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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No SSN, Deliberately Be a Covered Expatriate
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:
- If you have no Social Security Number, then you could not have filed income tax returns for the preceding five years.
- If you did not file tax returns for the preceding five years, you are (PROBABLY) unable to certify that you have met the requirements of the Internal Revenue Code for the preceding five years.
- If you cannot certify that you have met the requirements of the Internal Revenue Code for the preceding five years, then you are 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:
- Renounce U.S. citizenship before getting a Social Security Number, and deal with the problem of being a covered expatriate; or
- Go through the process of getting a Social Security Number, then filing five years of tax returns, and THEN renounce U.S. citizenship.
Choice 1 – Renounce Without a Social Security Number
The first choice is suprisingly appealing to a lot of people. It can work, and work well, for two reasons:
- Being a covered expatriate does not cause any tax pain for the person; or
- The person had no tax filing requirement, so can indeed certify total compliance with U.S. tax law. In other words, you are saying “I was required to do nothing, and I did exactly what I was requried to do: nothing.”
The “No Pain” Covered Expatriate
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:
- You might have to pay tax to the United States because you renounced your U.S. citizenship; or
- If you give money (while you are alive or when you die) to U.S. persons, they will have to pay a massive tax for the privilege of receiving the money.
“No Pain” Means No Tax For You To Pay
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:
- Pensions. You have a foreign pension plan and you have not retired; this is treated as if it was distributed to you immediately when you renounce your U.S. citizenship, causing a giant lump sum of U.S. income tax.
- Trusts. You are the beneficiary of a trust; here you face a continuing liability to the U.S. tax system when you receive distributions from the trust.
- High Capital Gain. You have assets of various types (your house, rental properties, investments in stocks, ownership of a business), and if you sold all of those assets today you would have capital gain that is more than a threshold amount ($693,000 for renunciations in 2016).
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.
“No Pain” Means No Tax For Your Heirs To Pay
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.
Choice 2 – Get the Social Security Number, Then Renounce
Who should get a Social Security Number first, fix the previous five years of tax returns, and THEN renounce U.S. citizenship?
- You would have some tax liability if you renounced as a covered expatriate, but would have no tax liability if you renounced and were not a covered expatriate.
- You have U.S. heirs and you want them to not pay tax on the gifts and inheritances they receive from you.
You Have Tax Liability Triggered By Renunciation
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 (assets minus debts) is more than $2,000,000; or
- Your average Federal income tax liability for the preceding five years was more than $161,000 (for expatriations in 2016).
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.
You Have U.S. Heirs
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:
- Do not be a covered expatriate (get the Social Security Number, file old tax returns, then renounce); or
- Do not give any money to U.S. persons, during your lifetime or when you die; or
- Expect the people who receive money from you to pay a large tax.
You Are a Wealthy Dual Citizen
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.
You Are Wealthy and Under Age 18.5
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.
The “PROBABLY” Exception – Renounce Without Pain
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:
- File tax returns; or
- To never have needed to file.
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.