Hi again from Phil. Welcome to the biweekly Expatriation newsletter, this time written in the lovely Al Faisaliah Hotel in Riyadh, which is being remodeled at the moment. But it’s still lovely.
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This time I am going to talk about the deliberate choice to be a covered expatriate. The triggering reason is usually “I do not have a Social Security Number”.
The question was triggered by an email I received a while ago:
I recently read your blog and I have a question I hope you can help me with. I’m a dual US/XYZ citizen because I was born in the US but have never filed US taxes because I wasn’t aware I had to. I’ve never had a US passport and do not have a Social Security Number.
To be able to file taxes I will have to take a trip to the US consulate in CITY to apply for a passport, then another trip to ANOTHER-CITY to apply for a SSN.
Would it be an option for me to NOT go through this process and renounce citizenship and become a ‘covered expatriate’? Would that mean I do not need a US passport or SSN? Are there any other consequences apart from the Exit Tax?
I do not have a lot of assets (less than the exclusion amount) so if becoming a covered expatriate means I do not need to file any tax returns would that be the easiest way out?
This situation is common here in Saudi Arabia, where parents would have gone to university in the United States and had a child or two while living there. They returned to Saudi Arabia when the children were very young, and the children have lived the rest of their lives in Saudi Arabia.
If you do not have a Social Security Number, you probably have not filed U.S. income tax returns. (Is it even possible to do so? Maybe in exceptional cases.)
And if you have not filed U.S. income tax returns, you cannot pass the certification test. An individual is a “covered expatriate” if:
“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.”
IRC §§ 877(a)(2)(C), 877A(g)(1)(A).
There are a series of linked “if/then” statements that lead to a conclusion that you will probably be a covered expatriate:
Don’t worry. I will explain the “probably” exception shortly.
Someone in this position (a U.S. citizen with no Social Security Number who wishes to renounce citizenship) is in a bind. The two choices are:
The first choice is suprisingly appealing to a lot of people. It can work, and work well, for two reasons:
For many people, being a covered expatriate is no big deal. If this is you, then it makes sent to think about the strategy of renouncing your U.S. citizenship first and dealing with the tax stuff second.
There are two problems with being a covered expatriate:
If you figure out that you do not have to pay any U.S. tax because you renounced your citizenship then your life is filled with paperwork but not tax problems. Here are some typical examples of when you must pay U.S. tax simply because you renounce:
There are other situations as well. Go through your financial life carefully and look at it through U.S. tax system eyes. Look for ways that you would owe U.S. income tax. Look primarily at Internal Revenue Code Sections 877 and 877A for how it works.
If you decide there is no tax cost to you for renouncing your citizenship, then it is a good idea to renounce your U.S. citizenship first, then deal with the tax paperwork later. You are a covered expatriate but you do not care.
The second problem with being a covered expatriate is having U.S. heirs. If you have children or grandchildren who will inherit money from you, they will pay a large tax (40% under current law) on ever dollar they receive from you. This applies to gifts and inheritances.
See Internal Revenue Code Section 2801 for the details. Proposed Regulationshave been published on this topic.
If you are confident that you will never have children or grandchildren who become U.S. taxpayers, then you do not care if you are a covered expatriate or not.
Who should get a Social Security Number first, fix the previous five years of tax returns, and THEN renounce U.S. citizenship?
You are looking for a tax liability that is triggered just because you renounced your U.S. citizenship. This means that you are looking for tax liability that is triggered because you are a covered expatriate.
There are three ways you can be a covered expatriate. The certification test is one of them. You are trying to decide whether it is worth going through the work of fixing the problems with the certification test.
But you are not going to go through all of that work is something else will make you a covered expatriate. So here are the other two reasons you could be a covered expatriate:
Your net worth is easy to calculate.
Your average Federal tax liability is a bit harder. By definition you were not filing tax returns to report your income in those years. Look at the situation and make a guess.
If both of those bullet points are true (net worth below $2 million, average Federal tax liability lower than 4161,000) then it makes sense for you to fix the Social Security Number problem, fix the “I never filed tax returns” problem, and THEN renounce your U.S. citizenship.
By fixing everything, you pass the certification test, which is the only remaining way by which you could be a covered expatriate.
If you have U.S. heirs, it is vital that you not become a covered expatriate. If U.S. people receive gifts or inheritances from a covered expatriate, they pay a tax for the privilege of receiving the money. (Note: exception for a U.S. spouse).
Your only choices will be:
People who are dual citizens and are wealthy should get a Social Security Number, file five years of tax returns, then renounce their U.S. citizenship.
Someone who became a U.S. citizen at birth and also became a citizen of another country at birth — these people have a possibility of not being a covered expatriate regardless of the level of their wealth. The only thing they must do correctly (to avoid being a covered expatriate) is pass the certification test.
Passing the certification test means getting the Social Security Number so you can file the five previous years of tax returns.
It is well worth the delay and paperwork to use this exception.
Similar to dual citizens, someone who is between age 18 and 18.5 can renounce and not be a covered expatriate — regardless of wealth — if the certification test is satisfied. These people should also go through the agony of dealing with the Social Security Number application system.
I mentioned the “probably” exception above. Just to reiterate: getting the Social Security Number is a prerequisite to filing tax returns. But the real thing we are trying to do is find a way to satisfy the certification test. There are two ways to do that:
For young people (still in university, usually) it is quite common for that person to never have had a job — or to have earned only small amounts of money from part-time jobs. These people would not be required to file an income tax return.
If this applies — and if there are no other weird things that trigger a requirement for you to file some kind of U.S. tax paperwork — then you pass the certification test automatically:
The Internal Revenue Code told me to do nothing, so I did nothing. And I did it extremely diligently, every year. 🙂
That’s the overview. Now for the usual disclaimer. This is not advice to you or anyone you know. It’s amusement. Go hire someone to help you work through your expatriation. The rules are weird, illogical, and infuriating. And incomplete. Hehe.
Just get someone to help you shed the U.S. tax system cleanly and permanently. You’ll thank me later, even if you are grumpy about spending money now. You have the rest of your life to enjoy your freedom.
See you in a couple of weeks.