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Here’s an email I received a couple of weeks ago. My correspondent tells a story that I suspect is far too common. (Very) lightly edited, here is the email:

I have read many of your awesome blog posts. One thing I can’t seem to find anyone address online is lack of compliance due to financial difficulties.

My situation is I moved overseas 16yrs ago, got a CLN almost two years ago. I earn nowhere near any threshold (like 35k US a year maybe). I also have no net worth really.​

I knew when I got my CLN I was supposed to do 5yrs of filings and the 8854, but as I dug into it it was overwhelmingly over my head. I became paralysed about it for a while. I then approached some online expat tax sweatshops and ended up looking at well over 5k in my country’s money to have assistance. Well, just getting by I said to myself, I can’t actually afford to do this. Time has gone by and I still haven’t filed anything and am now a covered expat.​

I have no ties to the USA and am never setting foot there again. I live in [COUNTRY]. Now people say I’ve left it too late and if I’m never setting foot there again don’t try to make it right as you’ll draw attention to yourself.

Sure I would like to make things right but there must be 1,000’s of us out there not capable of doing these filings, need help due to the complexity yet can’t afford all this. Maybe a blog post could address this. For now I am just trying to live my life, support my family and get by.

Late Form 8854 = Covered Expatriate

My correspondent already knows the answer to the question, but let’s just walk through the law to show how someone who files a late Form 8854 (or never files one at all) is a covered expatriate.

Someone who relinquishes U.S. nationality is an expatriate. IRC §877A(g)(2)(A).

Someone who is an expatriate and fails (or satisfies, depending on your point of view) one of three tests is a covered expatriate. IRC §877A(g)(1)(A).

One of those three tests is called the certification test. It says a taxpayer is a covered expatriate if he or she:

fails to certify, under penalties of perjury, compliance with all U.S. Federal tax obligations for the five taxable years preceding the taxable year that includes the expatriation date, including, but not limited to, obligations to file income tax, employment tax, gift tax, and information returns, if applicable, and obligations to pay all relevant tax liabilities, interest, and penalties (the “certification test”). This certification must be made on Form 8854 and must be filed by the due date of the taxpayer’s Federal income tax return for the taxable year that includes the day before the expatriation date. See section 8 of this notice for information concerning Form 8854.

See Notice 2009-85, Section 2.

Here is what you must do in order to avoid covered expatriate status:​

  • File Form 8854 before the due date for the year in which you relinquish U.S. citizenship; and
  • Check the “yes” box on Form 8854, Part IV, Section A, Line 6.​ 

What does “late” mean?

When is Form 8854 filed too late? Let’s look again at Notice 2009-85, Section 2:

This certification must be made on Form 8854 and must be filed by the due date of the taxpayer’s Federal income tax return for the taxable year that includes the day before the expatriation date.

Almost every human has a taxable year (the time period for computing your income tax liability) of January 1 through December 31. Trust me — you will know if you have something else, because it takes an enormous amount of prescience and doing the right thing at the right time.

The default filing deadline for a human’s income tax return is April 15 of the following year. Americans abroad (in most but not all cases) get until June 15 to file their tax returns and pay their tax liability. Nonresident aliens (hey! that’s you after you expatriate!) generally have a June 15 filing deadline.

You can get an extension to file your income tax return until October 15, using Form 4868 — whether you are a U.S. citizen abroad or a nonresident alien.

And you can get an an additional extension until December 15 for filing your income tax return, if necessary.

If you get a valid extension to file your income tax return, the same extension applies to the filing deadline for Form 8854. Notice 2009-85, Section 8 says:​

Time and manner of filing initial Form 8854. A covered expatriate must file Form 8854 with the covered expatriate’s Form 1040NR or Form 1040, whichever is applicable, for the covered expatriate’s taxable year that includes the day before the expatriation date. A covered expatriate who is required to file Form 8854 for such taxable year will be considered to have timely filed Form 8854 if it is filed by the due date of the original Form 1040NR or Form 1040 (including extensions) for such taxable year. Covered expatriates who are U.S. citizens or long-term residents for only part of the taxable year that includes the day before the expatriation date must file a dual-status return. See section 8.B of this notice.

TL;DR:

  • File your Form 8854 by June 15 of the year following the year in which you expatriate. If you apply for an extension of time to file your income tax return (to October 15 or December 15), file your Form 8854 by that extended deadline.
  • If you file Form 8854 after that date, you will be a covered expatriate, even if you have no money at all. ​

What to do if you are late and you are poor?

What is the appropriate course of action if you are late filing your Form 8854 and therefore you are a covered expatriate?

My standard answer to that is to file it late. Clean up your messes in life. Be a covered expatriate, deal with the consequences, and move on.

But what if you are poor? What are the consequences and what is the best strategy for you to pursue? What, for instance, should my correspondent do?​

Whenever you are making a strategy decision, follow this decision tree:​

  • What are my risks?
  • How expensive are my risks if things go horribly, horribly wrong?
  • What does it cost to reduce the risks to an acceptable (to me) level?​ ​

Or put it another way:​

  • “What am I buying?” (Elimination of a risk).
  • “What is the price for that?” (The cost in time, money, and worry).​ ​

The cost of being a covered expatriate

The consequences of being a covered expatriate are (generally speaking):

  • Pretend you sold everything on the day before you renounced your citizenship; the first (whole lotta money, the exact amount depends on the year you expatriated) of the capital gain is tax-free, then everything above that is taxable. (For my correspondent, it sounds like the tax cost of this is zero because he/she has no net worth to speak of).
  • Treat retirement accounts as distributed in a giant lump sum on the day before you renounced citizenship and pay U.S. income tax on that. (For my correspondent, I do not know whether this will cause a tax cost or not).
  • Certain consequences arise from being the beneficiary of a trust. (We do not need to worry about this for my correspondent, I would guess).
  • If you ever give money to U.S. persons (or leave an inheritance to a U.S. person), that recipient will have tax to pay for the privilege of receiving something from you. (Again, my correspondent probably does not care).
  • File an income tax return and Form 8854 for the year of expatriation. This costs you either time, money, or both. (This is the primary complaint for my correspondent).
  • Possibly you might file U.S. income tax returns for the five prior years (before the expatriation year). This is a risk factor that you might not care about. For my correspondent, I suspect the tax liability is nil (because of low income, and the fact that he/she pays income tax already in the country of residence and therefore would get a foreign tax credit).​ ​

What I would do in this situation

My correspondent does not have several thousand dollars to have the Form 8854 and income tax return prepared correctly by an accountant.​

If I were in this position, I would download the forms and do them to the best of my ability, by hand. I would do them badly if necessary. The most important point is to get stuff filed, because it looks to me as though the tax cost is nil.​

If you make a mistake in doing the paperwork, good for you. You caused more friction and wasted effort inside the Internal Revenue Service. We salute you for making their lives more difficult. 🙂 The IRS deserves it for being at the forefront of forcing people to follow obtuse, offensive, and useless rules. Hehe. I am not bitter, and I do not judge.

Seriously, though. What can the IRS do if you, as a normal human, do your best in attempting to follow their broken procedures? You have no downside. “Oh, you should have filled in Line 27.” “Fine,” you say. “Here is my answer to Line 27.”​

Short answer: do the paperwork, do it badly if you must.

Go all Old Testament on them and curse the U.S. government and its children’s children’s children, if you must. (You will feel better if you do, and who knows — maybe this will have some sort of metaphysical impact, though it seems to me that the Children of Israel had turmoil and trouble for thousands of years with or without the multi-generational theological spells cast upon their enemies).​

Disclaimer

Despite anything in this newsletter to the contrary, I, for one, welcome our civil servant overlords (YouTube) and am ready to prostrate myself before them and do their bidding.

Don’t take this as tax or legal advice. We certainly do not want to poke our overlords with a pointed stick (YouTube) and incur the wrath of The Uncle of Sam.

Go hire someone competent. You can tell that I have immediately disqualified myself from that category! 🙂

Until next time!​

Phil.