Hello again from Phil Hodgen. This is the biweekly Expatriation Only
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This week: what is a “significant change”?
This week’s question is from reader V, who emailed me and asked about reporting significant changes in net worth for Form 8854 purposes. Edited heavily to obscure personal facts:
Thanks, once again, for your incredibly useful thoughts.1 You mentioned that you have probably received all possible questions re the renunciation process. How about this one: What constitutes a significant change in one’s financial situation? This is a question that is asked on Form 8854.
My wife will be renouncing this year.
She inherited about $100,000 from her mother, and gave half to me in one year, and the other half in the following year. She reported the gifts in [Country of Residence] but was not required to report the gifts to me because they were under the allowable limit.2
My question is: Does any of this stuff have to be rereported on Form 8854 as a significant change in her financial situation?
What Form 8854 Wants
Form 8854 has a balance sheet requirement, where you report your assets and liabilities. This helps the IRS understand whether your net worth is above or below $2,000,000 — making you a covered expatriate (above) or not a covered expatriate (below).3
The Instructions to Form 8854 have an additional requirement, which you will not find in the Internal Revenue Code:
If there have been significant changes in your assets and liabilities for the period that began 5 years before your expatriation and ended on the date that you first filed Form 8854, you must attach a statement explaining the changes.4
The five years is logical: it is the same five years that applies for the certification test. The fact that the IRS asks for information that is not specified in the Internal Revenue Code may irk you, but it is clearly within bounds of their discretion.
So you have to answer the question.
What is “Significant”?
The big question — that puzzles V — is the meaning of the word “significant”.
Well, that depends. How long is a piece of string?
I kid, I kid. The answer is that no definition of “significant” exists for this purpose. You have to make up your own rules.
Tax law is full of terms like this. Material. Substantial. Sometimes there is a helpful definition attached to the word, like “substantial understatement of income tax”. That phrase as a measuring stick attached to it: 20%.5
I give that as an example, not because it is at all relevant here.
The point is, for your Form 8854 balance sheet purposes, you have no guidance.
What We Do
Here is what we think:
- If the transfer triggered a gift tax return, tell the government about it.
- If the transfer did not trigger a gift tax return but moved you from covered expatriate territory (net worth above $2 million) to noncovered expatriate territory (net worth below $2 million), tell the government about it.
- If the transfer did not trigger a gift tax obligation (e.g., a green card holder permanently living abroad making a gift of non-U.S. situs assets) you probably want to wave the flag at the IRS anyway.
Essentially, think of it this way. If you did not tell the IRS and they found out later that you had transferred assets away from yourself, would you get a queasy feeling in your stomach?
Or, from a different angle . . . if you are doing some financial engineering before expatriation and you just can’t stop grinning because you think you are so clever, you should probably stop and think a little while.
I think the IRS is looking to see if you are pulling something skanky. Are you lying about your net worth? Did you make an undisclosed transfer of assets away from yourself in order to save taxes?
It’s not the crime that took Nixon down. It was the cover-up. Be sure that you can never be accused of lying by omission.
Situations Like V’s
For situations like V’s, I suspect that there would be no need to report two $50,000 gifts from his U.S. citizen wife on her Form 8854. They weren’t big enough to matter for gift tax reporting. They probably do not make an impact on whether his wife will be a covered expatriate or not.
Even if the two gifts were 100% of his wife’s net worth — after the gifts she was stony broke — I would still have the same opinion. The gifts had no conceivable impact on any U.S. tax obligation or reporting obligation.
V, this is not legal advice, because I don’t know anything about you or your wife. I’m just giving you the way I would reason through this problem. Give the whole picture to someone who can render competent advice, and follow their advice.
At some point the government will write rules about this. As always, whenever the government issues Treasury Regulations or any written guidance, somebody kicks a puppy and life gets a little worse for all of us.
Expatriate while getting out is relatively easy. The exit tax rules will only get stricter.