Revenue Code Section 877A(g)(1)(C).
An expatriate can return to the United States and resume U.S. residence, and become a citizen. A noncovered expatriate, of course, does this with no tax drama. The noncovered expatriate’s experience is the same as any other nonresident noncitizen who moves to the United States and establishes residency.
Covered expatriates have the same experience. They can re-enter the United States as residents and become citizens. As long as they remain U.S. residents or citizens, the covered expatriate status will not harm them: they will be taxed exactly like any other resident or citizen of the United States.