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June 10, 2013 - Phil Hodgen

Deliberately Choosing Covered Expatriate Status

I received a question from a reader that is worth discussing. Lightly edited to protect the innocent 🙂 here is the question:

Describing an anonymous third-party friend here of course. [Of course. 🙂 ] Dual US-Canadian citizen from birth, born in the US, lived a few years in the US in the 90s, filed tax returns those years only, then moved back to Canada. Recently discovered the whole tax and FBAR thing, far too stubborn to comply at this point.

To the question. If the net gain on all your assets was less than $650k (or whatever the limit is), could or should you renounce US citizenship, indicate that you were not tax compliant on form 8854, and enter the exit tax regime as a covered expatriate? Then you’d just have to do the exit declaration, at which you show net gains under the limit for taxation, rather than fuss about with five years of 1040s and FBARs and all that.

Or would this just piss off the powers-that-be? Fines aren’t collectible in Canada, so the risk is more travel inconvenience than financial penalty.

The Question is Really . . .

What the reader is asking is whether pursuing a strategy of deliberately declaring status as a covered expatriate will work.

Sheep and Goats

When you give up your U.S. citizenship the IRS categorizes you as a sheep or a goat.

You are a goat and condemned to hell if you are are rich (the definition is irrelevant for this question) or if you have not been faithful with your U.S. tax obligations (paperwork and payment of tax). The IRS is too polite to call you a goat, so they call you a “covered expatriate.”

If you are poor (again, we don’t care about what this means for the purpose of this blog post) and you have been faithfully filing tax returns and paying your U.S. taxes, then you are, to the IRS, a sheep. You are a mere “expatriate”.

“I Want to be a Goat”

In the scenario described above, the dual citizen is presumably does not meet the financial tests to become a covered expatriate. This means when he gives up his U.S. citizenship his status as “sheep or goat” (meaning “expatriate” or “covered expatriate”) turns on whether his U.S. tax paperwork and tax payments are up to date. Or not.

And here we are exploring a deliberate choice of NOT bringing all of the paperwork up to date, and NOT paying any U.S. income tax that is due.

If you want to see where this happens, look at page 1 of Form 8854, near the bottom, where the person signing the statement says under penalty of perjury that all of the tax obligations for the last five years (Title 26 is the part of the United States Code having to do with taxes) are up to date and paid.

This person will deliberately not file tax returns for the prior five years, and of course will not pay the taxes due. Or the penalties for late filing various forms — whatever they are. He will, however, presumably file excruciatingly correct U.S. tax returns for the year of expatriation.

Consequences of Covered Expatriate Status

The consequences of being a goat covered expatriate are:

• Gift. If you make a gift to a U.S. person, the recipient has a potential tax to pay. See 26 USC Section 2801. Presumably our hypothetical dual U.S./Canadian individual will never give a penny to a U.S. person.
• Bequest. If you die and leave an inheritance to a U.S. person, the recipient has a potential tax to pay. Again, see 26 USC Section 2801. Again, I assume this is not going to happen, so our hypothetical dual citizen won’t care about this.
• Lorena Bobbit. The IRS could go on a binge of jilted-lover vengeance and attempt to tag our hypothetical dual citizen with U.S. tax liabilities and penalties for past sins. This is a risk if the Canadian tax authorities are playing footsie under the table with our IRS Overlords. If the Canadians have half a spine and tell the U.S. government to go bite tires, then there is no risk — unless our would-be goat decides to travel to the United States. I suspect there is no extraordinary rendition of Canadians to the United States for taxes owed to the USA. Yet.
• “Hello, Lion. May I inspect your teeth?”. If our deliberate goat decides to travel to the United States, the consequences are unknown to me. If there is a criminal indictment, there would be the possibility of arrest. If it is a mere civil tax debt to the U.S. government, well, I thought we abolished debtor’s prisons a while ago. But don’t quote me on this–it’s a Brave New World we’re living in. So the better answer is to stay out of the United States for the rest of your life.

Happy Goat

In short, I think you could be a covered expatriate, and you keep yourself and your money out of the United States for the rest of your life, then you can be a happy goat.

Primary Purpose

This is not my advice to my expatriation clients. I keep telling them over and over again — your primary purpose is to exit the United States cleanly and permanently. It is worth doing some extra paperwork and possibly paying some tax to be absolutely bulletproof. Don’t let grumpiness cloud your judgment.