Why people expatriate
[This is a Tomi Ahonen-style missive about expatriation. It is over 5,000 words long, and written on Emirates flight 215 from Dubai to Los Angeles, because it’s 16 hours of flying and what else are you going to do flying over the North Pole but listen to music and write a manifesto? If you’re looking at it in your RSS reader you might just decide to skip it. I wouldn’t blame you. By the way, did you know that it is 8 hours flying time from the North Pole to Los Angeles, almost exactly?]
Oh. This post was inspired by a call I received whilst in Dubai from a gent in London. We talked about this topic for about 20 minutes and, well, this post is what happened. Keep the calls and emails coming.
Introduction
Americans are giving up citizenship and permanent resident (“green card”) status in increasing numbers. It is a significant part of our law firm’s practice, and discussions with people in the Middle East were a major part of my visits to Beirut and Dubai on this trip. People are giving up U.S. citizenship even though the rules from 2008 onward make it expensive to do so. The current tax rules can impose a substantial–and immediate–income tax on someone who gives up citizenship. They do it because keeping U.S. citizenship is getting more expensive, in economic and non-economic terms. Many of the non-economic reasons people expatriate are due to tax enforcement policies and a culture of fear encouraged by the IRS. Expatriations have visible costs and hidden costs of lost opportunity to the United States. People who give up citizenship are forever outside the U.S. tax system. There is no further hope of tax revenue from them. But more important, there is an opportunity cost to the USA. Productive people opt out of the U.S. system. They invest their money elsewhere, creating businesses, jobs, and wealth in other countries. This weakens the United States and strengthens other countries. Equally important, millions of Americans abroad living ordinary lives is an undisguised good thing. They are unpaid goodwill ambassadors, living in other countries and making friends. Every expatriation removes one such goodwill ambassador, converting him or her into someone who grumbles about expatriation at cocktail parties. This is important. Maybe more important than we realize. Keep doing what you’re doing and you will keep getting what you’re getting. We should expect expatriations to continue because government policies will not change.How to expatriate
Let’s start with a little technical background–how someone expatriates. I am going to refer to citizens terminating citizenship, just to keep things simple. However, the same processes and concepts apply to persons who have held a green card visa for a significant amount of time–generally eight years, but the counting rules for permanent residents are weird.Terminating citizenship
In order to terminate your citizenship, you do some paperwork, have an exit interview at an Embassy or Consulate, and receive a Certificate of Loss of Nationality. Unless there is evidence that you do not understand what you are doing, or you are being coerced, you will achieve the desired result. “You’re crazy” or “someone is twisting your arm” (in the judgment of the Consular official) are good reasons to deny you the termination of citizenship that you’re asking for. This makes sense. What to expect seems to vary from one diplomatic outpost to the next. Some people report enthusiastic questioning by Consular officers; others report that they received matter-of-fact and indeed friendly treatment. Generally, there is nothing to fear. The Department of State forms are poorly designed and sometimes difficult to understand but you will get through the process.How to deal with the exit tax stuff
Getting the Certificate of Loss of Nationality is not enough, however. You also need to tell the IRS that you are no longer a U.S. citizen, handle the paperwork, and possibly pay some tax. This tax is colloquially referred to by those of us in the tax business as the “exit tax”. You tell the IRS about your loss of citizenship–and settle up on the tax bill–by filing a complicated income tax return for the year in which you terminate your citizenship. The filing deadline is the same as it always is. For Americans abroad it is June 15 of the next year, and extensions are possible. The tax return is a dual-status tax return (see Chapter 6 of IRS Publication 519) consists of three parts:You might or might not have to pay income tax because you expatriated. The IRS looks at you as either an “expatriate” (and you do paperwork only) or a “covered expatriate” (you do paperwork plus pay some tax). A covered expatriate is someone who is rich by IRS standards. You had an average Federal income tax liability of more than $151,000 (for expatriations in 2012) for the prior five years? Or your net worth is $2,000,000 or more? Either way, you are rich. You are a covered expatriate. A covered expatriate is also someone who–regardless of net worth or prior Federal income tax liability–cannot say under penalty of perjury that the prior five years of Federal tax obligations are fully satisfied. Finally, a covered expatriate is someone who is late filing the exit year income tax return on time. If you’re a covered expatriate, here’s how you calculate your exit tax. Pretend all of your IRAs, HSAs, and similar tax-deferred accounts distributed everything to you on the day before your appointment at the Embassy. It’s all taxable income. There is no early distribution penalty. Some pensions are treated as your entire pension benefit is distributed to you as a lump sum. You pay U.S. income tax on this make-pretend distribution although you might be decades away from retirement. If you are a beneficiary of a trust, generally you will be taxed as taxable distributions are made. As for everything else, pretend that you sold it the day before your appointment at the Embassy. In investment jargon, your assets are marked-to-market. Calculate the capital gain, deduct the exemption amount ($651,000 in 2012), and pay tax on the rest at the normal tax rates. If it is long term capital gain, pay tax at 15%. If it is short term capital gain, pay at those rates. If it is depreciation recapture, ordinary income, whatever–apply the relevant tax treatment to it. After you have filed that final year income tax return, you have no further tax obligations to the United States, whether you are a covered expatriate or merely an expatriate. After you expatriate, you will owe income tax to the United States only if you have U.S. source income.
- – Form 1040 for January 1 through the day that you terminated your citizenship (usually the day of your exit interview at the Embassy). Report your income normally, as a U.S. taxpayer usually would.
- – Form 1040NR for the day after your exit interview through December 31. Report your income like any other nonresident/noncitizen of the United States on the planet. Generally this means that you only report (and pay U.S. income tax on) income you received from U.S. sources.
- – Form 8854. This is the critical one. This is the form by which you inform the IRS that you have expatriated. You determine whether you must pay an income tax because you expatriated (or not), and do the necessary calculations of the taxable income created by terminating citizenship if you do owe tax.
Why?
An economist would say that the demand curve predicts that as the cost (broadly defined) of a good increases, demand decreases. A human would say that if something is more expensive, you’ll buy less of it. Expensive can mean financial cost, of course. But it can also mean non-financial factors. As you get closer to the edge of a cliff, the risk of falling off increases. We would expect people to shy away from the cliff’s edge, with some willing to tolerate more risk than others. The tax system I described above was enacted in mid-2008. It replaced a system that did not impose an immediate tax on expatriates. In mid-2008 it became immediately more expensive (financially) to expatriate. Thus, we would expect to see fewer people take this step. Yet we have seen the opposite. The rates of expatriation have increased over those seen before 2008, and since 2008 the number of people expatriating every year has increased. This is counterintuitive. Why are more people expatriating every year? Again, looking at the question using economic concepts, the cost of expatriation has increased. But the cost of keeping U.S. citizenship has also increased, primarily in non-financial terms. Thus, a person’s decision to expatriate is logical: the cost (broadly defined) of keeping U.S. citizenship is more than the cost (broadly defined) of giving it up.Tax returns are expensive
A U.S. citizen living in the United States has no exposure to the additional burden that an American abroad faces in preparing her income tax return. There are forms and filing requirements unknown to U.S. resident taxpayers, triggered merely by living an ordinary life abroad. Forms 3520, 8891, 8621, 8938 and many others can be required. These requirements have become more onerous over the last few years. Form 8938 was required starting with 2011 tax returns. It requires reporting of various foreign assets. (Imagine if you, a resident taxpayer, were required to tell the U.S. government what you own and how much it is worth). Form 8621, long-ignored, is now required for any American abroad who buys a mutual fund–equivalent to one from Vanguard or Fidelity–issued by a foreign company. Failing to file certain forms can leave the statute of limitations (the amount of time the IRS has to audit you) open forever, rather than the three year rule that normally applies. The additional requirements for tax returns mean that the accountants’ fees paid for tax return preparation are higher for Americans abroad. The requirements they face are obscure and technical, with high penalties for error. Americans abroad pay more than resident Americans for their tax return preparation. Someone living outside the United States must think of this when considering expatriation. Indeed this is a primary factor in expatriation cases that our firm handles for normal people. (Your definition of “normal” may be different from mine).Expensive tax returns, no tax paid
It is important to note that for most Americans abroad, there is no income tax paid annually to the United States. They just prepare complicated tax returns and file them. Two rules, designed to ensure that Americans abroad are taxed fairly, ensure this. The first of these rules is the foreign earned income exclusion. Look at Form 2555 to see how this works. For 2012, the first $95,100 of earned income is not taxed in the United States. Most people do not earn that much salary, so most Americans abroad pay no income tax in the United States. The second of these rules is the foreign tax credit. Look at Form 1116 to see this in action. A dollar of income should not be taxed twice. So, an American abroad pays tax in his country of residence, then claims an offset for that tax paid against his U.S. income tax liability. For people living in Europe, New Zealand, Australia, and other high-tax countries, the result is usually a U.S. income tax return with zero income tax payable to the United States. Imagine what it is like to $2,000, $3,000, or more for tax return preparation, with a zero tax bill. It is a pointless an expensive exercise.Dual citizens abroad who pay income tax
If we exclude people making under $95,100 in salary, and if we exclude people living in high-tax countries who can eliminate U.S. income tax using the foreign tax credit, that leaves only people who live in low-tax countries and have salaries above $95,100 as those who pay income tax. This, I would guess, is a small percentage of all Americans abroad who would be candidates for expatriation. The income tax on these individuals’ salary, plus income tax on investment income (to the extent not offset by foreign tax credits) will be the major components of Federal income tax collected from Americans abroad. It can’t be a large number, but I have no access to statistics. (I’m on a plane!). My guess is that the revenue is small. But something is better than nothing for the IRS. This is a relatively small number of people, but for them the U.S. income tax will definitely be a factor in deciding whether to expatriate or not. The appeal of paying nothing rather than something is undeniable.Expensive tax returns, no tax paid, downside risk
Our would-be expatriate considers paying a lot of money every year to prepare U.S. income tax returns, while paying no U.S. income tax. If there is an error on the tax returns, the potential penalty risk for our would-be expatriate is astronomical. Penalties can be $10,000 for leaving one of your bank accounts off Form TD F 90-22.1. This problem has been exacerbated in the last few years of the IRS pursuit of undisclosed bank accounts. As the news circulated about the treatment of ordinary taxpayers, fear was created in the hearts of people who were considering expatriation. The trickle of stories about voluntary disclosure penalties was not helped by the harsh PR from the Internal Revenue Service. The Commissioner announced loudly and repeatedly that Americans with assets abroad were targets for IRS investigation, and prior sins could be repaired only in extremely expensive ways. In summary, an American considering expatriation sees substantial personal expense, and for what? The possibility of massive IRS penalties for screwing up some paperwork? That sounds unappealing.Home country tax benefits
The United States has all sorts of tax-deferred accounts for various purposes: accounts for health care benefits, accounts for education savings, and others. Many other countries have similar schemes for their residents, allowing them to save for education, buying a house, or retirement. A Canadian has a variety of tax-deferred accounts available for saving money–for tuition, for retirement, etc. If that Canadian also holds a U.S. passport, the tax deferral granted by Canada is ignored by the U.S., and the earnings on that account are taxed in the United States. The U.K. has its ISA. Australia has its superannuation. A dual citizen loses home country tax benefits because of U.S. tax policy.Even basic banking is becoming a problem
Because of FATCA, foreign banks are identifying their U.S. citizen customers and closing their accounts. FATCA, for those of you unfamiliar with the law, is a U.S. law which attempts to coerce foreign banks worldwide into reporting all of their U.S. customers to the Internal Revenue Service. To call this an unfunded mandate is an understatement. Rather than pay for this reporting exercise, many foreign banks find it cheaper to shed their U.S. customers. It is increasingly difficult for Americans abroad to have the regular bank accounts needed to live.U.S. estate tax
Similarly, the estate tax will be a concern for some. Americans living in countries with a tax on death similar to the U.S. estate tax will likely be indifferent. A tax will be imposed by one country or another when they die. But for those living in countries with no estate tax, the impact is profound. I have many clients in the Middle East. There it is the norm to have very large family-owned businesses. If two brothers own a business and one is a U.S. citizen, upon the citizen’s death an estate tax will be imposed, essentially causing his share of the business to be sold to the non-citizen’s side of the family. In order to preserve the family business, ownership must be removed from U.S. citizens.Benefit gap of U.S. citizenship over competing alternatives
Another reason why expatriation increases, I think, is because the alternative isn’t that bad. And it’s getting better all the time. The gap has (for many people) narrowed when considering the benefits of keeping U.S. citizenship compared to holding a different passport. Someone holding a U.K. passport will see little perceived benefit to U.S. citizenship. She can move freely about the planet and live in a first-tier country. Other citizenships are not quite as useful. Iran, at the moment, is under a variety of international sanctions and this makes life more difficult for its citizens. An individual with Iranian and U.S. passports might find it prudent to hold onto the U.S. citizenship. This benefit gap will continue as more countries aggressively improve their immigration policies to attract desirable immigrants. Also, economic development means that countries will improve and become more desirable to live in.Future legislation
Finally, people must guess about the future. Political signals from the United States show that expatriation and tax policies are likely to get harsher.The cost of expatriation now is less than the expected future cost of expatriation. Better to take the medicine now rather than later.
- – There is a fear that the Reed Amendment will be enforced. This is a long-standing and unenforced law that permits the United States to bar re-entry to expatriates.
- – Senator Schumer’s recently-proposed (May, 2012) bill to exact a tax surcharge on expatriates is noticed by people considering this decision. This is a knee-jerk reaction to the Eduardo Saverin expatriation and is unlikely to be passed, but the mere occurrence of these stunts gives the appearance of less stability in U.S. tax policy and encourages expatriation sooner rather than later.
- – The increased tax reporting requirements (Form 8938, FATCA), coupled with Senator Reid’s proposal to give the IRS power to suspend a citizen’s passport if there is a suspected tax liability causes people to fear whether they might be prevented from leaving the United States at some point in the future.
It is entirely possible that the IRS would leave you alone and you would live a happy life.
You would not want to invest in the United States, and you might not want to travel to the United States. You would not want your spouse to be a U.S. person, or your children. All of these things create risk and complexity for you. But the rest of the world is a big and friendly place, full of interesting people and opportunities.
You would hope that intergovernmental relations between your country and the United States stay sufficiently strained so that nothing bad happens to you in the future. You would hope that the tax and other laws as they exist today will never, ever change.
I guess the best way to describe the strategy is that you live as a low-level fugitive with minimal risk. The practical question of “will it work” is impossible to answer because so much can change in the future. The real-life question of “should I do this?” is impossible for me to answer because it depends on how much unresolved legal ambiguity you are willing to live with for the rest of your life. You will have a tax debt to the U.S. government. The tax debt will never go away. The U.S. government can be a very determined debt collector if it chooses to be.
Once again it is a question of “Your money or your life?”
Or to put it in Dirty Harry terms, “Do you feel lucky?”
Great post…I was just wondering one thing though…I am considering giving up my citizenship and I am curious to know how the IRS intent to force me to pay the “exit tax” if all my assets are abroad and they have no access to it.
I do not think the changes expected at the end of the year will have an impact on the exit tax. The fact that tax is due will remain unchanged. The rate of tax, however, may change.
How do the expiration of the Bush Tax cuts later this year affect the “exit tax” when expatriating, especially as it pertains to the estate tax exemption for “covered expatriates”?
If you expatriate and pay the exit tax, does that relieve you of the requirement to complete all past delinquent U.S. income tax returns? Since you are required to indicate your tax liability for the past five years, must you also pay tax due in those past five years?
Particularly disadvantaged are retirees in a country like Australia. Our Australian pensions are tax free during retirement because we have paid tax on both contributions and earnings during our working lives. But the U.S. considers our pensions to be “non-qualified”, “private” pensions (even though they are mandated by the Australian government) and subjects them (at our most vulnerable time) to full U.S. income tax. The Foreign Earned Income Exclusion, of course, is not applicable.
I don’t see why not. The default tax will likely be 30% on it, by withholding as you receive payments.
Can you keep your united states civil service pension if you renounce your u s citizenship
The instructions for the 8854 form are confusing. Is there any place to get helpful information? Where do we include our RRSPs? I would like to get it all done correctly so that I don’t have any future trouble. You simply enter your amounts but don’t have a list of how you arrived at the amounts. How is that going to work?
Could you please explain where we include our RRSP on the 8854 form. Some of mine is interest bearing and some is stock based.
The instructions for 8854 filing are confusing. Is there any place to get some real help? My accountant isn’t all that sure about where to include things.
Further to Phil, June 15th, 12.12 pm.
RE: Talk of Taxation at Exit Interviews. It seems most consulates do not bring up tax at exit interviews, although we have it heard of it occurring at one other consulate (so there may be a few more out there). The only duty a consular officer has regarding tax is to ensure that you have read and understand the “Statement of Understanding of Consequences” (form 4081), which makes reference to tax in line 10. [The 4079 questionnaire, “Request for Determination of Loss of Citizenship,” asks if one files tax returns. This form is required for CLN applications based on s. (1) relinquishments. According to the DOS procedure manual (7 FAM 1260), the 4079 questionnaire is not required for renunciation. However, some consulates do ask renunciants to complete this questionnaire, but, again, they don’t seem to be asking questions about tax, at least from the reports we’re getting at Brock.]
RE: Exit Interviews Taking Place at the Counter in the Waiting Room. This is definitely very common. It may simply be for security reasons … that they decided in recent years to keep all people in one area of the consulate, with a security guard, rather than have them one-on-one with a vice consul in a private room. At one extreme, a Brocker reported a consulate with a very loud officer sort of “broadcasting” the exit interview to the waiting room (he sounded rather obnoxious in general). But at another consulate, a Brocker was told that they try to schedule exit visits for when there aren’t going to be people in the waiting room as it is a personal matter.
RE: He felt there was an attempt to embarrass him. With the exit-interviews-at-the-counter, I hope the semi-public setting doesn’t make anyone feel embarrassed. Just focus on yourself, and remember citizenship is a contract, so nothing dishonourable about terminating a contract according to the terms of its out clause.
ALSO: I’d like to mention that people are sharing their accounts of their exit interviews in the Consulate Report Directory, which is organised by location, at the Isaac Brock Society website. We welcome everyone to share their stories and/or to consult it for a heads-up on what to expect before their consulate visits
Anon…thanks for pointing that out. Makes sense now!
@Geoff: “The 2011 8854 instructions state (under “Date of Tax Expatriation”) that…”
I’m neither Phil nor Tim, but…
The part you’re quoting is under the heading “Expatriation After June 3, 2004, and Before June 17, 2008”. These were the “old rules”, prior to HEART. Between these dates you had to send an initial 8854 to the IRS as soon as you’d expatriated. (And then one each year after for the next decade; yup, a major PITA for no gain to anyone.)
Doesn’t apply now though. Post-HEART your “tax expatriation” date is the date you expatriate with DOS. Paperwork just comes later.
Phil/Tim
Thanks for your responses. The 2011 8854 instructions state (under “Date of Tax Expatriation”)that “For purposes of filling out Part I, the date of your expatriation is the later of the date you notified the relevant agency of your expatriating act or the date Form 8854 was first filed in accordance with these instructions”. There is then a caution containing the words “Until you file Form 8854…your expatriation for immigration purposes does not relieve you of your obligation to file U.S. tax returns and report your worldwide income as a citizen…”.
Under “When to file” it then says “File your initial Form 8854 as soon as possible after the date you relinquish U.S. Citizenship”.
So let’s say you expatriate in Jan 2013. Your dual status tax return (with form 8854 attached) for 2013 is not due until April 2014. To be safe, I think it would be wise to file a copy of Form 8854 ASAP after Jan 2013, and the attach a copy when the dual status return is filed in 2014.
Rather confusing, but an important timing point, don’t you think?
@Tim,
You are correct. Someone who terminates citizenship (or a long-held green card) files a tax return for the year of termination. The filing deadline is the normal deadline for that person: April 15 for some, June 15 for others, with the normal extensions available.
The tax return is a dual-status year tax return (Publication 519, Chapter 6) with a Form 8854 bolted to it.
This means that tax matters _should_ be off the table for that exit interview at the Embassy/Consulate — because tax returns aren’t due to be filed. The only reason I can think of for the Embassy/Consulate official to talk about tax is gratuitous hostility.
Or perhaps there is a data-gathering operation in place, where the U.S. government is attempting to understand the reasons for expatriation.
Nah. The government already know the truth, and there is no need for outside facts that might uncomfortably contradict what the government knows to be true. 🙂
Anyway. Talk of taxation at an exit interview should be out of bounds. I just heard from a guy who went through this in Central America and the exit interview wasn’t in a separate room. Just out in the main area. In the open. He felt there was an attempt to embarrass him.
I believe the 8854 is filed at the normal time for tax filing. So someone who renounces this year would have to file 8854 prior to June 15th 2013. I don’t believe you could file right now because the tax form for tax year 2012 have not even been published yet.
Hi Phil,
Firstly, thanks for a great blog entry describing this process. I was wondering if you wouldn’t mind clarifying the “expatriation date for tax purposes”. Your explanation above seems to indicate that it is the date of the exit interview at the Embassy, but the instructions for Form 8854 imply it is the later of that date or the date that Form 8854 was first filed.
For example, if I had my exit interview in December 2012, and I filed form 8854 in January 2013, which would be the applicable date for tax purposes? This is important as it would effect the relevant 5 tax years for Part IV Question 6 and also the year of the required dual status return.
Can the 8854 be filed immediately after the exit interview, or is it necessary to wait until the CLN is issued as confirmation?
Many Thanks
@Victoria The standard response I get about “why should I pay US taxes” is the belief that the US has 3 helicopters full of commandos on call sitting there to rescue me should I be caught in the crossfire of a war zone or kidnapped by rebel commandoes (I live in the European Community).
Sadly, my own mother even offered up this reason to me when I explained my decision to expatriate and said I could no longer bear the US compliance burden.
The bottom line is, most US residents have never been outside of their own country, they are completely insular and have absolutely no comprehension of the rest of the world, no respect for the sovereignty of other states.
Get real! Citizenship taxation offers such a free bonus! Especially in the start up phase. Catch out 7 million unsuspecting subjects, who you never bothered to inform (even when you had face to face contact at border control or embassies). Slam a minimum 10,000 $ penalty times 7 million… you do the math. Steal retirement assets from every other civilized country in the world, taking away from their citizens capacity to pay for their retirement and putting a burden on social services across the globe… who cares the US has it’s rights!. Tax people who don’t live there, don’t vote, have no voice!
What’s more: extra bonus! citizenship taxation is not just limited to citizens. With the US method you can freely and arbitrarily decide who is a “US person”. What is this “183 days over 3 years” rule? Every other civilized country applies 6 months. 6 months and you are a resident and thus a taxpayer. Period. Here, the IRS can decide whenever it wants to add another category to the “US persons” rule.
Perhaps they will add (retroactively of course) “anyone traveling to the US for vacation in the past 10 years” and start handing out 1040’s and FBARS on the international flights to Orlando.
Why on earth would they give it up? Would you?
Under prior legislation, the limit was 500,000$ above which you were considered “expatriating for tax purposes” and had to file for 10 years after expatriation. What would stop them from lowering it?
how many of the people, who have and will expatriate in the coming years, would have been willing to pay a reasonable “retainer tax” to retain their citizenship while abroad, eliminate the climate of fear, have easy filing and easy compliance, and then be able to move back and lead a productive life some time in the future?
I bet all of them. Yes, 100% even the very rich ones. People do not take these decisions for tax alone. It is the climate of fear, the complications, the uncertainty, and the changing rules that terrifies people into shutting the door behind them.
absolutely agree; i was watching the situation since 2004 and the door kept getting smaller and smaller. all indications pointed to getting out NOW or never.
that is exactly why I expatriated.
yes I am one of the famous 1781.
my heart goes out to you. I have always thought, what about the people who just happen to live in lower tax jurisdictions? You do not have US infrastructure, you cannot go down the road and borrow a lovely book or movie from a nice US library. You may have to pay a private guard to keep your children safe at night. You cannot walk about the streets in shorts and a T shirt and expect to come home in one piece. Indeed, you pay for the infrastructure you receive. But I verily doubt that any US resident person can understand this. Let me give you another example. I live in a highly taxed European country – one of the top 6 highest taxes in the world. Next door to me is a very small country, where if you have 3 kids, you pay NO income taxes. According to the “tax-is-the-only-reason” expatriation mentality, all of the bordering countries would have no more families with 3 children because they would all move to the neighbor where they would pay no tax. Surprise… this doesn’t happen! People choose where to live based on many other reasons, tax is only one of a thousand reasons. Until the tax becomes life-prohibiting and then you have to get out.
I personally don’t like the fact with foreign bank accounts, the congress/IRS decided to impose such harsh penalties.
The main reason is for the subliminal message that it carries. The IRS says (without saying it) that it believes that most people will do almost anything to avoid paying taxes, and that the only way to prevent this from happening is to impose huge penalties.
So, in a way, it tells people that they’re living in a country of thieves, which may then become a self fulfilling prophecy.
The right way to address that is not to threaten people with ever increasing penalties, put to simply ask from them to do better tomorrow than they did yesterday. And keep the big penalties for those who don’t want to learn.
Correction: My prior post should have referred to the American Jobs Creation Act of 2004, not 1984. Sorry about that!
@Pacifica –
The 2006 Canadian census showed 117,425 people reporting that they had a US birthplace, but were now Canadian citizens only. Very few of these people will actually be aliens as far as US law is concerned.
http://bit.ly/Ki8sz8
I have a great deal of trouble believing that 877A was intended to apply to persons who gave up their citizenship many years ago. Keep in mind that the predecessor provision, 7701(n), came into the Code in 2004 and was expressly made applicable solely to persons who expatriated after the date of enactment of the so-called American Jobs Creation Act of 1984. So, if the 2004 predecessor provision was clearly limited to prospective application, it really doesn’t make sense that the 877A rules would have been intended to go back in time to “recapture” individuals who were in effect “grandfathered” in 2004.
@Popol,
I don’t expect it because that involves big change in the Philosophy of Taxation. Such big changes would be signalled well in advance by all sorts of policy analyses from the Joint Committee on Taxation, the Treasury Department, and elsewhere. I haven’t seen those signals that indicate that the topic is being primped and preened for public presentation.
But I hope I am wrong. A territorial system would be simpler for Americans abroad.
Thanks, Phil, Petros and Tim for your input.
Phil, Amazing no one has sought judicial decision on this question already. I sure won’t be the human sacrifice. I had a very peaceful uni-national life until this US-mess came up in late 2011.
And as Petros pointed out, I already had to “stand up for my rights,” which was the last thing I ever wanted (or expected) to have to do, when I had a hellish experience at a consulate. Unbelievable. I was really blindsided as I’m just a run-of-the-mill nobody with no family in the US who hasn’t had any connection to the country in almost 40 years. I did get my file transferred to a different consulate, where the personnel were terrific, and the first consulate actually apologised. In fact, when I sought recourse, my problem was taken very seriously and acted upon very quickly, leading me to believe that DOS does not at all condone such handling of expatriation matters and that DOS is a decent and sensible department.
But it’s still unsettling that such incident could occur in the first place. And unlike DOS, IRS doesn’t even have a reputation for being level-headed and fair-minded to begin with.
I think that the ex post facto application of 877A is unconstitutional, but I’m getting the feeling that IRS generally does whatever it wants until someone takes them to court and the court tells them to stop doing it. They seem like loose cannons, they’re so opaque and confusing, and that Shulman seems to set the tone of a crusade rather than a business-like revenue-collecting agency.
It’s like impossible to know what you’re supposed to do. I think it’s important to wrap up all the loose ends neatly. Certainly, I’d just like to blow it off (if that’s legally correct) and get back to my normal life, pre-US-crisis. But, regardless of if it’s fair or not, I do want to follow the law … anything to wrap this up smoothly … if I could just figure out what the law is!
Phil,
You are saying that the US switching eventually to terrotorial based taxation won’t happen. I might be naive but there is definitely a trend in D.C. pro terrotorial based taxation for corporations, couldn’t that flow over to individuals also?
Phil,
Shouldn’t the correct penalty for someone such as Pacific be the as that of not filing a treaty election(by not informing the consulate of her expatriating act back 1979 and becoming a Canadian citizen Canadian resident US Non Resident Alien under the terms of the US Canada Treaty). Thus if the tax loss to the Treasury is less than 10,000 there is NO penalty. Just like as you discussed earlier when someone fails to file the RRSP treaty election. Maybe I have this wrong but I “think” this might be the correct way of looking at.
Another way of looking at is if Pacific loss of US citizenship was for reasons of “income tax avoidance” as defined by US law back in 1979(these early anti-expatriation provision wer put in place in 1966) then she was obligated to continue to file returns for ten years until 1989. By not filing these returns from 1979 to 1989 there are still outstanding statute of limitations issues for those years but I can’t see how there would be any issues for years after 1989. (An important question is whether the IRS under any circumstances is still interested in pre 1990 or even pre 2000 failure to file issues notwhithstanding the unlimited statute of limitations). It seems hard to make any argument that Pacifica was still a US citizen after 1979 if her CLN states 1979 as her of expatriation. In fact I worry that people filing in this position could actually cause their CLN’s to be revoked by the State Department.
@anonymous:
Someone who relies on black helicopters to ride to the rescue probably put himself/herself in a bad position to begin with. Not always, but most of the time I would guess. I put that into the post semi-facetiously just because I like the imagery. 🙂
Yet still, this is one of the arguments from those who claim expatriates are un-American: how can you rely on the U.S. Army rescuing you? That’s one of the bargains of citizenship, isn’t it? And my response is “Maybe you don’t have a God-given right to be rescued if you deliberately insert yourself into [Scary Country du Jour].”
@Petros,
Thanks. I will take a look at this later. The problem that Pacifica has is one of the Great Unsolved Problems. I suspect sooner or later someone will become a human sacrifice (willingly or unwillingly) and this question will be tested in court.
Phil, with regard to the date of relinquishment, one of our people dug up a really important aspect of the law, and the Brockers could probably benefit from seeing your take on it (or perhaps you didn’t see this): http://isaacbrocksociety.ca/2011/12/16/did-you-relinquish-before-february-6-1995-then-you-did-not-have-to-inform-the-state-department/
In any case, two dates are indicated, one in 1994 and another in 1995. Like everything in the laws of your country, conveniently written by lawyers so that only lawyers can understand them, it is as clear as mud.
I think that the person like Pacifica should just give the US the middle finger and be done with IRS. She went through personal hell to relinquish, dealt with obstructionist consular officials (to the point that some of people are now completely avoiding that particular consulate and going to a different one.)
One of the problems that many of our people face is that they have trouble standing up for their personal rights: like the right to expatriate and to tell their once beloved country that they are full of crap if they think that we are going to pay them even one red penny in tax. The 100K people that Pacifica is talking about should just flip the bird to the US and tell the IRS, Prove it in court you jerks! This is the most ridiculous claim that I’ve ever heard: these people were told that they lost their citizenship when they became Canadians. Now border guards are making them travel on a US passport and reinstating them without giving them anything like Miranda right warnings: “You have the right to relinquish your citizenship. Our laws say you can have it back, but you have a right to refuse the reinstatement of your citizenship. Any reinstatement of your US citizenship can and will be used against you in order to collect taxes from you and to force you to divulge your bank accounts to the Treasury department and the IRS–furthermore, you will become vulnerable to severe fines if you omit or make a mistake in your filing requirements.”
As to the so-called advantages of keeping US citizenship:
Black helicopters rescuing you:
Just as likely, or almost as likely if you are a citizen of UK, France, other countries. But citizens of many countries are just not too valuable as hostages.
World travel:
For citizens of most industrialized countries, business/vacation travel is just as easy as for US citizens. Visa-free travel may not be as extensive, but that is only important for spur of the moment trips. In practice, visas to most places you’d want to travel to involve proving you have assets and ties in your country of residence so that you’re not likely to want to immigrate illegally to work at a minimum-wage menial job. In other words, even if your country of citizenship/residence is poor, you’re not. There’s a nominal fee and a couple of weeks wait, but no major barriers.
Feeling to belonging to a powerful nation or larger group/culture:
I’m not sure that one’s passport really accomplishes this. You can be an ethnic (fill in country name)because of ancestry, family ties, language, etc. without having that country’s passport — and vice versa.
Living in the US/ children being US citizens:
Generally agree with this one, but this is not impossible for non-US citizens, especially Canadians, and/or the highly skilled.
Thanks for your quick reply, Phil! Ex post facto application of exit tax law would make an excellent blog post! There are lots (possibly upwards of 100,000) people in Canada in this boat, who were told they automatically relinquished US citizenship prior to a DOS policy change in 1986, now affected by IRS legislation passed first passed in 1996.
Could you, off the top of your head, briefly explain why 877A is applied ex post facto?
It sure doesn’t seem fair to apply a law that didn’t exist at the time. I think there’s a good chance Federal Court would strike it down. But I sure won’t be the Crash Test Dummy! I’m not near the limit to be “covered” or owe tax, thank goodness, let alone go to Federal Court. But the aggravation of dealing with this government after a lifetime of dealing with the “user-friendly” Revenue Canada is a morass of confusion.
Re the paragraph in your post on “Goodwill.” Having relinquished for purely personal reasons (nothing to do with policy, tax or otherwise), I always felt very positive towards the US as a foreign country for decades. But since finding out I might be a retroactive USC or retroactive US person, it’s been the cause of a real nightmare of stress.
Thanks for these clarifications. I should not stray out of the Internal Revenue Code, apparently. 🙂
Thanks for the clarification Asher. You are right, of course. I guess a better way for me to state this is to say that these forms are part of an American abroad’s everyday life and tax returns, while for most Americans at home, they are the exception.
“That your children will also be U.S. citizens is valuable, too. ”
Technically not true, they are eligible to apply, but have to go through the same application and interview process as anyone one else. Your four year old will have to have an INS interview.
“Someone living in the United States for 10 years on an L-1 visa ”
Maximum stay on an L-1 is seven years. At that point you have to reside outside the US for one year before you can come back.
Excellent, comprehensive post Phil. I particularly enjoyed the economic and humanistic perspective, in addition to the legal issues.
One comment. In the section that is titled “Tax returns are expensive”, the theme is the added burden and costs to expats filing tax returns from abroad, as contrasted to filings by US resident taxpayers. You cite a string of IRS tax forms that are “unknown to US resident taxpayers”, e.g., 3520, 8621, and new form 8938. I am certain, Phil, that you know that these very forms are also applicable to US resident taxpayers, but the text reads as if these forms are only applicable to expats. Thus, US resident taxpayers are, in fact, also “required to tell the US government what [they] own and how much it is worth”
Thanks. Fixed that. This demonstrates the peril of writing stuff on a plane.
Yes the erosion of privacy is breathtaking. As systems move away from cash and toward “more transparency” (doesn’t that sound like rainbows and butterflies?) we will have less privacy and less control over our own lives.
Americans abroad are at a disadvantage because there are no politicians in Congress who care about them.
Americans at home are at a disadvantage because they’re willingly ceding privacy and control over their own destinies at every opportunity.
Watch for Bitcoin (or its successor) to get sufficiently strong. Then watch the government’s reaction. Truly anonymous currency will destroy governments as we know them.
@Pacifica777,
This is a vexing problem. I am going to have to write an actual blog post about it. As you note, Section 877A(g)(3)(B) would seem to be the provision that applies to you. It says, for someone like you, that your “expatriation date” is the date you give the U.S.A. the piece of paper saying you ceased being a citizen in 1979:
This means that you will get your Certificate of Loss of Nationality backdated to 1979, but from the IRS point of view they will take 2012 as your expatriation date.
This is going to require someone to be a crash-test dummy to test this in the Federal courts. I agree that it is unfair. I doubt that I would want to be that crash-test dummy.
Hi Phil,
I’d appreciate if you could clear up this really important question regarding exit and other tax obligations? Do IRS obligations and 877A apply ex post facto to people who expatriated before the law itself was in effect?
I relinquished in the 70s, back when both the US and Canadian govts told us that loss of US citizenship was automatic upon taking Canadian citizenship, and no one ever mentioned CLNs back then. I was truly shocked recently to learn I might have an unexpected citizenship. However, the US consulate has confirmed my belief that I ceased to be a USC in 1979 and that I will get a CLN to that effect.
As I understand it, prior to HIPAA (1996) IRS obligations ended the day US citizenship ended … then HIPAA created the notion that IRS obligations ended, not with the act of relinquishment, but on the date you notify Dept of State of the relinquishment.
The current law, as far as I’m aware, is 877A, enacted in 2008. It also continues IRS obligations until the date you notify Dept of State of the relinquishment.
I understand that US laws are not ex post facto, unless stated to be such. But US law often seems not only unfamiliar, but downright illogical, to me … logging out of the US govt is the first interaction I’ve ever had with it in my life … and it’s driving me nuts!
So, I ceased to be a USC in 1979. I notified DOS of this in 2012. So, did I cease to be an “IRS person” in 1979 or 2012?
Hopefully, 1979. But either way, at least I’ll know what I’m supposed to do … I can’t wait to close the book on this truly disturbing interlude of my life.
Thanks,
Pacifica
I concur with Sally about Anon’s point. Let’s just give a hypothetical situation here. what if you’re a 40-something American executive living abroad long-term and you’ve been a good kid and your assets (pensions, house/apartment/and savings) have put you halfway to that magical 2 million mark. You are in your prime earning years and all these assets are appreciating and earning interest. Damn if that doesn’t make you really uneasy. And then there is the distinct possibility that that 2 million may be dropped to 200,000. Changes your whole outlook on life.
And just from a very personal point of view. I’ve spent nearly 20 years of my life abroad. In that time I’ve been abroad I’ve used nothing in the US – only services in my host country for which I have paid my taxes (happily paid by the way since these services are really good). The U.S. didn’t educate my children, pay my unemployment when I was job less, help me purchase a home or encourage me to save for retirement and today they are not paying for my chemotherapy. So when I am asked to pay my “fair share” I am really confused as to what they mean by that. Would a homelander in the audience like to explain?
Concrete example of the threshold’s impact. I’m just below the threshold now but will be over fairly soon. I renounced before I went over. You don’t really have time to think too much about it; you see the door closing, so you have to take the chance while you have it.
Anon of June 6, 5:46 made a good point. For someone living comfortably, but well below the $2mm threshold, the thinking might be: “What if they lower the threshold drastically, like by half, and the dollar tanks at the same time? Then I’d be trapped. Better get out now.”
It’s not inconceivable that both would happen at the same time. Economic turmoil might frighten Congress into lowering the threshold. Weimar Germany instituted their “Reichsfluchtsteuer” in a panicked and misguided attempt to keep money in the country during economic turmoil. It was only later that the Nazis used the tax to confiscate everything that Jews owned.
Great post, but a small, although significant typo:
“Thus, a person’s decision to expatriate is logical: the cost (broadly defined) of keeping U.S. citizenship is less than the cost (broadly defined) of giving it up.”
It should read: “the cost (broadly defined) of keeping U.S. citizenship is *MORE* than the cost (broadly defined) of giving it up.”
Best line:
“More time means more laws.” — Ain’t that the truth!
Most first world countries have strong laws in place against making people stateless. In fact I would argue if you are a US and and a citizen of a second country(and consider yourself to have or want to have stronger ties to that second country) but want to live in a third country it is probably best to renounce your US citizenship and be seen solely as a citizen of that second country. I am thinking of New Zealand for example were newly naturalized citizen are “supposed” to commit to living in New Zealand however the NZ can’t really keep people from leaving after they naturalize(especially to Australia where they are entitled based on Kiwi citizenship to work permits) and won’t make people stateless. However, in theory if you were a US citizen who naturalized as a Kiwi but kept your US citizenship and left NZ there is a remote possibility NZ could revoke your citizenship if you remained an American also. Others (Just Me??) might have more info on the intracies of NZ in these circumstances. Another example is the UK government can revoke a UK citizen’s citizenship if it is the public “interest” but not if it would make someone stateless.
Thanks Phil. One other thought that has not been examined enough to my mind, based on your excellent post.
It is indeed remarkable how US citizens abroad are victims of double standards, but also of recklessness by an insular federal government. Take FATCA. Here we are, more than a decade after 9/11. One strong idea emerging from the aftermath of that crime was better protection for Americans at home and abroad, often to an excessive extent, some might argue.
So what does the IRS want to do today? It wants to enroll foreign banks and financial institutions to essentially catalog and spy on Americans, and report on their bank accounts, transactions, family relationships, and much else when you examine any standard KYC form. In other words, it wants data bases to be prepared on American citizens by unaccountable foreign entities.
From a civil liberties perspective this is outrageous. But what about from a security perspective? Revealing such personal information may not pose problems in Geneva or London (then again who knows?), but many Americans happen to live in countries where (a) they may be targeted, and (b) where there is absolutely no oversight of how the information on Americans will be collected and used by banks or financial institutions under FATCA–or even a determination of who might have access to that information.
The IRS is also creating potential means of leverage over Americans, and vulnerabilities, that can be used against them, depending on who gets his or her hands on their data (assuming they can actually open an account). And all this without any discernible means to ensure the system is not abused.
In fact the IRS doesn’t seems to care, so obsessed is it with getting more revenue, and apparently so convinced that Americans abroad are guilty until proven innocent. There is an element of bullheaded parochialism here, and sheer arrogance, that is breathtaking. Of course, when a government betrays your trust in this way, people will think more about expatriation. Any surprise there?
Yep. Sixteen hours in the sky in a large, noisy metal tube — it isn’t pleasant. 🙂
But Emirates is a great airline to fly, though I have noticed that the last two airplanes I have been on have had little things broken here and there. (Beirut to Dubai, and Dubai to Los Angeles). I’m not sure what that means — just my luck, or indicative of bigger things happening at Emirates.
Phil.
@M,
You are right. Taxes are one part of the equation. Non-tax costs (and benefits) are the other, and frequently they are the deciding factor. Living in a tropical paradise with zero tax is all fun and games until you need high quality medical care, for instance.
That’s why it is important to remember that we are mortal. We live once. We should optimize our lives for the important things (friends, family, health, etc.).
Wow! Maybe you should take shorter flights! Thanks for doing this, it is a wealth of information. I am glad Petros is also posting it at IBS
@Peter,
Be my guest. Many thanks.
Phil.
Thanks Phil for a comprehensive and thoughtful article. Just one comment: I would add that even Americans who live in low-tax countries are not necessarily favored. Low-tax countries, especially in the developing world, are frequently ones where public services are inadequate, which imposes higher indirect taxes and costs on individuals, usually without much accountability when it comes to government. Often, one has to consider the package deal, beyond mere tax rates.
Hi Phil: excellent summary. I wonder if you would permit me to reproduce this post at the Isaac Brock Society (which has moved to http://isaacbrocksociety.ca ).
@Anon,
This is a good point. The abrupt shift in tax treatment does cause a change in decisions.
I see the equivalent behavior with green card holders. As soon as they hit the time threshold (holding a green card “in” 8 of the last 15 years, an unnecessarily technical trap), their position shifts.
Before that moment they can jump on a plane and leave. No exit tax regardless of wealth. No intrusive paperwork. After, they are subjected to the full glory of the exit tax.
This is a massive economic discontinuity that encourages people to leave the USA before reaching the “in 8 of the last 15 years” point.
If they want to stay in the US forever, I recommend keeping the green card. If they are unsure I recommend that they leave the USA by year 7. If they want to stay and hedge their bets, we look at terminating the green card and replacing it with a different type of visa.
“An economist would say that the demand curve predicts that as the cost (broadly defined) of a good increases, demand decreases… In mid-2008 it became immediately more expensive (financially) to expatriate. Thus, we would expect to see fewer people take this step. Yet we have seen the opposite… This is counterintuitive…”
I’m not sure it’s as counterintuitive as you suggest.
HEART defines you as “rich” if you own $2MM of assets but “not rich” if you own $1 less than that. The cost of holding US citizenship rises dramatically once you pass that threshold, but there is no change at all in the (supposed) benefit. This is a discontinuity in a “non-convex” demand curve:
http://en.wikipedia.org/wiki/Non-convexity_(economics)
I suspect this is what is driving the increase, and is entirely consistent with economic theory. In other words, post-HEART and ceteris paribus, we’d not expect to see fewer people expatriate, we’d expect more, because they want to get out before becoming “covered”. And of course that’s what we get. The non-financial hassle factors you mention simply add to the momentum.