You should subscribe to the Expatriation Only email list. You’ll get a weekly email that usually answers someone’s question about expatriation. The subject is always expatriation. This is the email that went out earlier today.
My agenda this week includes meeting with a lot of people in Riyadh who are thinking of giving up their U.S. citizenship. For some people it is an easy decision, and for others it is painful. Tears-in-their-eyes painful.
Here’s the problem they face. I will cobble together a question because I have had this conversation with a lot of people this week:
I was born in the United States but my parents brought me back to Saudi Arabia when I was two months old. I have lived here ever since and never applied for a Social Security Number. Now I want to give up my U.S. citizenship but I know that there are lots of tax forms to file. How can I do this without a Social Security Number?
The short answer? You almost certainly want to clean up your prior year tax nonfiling. The only question is whether you do this before or after renouncing your citizenship.
- If the tax cost of covered expatriate status is too high, get the Social Security Number, then fix the past, then renounce.
- If the tax cost of covered expatriate status is low enough (like zero!), renounce, then clean up the past years.
Step By Step
- Know the three ways that you can be a covered expatriate. Not filing your tax returns is one (and you haven’t filed if you don’t have a Social Security Number. The other two are that you are you too rich (net worth of $2 million or more), or you had a large Federal income tax liability for the prior five years.
- If one or both the other two ways of being a covered expatriate apply to you, then it really doesn’t matter whether you expatriate without a Social Security Number and clean up your tax stuff after renunciation. You are a covered expatriate.
- If the other two ways of being a covered expatriate do not apply (your net worth is under $2 million and your average tax liability for the prior five years is under $157,000) then the question of fixing unfilled tax returns before expatriation matters a lot to you. It makes the difference between covered expatriate status and not covered expatriate status.
- Now look at the tax consequences of being a covered expatriate. Does this trigger any exit tax liability? Pretend that you sold everything you own when you expatriate. Is the capital gain above $680,000? If so, you will pay tax for the privilege of renouncing your citizenship. Do you have IRAs and other strange Congress-created tax-advantaged accounts? Do you participate in pension plans? Are you the beneficiary of a trust? All of these might create tax liability for you when you renounce.
- If you have decided that the actual cash tax consequences of renouncing citizenship is small enough for you to handle, then covered expatriate status is OK. You are going to expatriate first, then do cleanup. You will get an Individual Taxpayer Identification Number after renouncing and do a bunch of tax filings.
- If you have decided that the tax consequences of being a covered expatriate are too high, you will get a Social Security Number first, fix all of your tax filings, and then renounce carefully, in order to avoid covered expatriate status.
- For both of these choices, you will need to figure out how to clean up the past. The three choices are the Voluntary Disclosure Program, the Streamlined Procedures, or “just file”. You will do these either before or after renouncing your citizenship.
Covered Expatriate Status
Giving up U.S. citizenship has tax consequences. The tax consequences are trivial (you have only paperwork to do) if you are not a “covered expatriate”.
If you are a “covered expatriate” you have the paperwork to do, and you have the possibility of paying some income tax to the United States. In addition, if you are a covered expatriate you cannot make gifts to U.S. persons or leave inheritances to them without a massive tax cost being paid by the recipients of those gifts or inheritances.
Usually, you would like to avoid being treated as a covered expatriate.
There are three ways to be a covered expatriate. One of them applies here: you are a covered expatriate if you are not fully up to date with all of your tax filings and tax payments. (Go look at Form 8854, page 3, at the bottom of the page — question 6.) This is the “certification test” where you certify that as far as tax is concerned, all is quiet on the Western Front.
No Social Security Number + Renounce
If you do not have a Social Security Number, then you could not have filed your income tax returns. By definition you have not done everything you are required to do for tax purposes under U.S. law. If you renounce your U.S. citizenship, you will be a covered expatriate.
There is only one possible exception to this: you never did anything that would trigger any kind of tax filing obligation under U.S. law. You never had enough income to be required to file a tax return. You never owned the “wrong” kind of assets that would trigger a requirement to file a piece of paper. You never received a large gift from anyone.
But for everyone else, you were required to do something under the U.S. tax law, and you didn’t. If you renounce while that is not fixed, you will be a covered expatriate.
Renounce Without a Social Security Number
This means your decision is pretty simple. If you want to renounce fast, you will have to live with the fact that the IRS will treat you as a covered expatriate. So you need to figure out how painful this is. Here are the consequences:
- You are treated as if you sold all of your assets, and you will pay tax on the capital gain above $680,000;
- You have the potential for taxable income from a variety of other sources, such as non grantor trust, pension plans, and special financial accounts like IRAs; and
- U.S. persons (like your children) who receive gifts or inheritances from you will pay a tax on whatever they get from you.
So here is what you do. You look at your situation and see if any of this matters to you.
- Look at all of your assets and calculate the capital gain. If the total capital gain is less than $680,000, then you will not pay any tax because of that. [Reference for tax nerds: Internal Revenue Code Section 877A(a)].
- If you do not have any “specified tax-deferred accounts” (like IRAs), you do not have any tax liability that will come from that direction.
- If you do not have deferred compensation plans and you are not a beneficiary of a non grantor trust, then you have no tax problems from those directions either.
- If your kids are not U.S. citizens or residents, then you do not have a problem there — they will receive gifts or inheritances from you without having to pay U.S. tax for the privilege of receiving stuff from you.
If all of these things are favorable, you can safely expatriate as a covered expatriate. The major milestones in your action plan will be (1) renounce citizenship; (2) prepare all your prior year tax filings; (3) prepare Form W-7 to apply for an Individual Taxpayer Identification Number; and (4) file stuff after going through the risk analysis I am about to talk about.
If Covered Expatriate Status Is Too Painful
If you go through that analysis and you decide that covered expatriate status is too expensive for you (and you figure out that covered expatriate status is avoidable for you), then you have only one choice: apply for a Social Security Number, wait until it comes, file your prior year tax returns, and then and only then renounce your citizenship.
Risk Analysis: Prior Year Exposure
No matter which method you use — concede covered expatriate status and exit before cleaning up your old tax returns, or clean up your tax returns first then expatriate — you will have to figure out how to clean up the past.
You have a whole bunch of years of non-filing that you probably want to clean up. The most important thing when you cut your ties with the United States is to cut them cleanly, so Uncle Sam has no future leverage over you.
Now you look backwards in time and find out what your tax, penalty, and interest exposure will be. If the IRS found you and told you to file everything, what would you have to file? And since you are late, what kind of penalties would the IRS throw at you?
This analysis varies from person to person. Everyone’s situation is slightly different. But you will be able to figure out whether you are at a low risk for penalties, or whether you have a high risk.
If you have a low risk for penalties (e.g., you have very low income, your bank account balances were low, and you are not required to file all of the silly forms that the IRS wants you to file if you are a partner in a foreign partner, or a shareholder in a foreign corporation, or you received a large inheritance or gift from a nonresident) then you can be pretty comfortable proceeding with the expatriation. If the worst possible outcome occurs, it will not be that bad.
The only question is how should you proceed with filing those prior year tax returns and other forms, and how many years should you file for.
If you are at a high risk for penalties, then you will want to figure out how to minimize that risk. I do not like the idea of “don’t file” because the “how will they ever find me and if they find me what can they do to me?” strategy ignores the fact that it is hard to make predictions, especially about the future. Government policies might change. Technology might change. Your personal life might change.
You want to fix things. But how? Stand by.
How to Fix The Past
The three choices you have for fixing the past years (and I do recommend that you fix the past) are:
- The entirely awful Voluntary Disclosure Program;
- The quickly evolving Streamlined Procedures that are starting to show bureaucratic arthritis, in an effort to eliminate penalties; or
- Just obey the law and file what you’re supposed to file, taking your chances on penalties.
Those three topics are little universes unto themselves. Sorry. Some other day we’ll talk about them.
For people who have minimal exposure to penalties, there is no reason to do anything more exotic than merely file a bunch of forms with the IRS.
For people who have done sufficiently bad things that the IRS might want to make a poster child of you (see Admiral John Byng, for example) the Voluntary Disclosure Program might be the plausible solution. There is a lot to be said for being able to get on a plane and go anywhere you want to, anytime, without worrying.
For almost everyone, however, you will be in the vast middle. The penalty risk is high enough to matter. But you’re a normal person. Now the decision is between “just file” and the Streamlined Procedures. My experience is that the Streamlined Procedure is a puddle of confusion moving toward bureaucratic calcification and procedural complexity (IRS entropy points in that direction), but at the moment it is a worthwhile choice for many people.
Not Legal Advice
This isn’t legal advice to you, of course. Would you make life-altering decisions based on a random email you got from some guy you found on the internet? Nope. Me neither. Go hire someone. March through the analysis and figure out what is best for you.