(Thanks to email correspondent D.F., CPA for the inspiration for this blog post).
This post is for people who want to renounce their U.S. citizenship (or cancel their green card status) but they have not filed FBARs. They are concerned that going through the expatriation process will trigger massive FBAR penalties. Can they somehow finesse the FBAR problem and the penalty risks by simply not filing the late Form TD F 90-22.1 and getting out of the U.S. entirely?
Yes. You can expatriate, not file FBARs, and exit cleanly and correctly as far as the IRS is concerned. (Weird, amirite?)
This blog post sorely needs the TL;DR.
The certification test–to avoid covered expatriate status–only requires that you certify that your obligations under Title 26 of the United States Code are up to date. The FBAR filings are required under Title 31. Therefore you do not need to certify that you are up to date with your FBAR filings. You can leave the country, tell the IRS that your FBARs are not filed, and you still win.
When you renounce your citizenship, you want to avoid “covered expatriate” status if you can, because this will trigger a tax bill. You will be treated as selling all of your assets on the day before you renounce your citizenship, your IRAs will be treated as distributing to you in full, and a number of other events will be treated as occurring.
If you are not a covered expatriate, none of these costly “pretend” tax events are treated as occurring, and renouncing your U.S. citizenship will merely be an expensive paperwork exercise.
If you are a covered expatriate, you have an expensive paperwork exercise plus a lot of tax to pay to the IRS as you exit the system.
When you renounce your U.S. citizenship, you will be a “covered expatriate” if:
For the purpose of this blog post, let’s ignore the first two items–the financial thresholds. We will focus on the third test–the certification requirement.
You will find the certification requirement on Form 8854, Part IV, Line 6. This is on Page 2 of Form 8854. Line 6 says:
“Do you certify under penalties of perjury that you have complied with all of your tax obligation for the 5 preceding tax years (see instructions)?”
You either check the “Yes” box or the “No” box to the right of that question. Checking the “Yes” box means that you do indeed certify that for the five years before expatriating your “tax obligations” are fully compliant.
The Instructions for Form 8854 are where you go to figure out what this means. This is when you learn the reason that the Tax Court treats form instructions with disdain. There are extra words and a bunch of examples, but no real clue about exactly what “tax obligations” means.
Here, dear blog reader, figure it out for yourself. Look at Instructions for Form 8854 (2012), page 5. There you will find the line-by-line instruction for Line 6 of Part IV:
Check the “Yes” box if you have complied with your tax obligations for the 5 years ending before the date on which you expatriated, including but not limited to, your obligations to file income tax, employment tax, gift tax, and information returns, if applicable, and your obligation to pay all relevant tax liabilities, interest, and penalties. You will be subject to tax under Section 877A if you have not complied with these obligations, regardless of whether your average annual income tax liability or net worth exceeds the applicable threshold amounts.
Does this help you? I thought not. That’s why you come to this blog — to really understand what it all means.
Here is exactly what you need to certify when you check the “yes” box for Form 8854, Part IV, Line 6, and say that your “tax obligations” are all up-to-date.
Internal Revenue Code Section 877A contains the law governing the taxation of expatriates. Let’s start with the definition of a “covered expatriate”.
The term “covered expatriate” means an expatriate who meets the requirements of subparagraph (A), (B), or (C) of section 877(a)(2).” ((Internal Revenue Code Section 877A(g)(1)(A).))
An expatriate is a U.S. citizen who relinquishes citizenship ((Internal Revenue Code Section 877A(g)(2)(A).)) or a long-term permanent resident (i.e., green card holder) who terminates permanent resident status. ((Internal Revenue Code Section 877A(g)(2)(B).)) Let’s assume for the sake of this explanation that we have a citizen who renounced citizenship. We definitely have an “expatriate”. All we need to know now is whether we have a “covered expatriate” and for that we must go look at Internal Revenue Code Section 877(a)(2)(A), (B), and (C).
The item we care about–the certification test–is found at Internal Revenue Code Section 877(a)(2)(C), which says:
“. . . such individual fails to certify under penalty of perjury that he has met the requirements of this title for the 5 preceding taxable years or fails to submit such evidence of such compliance as the Secretary may require.”
Note the magic phrase “this title”. That is all you need to know to solve the dilemma of knowing what “tax obligations” means, and what you have to file in order to avoid covered expatriate status.
Federal law is encapsulated ((I use “encapsulated” in the same sense that asbestos is encapsulated in order to render it harmless, except that of course Federal law is recklessly harmful to humans. So I’m using it in exactly the opposite sense. You’re welcome.)) in the United States Code. That’s where you find all the laws that Congress passes. The United States Code is divided into different parts, based on the subject being addressed. These different parts are called “Titles“. If you’re interested in the laws governing the Coast Guard, you look at Title 14. If you care about “Foreign Relations and Intercourse” you look at Title 22.
So when Section 877(a)(2)(C) says you must certify you met the requirements of “this title”, it means that you certify that you satisfied everything in the Internal Revenue Code–Title 26 of the United States Code–that could possibly apply to you. Even the excise tax on arrow shafts. ((Internal Revenue Code Section 4161.))
FINALLY I get to the punchline of this joke. Here is the reason–straight from the United States Code–why you can expatriate, sign the form certifying you are all up to date with your tax filings, and NEVER FILE AN FBAR.
The FBAR filing is required by a law encapsulated ((Yes, in the asbestos sense of the word, this legal requirement is carefully embedded where it cannot cause harm to an expatriating human.)) in Title 31 of the United States Code. Specifically, Section 5314(a) says:
“Considering the need to avoid impeding or controlling the export or import of monetary instruments and the need to avoid burdening unreasonably a person making a transaction with a foreign financial agency, the Secretary of the Treasury shall require a resident or citizen of the United States or a person in, and doing business in, the United States, to keep records, file reports, or keep records and file reports, when the resident, citizen, or person makes a transaction or maintains a relation for any person with a foreign financial agency.”
The “Secretary” referred to is the Secretary of the Treasury, and the report that is required is Form TD F 90-22.1. ((Which the government needs. Because
Mafia drug dealers terrorists. Shut up and let the NSA listen to your phone calls and read your emails.))
You are required–if you want to avoid covered expatriate status–to certify that your tax filings under Title 26 are up to date. Since the FBAR is required under Title 31, you are not required to certify that your FBAR filings are up to date.
They aren’t up to date. It doesn’t matter. Your certification under penalty of perjury is accurate. You exit the United States without being tagged as a covered expatriate.