Welcome to Expatriation Only
, the biweekly newsletter about giving up U.S. citizenship and residence.
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Promoting Our Brand New Newsletter: Supers Only
We have a brand new newsletter: Supers Only
. It is a companion to our newest website, superannuationtaxusa.com
, currently in soft launch.
The subject? Australian superannuations – the Australian pension plan.
The audience? We are publishing the newsletter for Americans living and working in Australia, and Australians living in the United States. These two groups have a non-obvious U.S. tax problem, and it needs fixing.
The problem? The U.S. tax system doesn’t think superannuations are pensions. Instead, it treats them as foreign trusts. It’s a paperwork mess, and can generate unexpected taxable income.
The solution? The real solution (when the government gets around to it) will be a revision to the Australia/USA income tax treaty. I don’t expect that to happen anytime soon.
In the meantime? In the meantime, you need to prepare income tax returns and file them. That’s where our newsletter and the new website come in.
Subscribe to Supers Only
at superannuationtaxusa.com or hodgen.com/newsletters.
Renounce and be a Full-Year U.S. Taxpayer
This week’s topic comes from reader F.N. He wants to know how he can be a full-year U.S. tax resident, even if he expatriates. He has done the math, and figured out he comes out ahead if he does it.
F.N. is a U.S. citizen living and working outside the United States. As such, he enjoys the possibility of claiming the Foreign Earned Income Exclusion: the first $101,300 that he earns in 2016 will not be subjected to income tax by the United States. As a U.S. taxpayer, he can claim the foreign tax credit—another important objective for him.
But he plans to renounce U.S. citizenship, so this will cease to be a method for causing him to be a U.S. taxpayer, effective as of the renunciation date.
Lightly edited, F.N. asks specifically about:
“going from US citizen (abroad) to NRA (my spouse NRA all the time). Because FEIE on earned income and FTC on passive income have always reduced my US tax to zero when filing jointly, I am not worried about the maths. I am worried about whether I can file a joint return for the whole year, as a tax resident the whole year, i.e. not dual-status. Can I?”
Let’s pretend F.N. renounces his citizenship on November 1, 2016. This means he was a U.S. citizen (taxable on his worldwide income, qualifying for the foreign earned income exclusion and the foreign tax credit) through October 31, 2016. His first day of nonresident alien status is November 1, 2016. For income tax purposes, he files a
return — because he will be a citizen for part of the year and a nonresident alien for part of the year.
F.N., however, is looking for a way to make that stub period of time (November 1, 2016 – December 31, 2016) to be a time where he continues to be taxed as a U.S. resident. Thus, he wants to be taxed from January 1, 2016 to October 31, 2016 as a citizen, and from November 1, 2016 to December 31, 2016 as a resident alien
F.N., for you unfortunately the answer is “no”. It will not be possible to be a full-year tax resident of the United States.
But let’s explore the topic, because maybe F.N. knows something about his own life that I don’t know (!), or maybe this topic will be useful for others out there.
Full disclosure. I do not know F.N., have never met him, and I don’t even know where he lives. We exchanged a few emails. That’s all.
What Makes a U.S. Income Tax Resident?
There are four ways you can be a full-bore U.S. income taxpaying human, if that is your objective. One is by being a U.S. citizen. That is not interesting to us, because the whole point of the exercise is to renounce U.S. citizenship and terminate that status.
The other three are by being what tax law calls a
. You are an
because you are not a U.S. citizen, but you are a resident
of the United States and therefore fully within the reach of the income tax system.
The three ways to be a resident alien are:
- Be a U.S. green card holder;
- Spend enough time in the United States;
- Choose to be a U.S. taxpayer using the Internal Revenue Code.
Let’s look at each of these in sequence, and see if they will work for F.N. or not.
This is the permanent resident visa. You are entitled to live in the United States indefinitely, and the visa status you hold automatically makes you a resident alien for income tax purposes.1
F.N. will not apply for a green card. Even if he wanted to apply, it would take a long time for the permanent resident visa to be issued. There is no hope that he could renounce his citizenship on October 31 (for instance) and have a green card on November 1. It’s impossible.
Nor would a U.S. citizen, recently having renounced his citizenship, be interested in acquiring a green card. That is
out of the frying pan and into the fire
behavior. 🙂 You would do this only if you regret having renounced U.S. citizenship and you wish to become a U.S. resident again, with the aim of re-acquiring U.S. citizenship.
Substantial Presence Test
The next way to be a resident alien is to spend enough time in the United States to qualify. Every country has a rule like this: spend enough time here, and you are a resident. If you’re a resident, you should pay tax because you are living here.
The U.S. system is more complex than the system other countries use. You will be a resident alien for U.S. income tax purposes in a particular year if you:
- Spend more than 30 days in the United States in the current year;2 and
- Do some complicated math using a weighted average formula that looks at the current year and two preceding years, and get a number at the end of the equation that is 183 or higher.3
The complicated formula can be found in the Code, but we do not need math to tell us that F.N. should not use this method (
drop everything and spend many, many days in the United States so you can become a resident alien
) to achieve his purposes.
We can use logic. 🙂
F.N. wants to use the foreign earned income exclusion. In order to exclude earned income from being taxed in the United States, he must be outside the United States, working.
This means that F.N. has a choice:
- stay outside the United States, qualify for the foreign earned income exclusion, but be a nonresident for tax purposes; or
- come to the U.S., become a resident for tax purposes, but lose the right to exclude earned income from U.S. income tax because the income is not foreign earned income.
Would F.N. pull up roots and move to the United States so he could qualify for the substantial presence test? I think not. Spending days in the USA would defeat his ability to claim the foreign earned income exclusion — one of his primary objectives.
For the rest of you, the substantial presence test is a plausible way to establish yourself as a U.S. resident for income tax purposes for the entire calendar year in which you renounce citizenship or give up your green card status. We have seen this in a few situations. It’s rare, but can be done.
Choose to be an American Taxpayer (Internal Revenue Code)
The next way to be a U.S. resident alien (and therefore taxable just like a U.S. citizen) in the year that you expatriate is to choose to that status.
There are three different places in the Internal Revenue Code that allow you to do this.
Electing U.S. Resident Status (Immigrants)
Two of these places apply to the first year that you are a U.S. resident. Thus, these are for immigrants —- not for people like F.N., who are leaving the United States by renouncing U.S. citizenship.
The two places to look at Internal Revenue Code Section 7701(b)(4) (for anyone, married or unmarried), and Internal Revenue Code Section 6013(h) (for married couples). Let’s ignore these two methods, because someone who is renouncing U.S. citizenship does not plan on moving to the United States to become a resident.
Joint Tax Return for Married Couple
The third election method for being a U.S. resident for income tax purposes is only for married couples. If you are a nonresident alien and you are married to a U.S. citizen or resident, you can choose to be a U.S. taxpayer for income tax purposes (and for withholding of income at source on your wage income).4
Here is the critical requirement: is one of the two spouses a U.S. citien or resident on December 31? If yes, you are eligible to make this election:
“Two individuals who are husband and wife at the close of a taxable year ending on or after December 31, 1975, may make an election under this section for that taxable year if, at the close of that year, one spouse is a citizen or resident of the United States and the other spouse is a nonresident alien. The effect of the election is that each spouse is treated as a resident of the United States for purposes of chapters 1, 5, and 24 and sections 6012, 6013, 6072, and 6091 of the Code for the entire taxable year. An election made under this section is in effect for the taxable year for which made and for all subsequent years of the husband and wife. . . .”5
F.N. is a U.S. citizen, married to a nonresident alien. When he renounces his U.S. citizenship, both he and his wife will be nonresident aliens. He will not be eligible for the Section 6013(g) election.
For the rest of you out there, however, this is an attractive and easy election to make. We have used it many times. What is particularly good about this election is that it allows us to move assets between spouses without accidentally triggering capital gain recognition. Ordinarily, transfers between spouses will not cause income tax,6
but this rule does not apply when you have a nonresident alien spouse in the mix.7
By making the Section 6013(g) election, we continue to have two resident alien (or citizen plus resident alien) spouses, allowing asset transfers between the two spouses.
Moving assets between spouses is especially important in making the expatriating spouse avoid covered expatriate status. Or, if the expatriating spouse will be a covered expatriate, we want that spouse to give the highly appreciated assets to his/her spouse.
Is Dual Status Really That Bad?
Betteridge’s Law of Headlines says no.
Also, tax law says no. F.N. does not lose the foreign earned income exclusion entirely in the year of renunciation. He just loses a prorata amount of the exclusion.
F.N., maybe things won’t look as bad as you fear. If you are living in a country with a high income tax rate, you are going to pay tax on your income, no matter what. The foreign earned income exclusion and the foreign tax credit are designed to prevent double taxation of income. If the dual status return allows you to use these tools to avoid double taxation up to the date of renunciation, that’s all you need. After you renounce, you are not at risk for double taxation because, after all, you have successfully escaped. 🙂
As usual, don’t believe a word you read here. Hire someone with a brain to help you. F.N., good luck. My suggestion to you is to run the numbers on the dual status year, and see how bad/good the results are.
If the results are horrible, your only solution is to pick your expatriation date carefully. Run the numbers assuming you expatriate on December 29, 2016 (on the theory that you will only earn trivial income for those last two days of the year). Then, if you live in a country with a tax year that is not the calendar year (U.K. and Australia come to mind), pretend you expatriate on the last day of your home country’s fiscal year.
With these three scenarios in hand, you will be able to pick the least-bad date on which to renounce your citizenship.
Optimal solutions revealed by elegant analysis? Meh. Sometimes it’s better to use brute force to figure out what to do. Compute the results under multiple scenarios, and pick one.