Dual citizens and exit tax
I received a question from a reader:
Phil, enjoy your blogs they are very informative and funny at the same time. I would really like to know if a Canadian born American is subject to the exit tax if they have never lived or worked in the US.
Thanks in advance.
Yes. You have to go through the exit tax processes. The fact that you have that magic U.S. passport is enough to cause that unfortunate result. You may be able to get out of paying any exit tax, but you will still have to do all of the paperwork and filing requirements — five years of up-to-date tax returns in the United States and the Form 8854.
Here is how it works. A U.S. citizen who gives up citizenship is an “expatriate” for purposes of the exit tax rules. So for you that is unavoidable. With “expatriate” status comes a job of doing a lot of paperwork.
But what you really want to do is avoid “covered expatriate” status — this is where you have to do paperwork AND pay tax to the USA when you give up your citizenship. You may be able to do this.
A quick excerpt from the Exit Tax book that I’m writing now (shameless pimping on my part!):
Regardless of your financial status, you are not a “covered expatriate” if you satisfy all of the following items [see Section 877A(g)(1)(B), Notice 2009-85, Section 2(B)]:
- You became a U.S. citizen at birth; and
- You also became a citizen of another country at birth; and
- On your expatriation date you “continue” to be a citizen of that country; and
- On your expatriation date you “continue” to be taxed as a resident of that country; and
- On your expatriation date you were not a U.S resident for 10 of the 15 tax years that end with the year that you expatriated.
Note, however, that you will still have to certify that you are up to date with all U.S. tax requirements. Failure to do so will render you a covered expatriate even if you satisfy all of the dual citizenship requirements.
Your action plan should be:
- Make sure you have five years of clean U.S. tax returns on file with the IRS already. E.g., if you give up citizenship in 2012 be sure that 2011, 2010, 2009, 2008, and 2007 U.S. tax returns are all hunky dory.
- Make sure you fit within this exception to “covered” expatriate status. This answer won’t necessarily be obvious or easy. But it might. E.g., what does it mean to “become a citizen of another country at birth.” What if you didn’t qualify for that citizenship until your parents did a bunch of paperwork for you which they got around to doing when you were 15 years old?
- THEN AND ONLY THEN give up your U.S. citizenship.
- Do your “year of expatriation” U.S. income tax returns plus Form 8854.
- Throw a party for all of your friends.
Anonymous,
I haven’t given it that much thought, but at first blush it does seem like a real issue, unless the treaty requires the residence country to give a credit.
Michael, thanks for the article. It seems to me that aside from the issue you’ve written about, double taxation might be likely in more mainstream cases.
The example I’m considering is of an expat or ex-LTPR who must pay the deemed-distributed exit tax on an IRA account in their year of departure from the US, and then pay tax again to their new home country on withdrawals in later years. Many US tax treaties allow only the “state of residence” to tax retirement account withdrawals, and on staggered years such as this a treaty country may not allow a credit for the US exit tax paid perhaps decades earlier. In addition, taking early withdrawal of the IRA prior to departing in order to pay the exit tax may bring in a further set of issues — early withdrawal penalties and possible state tax on top (insult added to injury).
Any comments on this? Is my reasoning here correct? And if it is, any known cases of people successfully fighting this unilateral unwinding of tax treaties by the US?
I read liability to mean exactly that — liability, so if foreign tax credits wipe out that liability, you are not ‘covered’. Although if someone had a significant income, I would think they would meet the other prong — $2M assets.
Michael or Phil: Clarification regarding the exit tax PDF: “…Average annual net income tax liability for the five years immediately preceding the deemed expatriation that exceeds $147,000”.
This does not mean that someone had an income of that amount, but that someone had to actually pay this much in federal US (!) income taxes, correct?
So, broadly speaking, I could have an 7-figure income and more than 147k in income taxes, but pay all income taxes only to my host country and zero to the US due to a double-taxation agreement AND I do not have assets of 2M – I would not be a covered expatriate.
Is this the case or does the income tax liability refer to any income tax paid to foreign government as well?
Thank you Phil. Very thoughtful!
Thanks Michael for that response.
That’s why the FBAR is ridiculous in the hands of the IRS. They are applying it for the wrong reason to the wrong people. If I make money in Canada, then put it in a Canadian bank account, it is not laundered by definition. So the FBAR law doesn’t ever need apply to me. But then a money launderer isn’t exactly going to hand over his banking information to the Feds either, since that could lead to the end of his crime spree. So the IRS is wielding a useless law to extort money from people that the law was never intended to target. This is injustice of gargantuan proportions and it is a sign that the US has lost her way.
I think that this Congressman might be a natural ally in a fight to repeal FATCA…. See letter below. He is responding strongly to the IRS newest “What is good for the goose is good for the gander” rules which will require US banks (the Ganders) to report to foreign countries on interest paid to Non US residents in similar fashion as FATCA requires of the Gooses.
This could get interesting. 🙂
Charles Boustany, Jr., MD
Chairman
Subcommittee on Oversight
http://waysandmeans.house.gov/UploadedFiles/Letter_on_NRA_taxation_final.pdf
I think American Citizens Abroad is contacting him in their lobbying efforts to repeal FATCA. I am sending my letter, for what it is worth…
Michael may be modest but for the rest of you out there looking for his article, here you go:
http://www.robertsandholland.com/article.ihtml?id=604# (PDF)
@Canuck Parent of (Surprise) American,
Start from the assumption that someone with U.S. citizenship will have to do a bare minimum of paperwork:
– the de-immigration 🙂 paperwork at the Embassy and Department of State.
– five solid years of tax returns (in this case let’s say tax returns showing zero income).
– the exit year paperwork: Form 1040 (showing zero income), Form 1040-NR (showing zero income), and Form 8854 (presumably showing trivial assets).
Without knowing the full picture on the individual (which I am guessing is a kid which just might be related to you!) I would think there is a relatively easy (and tax-free) way to do this. Especially for kids. There is a window of time from age 18 to age 18 1/2 in which someone can relinquish U.S. citizenship without becoming a “covered expatriate.”
P
For anyone who expatriates while entitled to deferred compensation for services performed outside the US, BEWARE. The rules make it extremely difficult to avoid double taxation. (I won’t spam this site with any links, but there’s an article on my website for anyone interested.)
Thanks for replying Poser. Since those statutes are all related to tax crimes, and the FBAR is a non-tax requirement under a completely different title of the US Code (Title 31, relating to money laundering, not Title 26, relating to tax) I very much doubt they could apply to the FBAR statute of limitations. (That’s lawyer-speak for I think there’s no way in hell they could apply.)
Phil, So if I understand, a “Jus sanguinis” American citizen, born in Canada, of recent majority age, who has no significant earnings (babysitting money) and has never lived in US: easy to renounce?
Phil, if you are a dual citizen at birth and meet all the other conditions and hold both a US and Canadian passport would you still be free of the exit tax?
THANKS
Poser, in Europe there will be probably be legal challenges ultimately to the European Court of Human rights.
On the face of it FATCA contravenes both Article 8 (Privacy) and Article 14 (Discrimination)of the European Covention of Human Rights. Financial freedom would more than likely fall under its remit.
With particular interest is Article 14 which states “While the article specifically prohibits discrimination based on “sex, race, colour, language, religion, political or other opinion, national or social origin, association with a national minority, property, birth or other status”
It’s going to be difficult for a bank to plead innocent it had to sign a franchise agreement with the IRS and not break the “national or social origin” clause.
If my bank ever tries to pass information to the IRS or close down my account, as an EU citizen I have the right to go through the courts up to the European Court of Human Rights. Who knows perhaps the bank would want to help to keep EU citizens off the FATCA hook.
How can you open a bank account for an EU citizen (who may have been born abroad – except the US) and discriminate against a dual US / EU citizen? It doesn’t make sense.
We may not be able to stop Washington from FATCA Madness (perhaps Sen. Levin and Doug S have watched the 1930s movie Reefer Madness) while putting together FATCA, but we can bloody well stymie FATCA to make it ineffective for EU citizens.
If the courts rule against FATCA, the IRS would then have to convince the EU and 27 member countries to change their laws for the benefit of the IRS- good luck Doug!
Sorry, I “mis-remembered” a discussion at Townsend blog, and in googling it, I found that Jack had written as follows:
I therefore asked if this conclusion was correct: ” If I understand correctly, if a person is not under indictment, they are not a fugitive, and the FBAR requirements will expire normally at the end of 6 years, even if he/she is living outside the USA.” Jack didn’t actually reply to that conclusion.
discussion took place here: http://federaltaxcrimes.blogspot.com/2011/08/of-fear-and-hostages-mid-sight.html
Poser, I’m curious why you say the FBAR statute of limitations would be tolled for a person living outside the US. Can you elaborate?
Thanks for much for your response. That’s a good point (transferring assets) but it is really not possible now, because my understanding is that an expatriating act fixes the date by which the person is no longer a citizen for tax purposes. Since that act took place already, the forms must be filled out based on the state of affairs, mark to market, on that date. Thus, it is too late to do anything about it.
I thought, well I could just wait until the statute of limitations for FBAR expired, but apparently living outside the US, the statute of limitations may never expire.
Note the words of the 1868 Expatriation Act:
Ok, now let’s see, according to the law, I have committed an expatriating act, that is taking on the citizenship of another nation with the express intent of relinquishing my US citizenship. The IRS therefore cannot hinder me from expatriating–it is a fait accompli, and I am by statute no longer a US person. And I wish them good luck in collecting my assets into their unrighteous coffers, since the assets are here in Canada.
Just to be clear, it seems that the above Act was passed to hinder other nations from their claims on new Americans whom they believed should be loyal to their own nation instead of to the USA. Thus, the United States passed the 1868 Act, but now, with its expatriating laws, contradicts what is a natural right. It should be remembered that the US revolutionary war was fought on this very principle, the natural right of expatriation.
So I ask again, what are they going to do? I have natural law on my side, I have the Declaration of Independence on my side, and I don’t plan on giving them any information about my assets on any form. I am no longer a US person they have no claim on me. So are they going to arrest me at the border if I try to visit my family? What is this? Is this some despotic nation? (like the Communist China, or USSR?) Is it the Hotel California? You can check out any time you want, but you can never leave. Or have I died and gone to hell, a never ending loop of IRS bull crap.
There’s little reason to lie. In a previous post there was discussion to temporarily move assets into, for example, your non-US wife’s name (as long as you can trust she won’t run off with her fancy man!).
If I’m correct the exit tax only really applies if you have a consecutive number of years with six figure plus income (not sure of the figure without looking up but $125-150K US rings a bell), and assets of $2M US at any rate.
If you meet the income figure, you can skirt around the $2M asset rule by transferring.
However, I do agree filling all this IRS bu**sh*t non-sense form filling exercise to prove you owe zero tax is a waste of time.
In my opinion the US at present has about 20% of the world GDP, and by 2021 that will be down to around 15%. The US is losing about 0.005% share per year. Please remember with Asia growing at around 7-8% a year, and the US and Western economies at 1-3% this will happen by default.
The US will have to start acting like a country with a lower percentage world GDP in future full stop.
The forms are a violation of the constitutional rights of the expatriating American. Tell me why I can’t just continue living my life here in my country, and never fill out those exit forms. Because if I have to fill out those forms, you can be sure that I will have to lie on them, because I am sure the hell not going to tell the IRS (1) about my private assets; (2) about my bank accounts, which would show that I am in FBAR violation–for which I could be thrown in the slammer.
What will happen if I visit my family in the states? Are they going to throw me in a federal prison?