Green card abandonment and treaty election overlapNovember 25, 2014 - Phil HodgenExpatriation
This week's episode comes to you in the midst of the 2014 Tax Update and Planning Conference from the California Society of Certified Public Accountants. I am a speaker this year, in addition to being a member of the organizing committee for the conference.
Next week's episode will come to you from beautiful Toronto. Trust me–I do not have cold weather clothing. At. All. Your prayers are requested. Anything below 15C is cold for me. Single digits Celsius? Oooh, scary.
Ed Rezin, a CPA in San Diego (hi, Ed) sends in this question — looking at the question of the effective date of an expatriation by a green card holder.
A long-term U.S. resident, who is a U.K. citizen and in not a U.S. citizen, plans to deliver his "green card" – along with Form I-407 – to the U.S. Embassy in London on January 4, 2016. January 1, 2016 is a Friday so Monday, January 4, 2016 is the first business day for the embassy in 2016. His expatriation date would, therefore be January 4, 2016 and he would file a dual-status return for 2016.
However, if the taxpayer files a Forms 1040NR for 2016 with an election under the US-UK income tax treaty to be treated as a U.K. resident, the election would be retroactive to January 1, 2016 and a dual-status return would not be required.
Is the expatriation date January 1, 2016 under the Form 1040NR treaty election rather than January 4, 2016 based on the delivery date of the "green card" to the U.S. Embassy in London?
The short answer, Ed, is that January 1, 2016 is the first day of the rest of your client’s life. You do not prepare a dual status tax return for 2016.
How Green Card Holders Expatriate
A long-term resident of the United States is someone who has held a green card (aka permanent resident or immigrant or lawful permanent resident or variations on that theme but you get what I’m talking about, right?) for a long time (“in” 8 of the last 15 years, but let’s just stipulate that this requirement has been satisfied). (Hey, do you like the way this week’s email is full of lengthy asides nestled in parentheses? Me too.)
A long-term resident triggers the messy exit tax rules by ceasing to be a “lawful permanent resident” (a tax definition) according to the way this is defined in Internal Revenue Code Section 7701(b)(6). See, Internal Revenue Code Section 877A(g)(3)(B). (I would happily embed HTML footnotes into this email but (a) that’s a bit geeky and (b) I don’t know how to do it.)
There are two ways a “lawful permanent resident” ceases to have that status:
- The individual abandons the green card [see Internal Revenue Code Section 7701(b)(6)(A) and (B)]; or
- The individual makes an election under a relevant income tax treaty to be taxed as a nonresident of the United States and a resident of another country instead (see Internal Revenue Code Section 7701(b)(6) in the flush language at the end).
To put it simply, a green card holder can stop being a “lawful permanent resident” in both of the ways that Ed’s question identifies. One way is by filing Form I-407 at the Embassy. This is a voluntary abandonment of visa status. The other way is to use this tax treaty methodology. I will describe the tax treaty methodology in more detail in a second.
There is actually another way to stop being a “lawful permanent resident” and that is by having the U.S. government forcibly remove your visa status from you. This is called “revoking” the visa. If you spend too much time outside the United States or you do other things incompatible with being a permanent resident of the United States, the immigration boffins might look at you and say “Well, apparently you don’t want to live in the USA anymore. We’re canceling your visa.” You can go to court to fight this, of course, and eventually the judge will either rule in your favor or in favor of the government. But let’s ignore this unpleasant scenario. That’s a topic for another time.
What If You Do Both?
Ed’s client is planning on doing both of the things identified above. The client will go to the Embassy on January 4, 2016 and hand over Form I-407. The effective date of terminating U.S. permanent resident status under this method is the day you hand over the paperwork to the Embassy.
Then, when Ed is preparing his client’s final U.S. tax return, Ed will attach Form 8833 and make an election under Article 4 of the U.S./U.K. income tax treaty to cause his client to be taxed as a resident of the U.K. and a nonresident of the United States. Making this election causes his client to be a nonresident of the United States for the entire year of 2016. The last day of U.S. residence for his client will be December 31, 2015.
Article 4 of the U.S./U.K. income tax treaty is the “tiebreaker” provision that says “if a person can be taxed as a resident of both countries, here is how we are going to break the tie and treat that person as a tax resident of one country and a nonresident of the other country."
Specifically, Article 4(2) says:
(2) Where by reason of the provisions of paragraph (1) an individual is a resident of both Contracting States, then the individual's tax status shall be determined as follows:
(a) the individual shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him. If the individual has a permanent home available to him in both Contracting States or in either of the Contracting States, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closest (centre of vital interests);
(b) if the Contracting State in which the individual's centre of vital interests is located cannot be determined, he shall be deemed to be a resident of that Contracting State in which he has an habitual abode;
(c) if the individual has an habitual abode in both Contracting States or in neither of them, he shall be deemed to be a resident of the Contracting State of which he is a national; and
(d) if the individual is a national of both Contracting States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.
Presumably Ed’s client will look at Article 4(2)(a) and say “I have a home in the U.K. and I do not have a home in the U.S., so the U.K. wins.” Ed will prepare and file Form 8833 citing this provision of the treaty.
This move by Ed will have three by-products:
- His client will calculate his U.S. income tax liability as if he (the client) was a nonresident of the United States for the entire year of 2016;
- His client will still be required to file all of the instruments of fiscal proctology 🙂 that are applicable to him, as if he were a resident of the United States for income tax purposes (here I refer to FBARs, Form 8938, etc. etc. etc.); and
- (Most important for our purposes) his client will be treated as having ceased to be a U.S. lawful permanent resident for purposes of the exit tax for all of 2016.
Dueling Termination Dates
Now (hah! finally!) I start to being to approach the introduction to the discussion of Ed’s real question.
Ed’s client will have two dates on which he terminates his status as a U.S. taxpayer: January 4, 2016 (when he hands over Form I-407 to the Embassy in London) and that weird little metaphysical and infinitely small moment ‘twixt and ‘tween December 31, 2015 and January 1, 2016, when he ceases to be a U.S. lawful permanent resident (defined for tax purposes) and starts being a nonresident.
Which one should we use?
Well, the government does not give us any guidance on this question but logic (at least my logic) tells me that you can’t die twice, so the first time you die you are really dead. If you jump off a cliff and in mid-air you shoot yourself in the head, you died then—and not when you went splat at the bottom of the cliff. Sorry for the macabre example.
Similarly, if you terminate your lawful permanent resident status effective at the moment between December 31, 2015 and January 1, 2016, it really doesn’t matter what you do after that—give up the green card formally or not—because as far as the IRS is concerned, you are not a lawful permanent resident anymore.
So for Ed’s client, his expatriation date will be January 1, 2016, not January 4, 2016.
Preparing Income Tax Returns
Dual status tax returns. So exciting. /s
If you change status from being a resident taxpayer of the United States to being a nonresident of the United States, you have to file a tax return (of course). But more importantly, you have to file a tax return that shows the IRS the full calendar year of reporting for the year in which you change status.
Technically, Ed’s client is not changing status from resident to nonresident in 2016. He is a nonresident for the entire year of 2016. Therefore, his status is nonresident for the entire year of 2016. This means that his client files Form 1040NR (if there is a filing requirement at all).
Ed will compute income for the client as a nonresident for the full calendar year of 2016. Assuming there is some U.S. source income or some other trigger for filing a tax return, that’s what he will report. (Note that because of that stub of 4 days in 2016 I think Ed’s client will be subject to the various forms that the IRS wants in order to know everything about you, so the Form 1040NR will be required). Ed will bolt Form 8833 to the Form 1040NR.
Exit Tax Timing
Here’s where something non-intuitive comes into play. And this may affect Ed’s client and how and when he chooses to expatriate and make the treaty election.
When a long-term resident terminates that status and is treated as a covered expatriate (net worth test, net tax liability test, certification test yadda yadda) the tax rules say that all of his assets are treated as sold on the day before the expatriation date. Internal Revenue Code Section 877A(a)(1) says:
All property of a covered expatriate shall be treated as sold on the day before the expatriation date for its fair market value.
The expatriation date for Ed’s client is January 1, 2016. This means that all of the fun stuff for exit tax purposes will occur on December 31, 2015. (The same rule applies to all of the other special rules in Section 877A for taxation of other assets owned by a covered expatriate).
So all of the giant exit tax pain will appear on the client’s 2015 income tax return—a Form 1040 for the full year.
This is probably the intention of carefully timing expatriation events the way Ed describes it. But it points out an important consideration: read the Code carefully before making a decision. If you casually assume (using the example above) that the magic exit tax computation date is January 1, 2016, you just might have made an error. Tax answers given without reading the Code and Regulations should be viewed with suspicion. 🙂 Including any such answers you get from me. Or maybe ESPECIALLY from me. 😀
In the battle of competing expatriation events, the earlier event wins. You can use this to your advantage to avoid doing a dual status tax return, if that is important to you.