Tax Implications of Expatriation

U.S. citizens who plan to renounce their citizenship and green-card holders who plan to end their U.S. resident status for federal tax purposes can simply file their final U.S. tax return provided they are not deemed to be a “covered expatriate”.

If they do meet the definition of a covered expatriate they may be subject to an exit tax upon relinquishing their U.S. citizenship or resident status. The exit tax is based on the total value of the person’s assets and assumes all such assets are sold on the date of expatriation at their fair market value on the date of expatriation.

The term “covered expatriate” means an expatriate who:

1. Has an average annual net income tax liability for the five preceding tax years ending before the expatriation date that exceeds a specified amount that is adjusted for inflation – $165,000 in 2018 – the “tax liability test”
2. Has a net worth (total of U.S. and non-U.S. assets) of $2 million or more as of the expatriation date – the “net-worth test”
3. Fails to certify, under penalties of perjury, compliance with all U.S. federal tax obligations for the five (5) tax years preceding the tax 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”

Exceptions apply in determining whether one qualifies as a covered expatriate. In particular, an expatriate will not meet either the tax-liability test or the net-worth test if:

1. The expatriate became, at birth, a U.S. citizen and a citizen of another country and, as of the expatriation date, continues to be a citizen of, and is taxed as a resident of, that other country, and has been a U.S. resident for not more than 10 tax years during the 15-tax-year period ending with the tax year during which the expatriation date occurs; or
2. The expatriate relinquishes U.S. citizenship before the age of 18 1/2.

The “expatriation date” is the date an individual relinquishes U.S. citizenship or, in the case of a long-term resident of the United States, the date on which the individual ceases to be a lawful permanent resident of the United States.

Streamlined Filing Compliance Procedures:

U.S. citizens and tax residents can use the streamlined filing (domestic or foreign offshore) compliance procedure to resolve a delinquent filing problem. This process covers both income tax and information returns for non-U.S. financial assets. It generally involves filing at least three years of income tax returns and six years of financial asset information returns. All tax due, interest, late payment penalty and offshore penalty must be paid at the time of filing, after which the taxpayer is deemed to be current with the IRS. Individuals who meet the definition of a foreign resident (as defined in this procedure) are not required to pay the 5% offshore penalty on the total highest value of their non-U.S. financial assets.

It should be noted that if the streamlined approach is to be used in an expatriation situation, five (5) years of income tax returns must be filed.

It appears that taxpayers who are neither U.S. citizens or tax residents are precluded from using the streamlined filing compliance procedure. As such, there is no process to ensure that the IRS will not ask for tax returns for years prior to the years the individual volunteers to file. Individuals in this situation are generally advised to seek legal counsel prior to filing if the chance of significant liabilities exists. For tax returns they do file they would need to pay all taxes due on their U.S. source income, plus the following:

1. Interest on tax due – accrues on any unpaid tax from the due date of the return until the date of payment of all taxes due. The interest rate is determined quarterly and is the federal short-term rate plus 3%. Interest compounds daily.
2. Late payment penalty – one-half of one percent for each month, or part of a month, up to a maximum of 25% of the amount of tax that remains unpaid calculated from the due date of the return until the date the tax is paid in full. See Note A
3. Late filing penalty – usually 5% of the tax owed for each month, or part of a month that your return is late, up to a maximum of 25%. See Note A

Nonresident aliens do not have a requirement to file information returns disclosing their non-U.S. financial assets.

Note A: The IRS may provide administrative relief from a penalty that would otherwise be applicable under its First Time Penalty Abatement policy.

You may qualify for administrative relief from penalties for failing to file a tax return, pay on time, and/or to deposit taxes when due under the Service’s First Time Penalty Abatement policy if the following are true:

• You didn’t previously have to file a return or you have no penalties for the 3 tax years prior to the tax year in which you received a penalty.
• You filed all currently required returns or filed an extension of time to file.
• You have paid, or arranged to pay, any tax due.

The failure-to-pay penalty will continue to accrue, until the tax is paid in full. It may be to your advantage to wait until you fully pay the tax due prior to requesting penalty relief under the Service’s first-time penalty abatement policy.