On July 19th, the Internal Revenue Service (IRS) through its Large Business and International (LB&I) Division announced six new “compliance campaigns” for taxpayers. Significantly, one of these campaigns targets “expatriation”, and apparently reaches back to those who “expatriated” on or after June 17, 2008. The campaign will be looking at “expatriates” – US citizens who gave up their US citizenship and long-term residents (green card holders, who held the card in eight out of the last 15 taxable years) who relinquished their green card. The IRS realizes that many of these individuals may not have met their filing requirements or tax obligations and the agency wants what is owed! The agency stated that it will address noncompliance “through a variety of treatment streams, including outreach, soft letters, and examination.”
What is a “Compliance Campaign”?
A “compliance campaign” is a targeted directive on a particular tax issue. A “campaign” is initiated when the IRS determines that there are specific US tax issues on which the agency should be focusing and responding. Typically, the campaign will focus on an area where it believes taxpayers have not been compliant and where it believes tax dollars and penalties can be significant. The IRS budget has dwindled over recent years and so, it must use all of its resources most judiciously. Campaigns will require the IRS to dedicate significant time, resources, training, and tools toward the particular tax compliance goal.
To date, LB&I has announced a total of 59 campaigns (full list here), including the following six new ones:
- S Corporations Built-In Gains Tax.
- Post Offshore Voluntary Disclosure Program Compliance.
- High Income Non-filer.
- U.S. Territories – Erroneous Refundable Credits.
- Section 457A Deferred Compensation Attributable to Services Performed before January 1, 2009
What Does this “Expatriation” Campaign Mean?
The roll out of this campaign can mean assessment of tax and penalties for those who have not properly left the US tax system upon expatriation. In addition, it can mean these individuals will be treated as so-called “covered expatriates” (discussed below) for failing to meet their tax obligations.
There is no indication in the IRS announcement that the agency will be implementing any special programs or initiatives to assist expatriates to come forward and rectify their tax situation (for example, offering a reduced penalty framework). The IRS efforts appear to be strictly focused on finding those who have not been compliant with their US tax obligations and expatriation filings and enforcing the relevant laws against them.
Can the IRS find you? Yes, it can. Remember, the Department of State sends the IRS all of the information about individuals who give up their citizenship or who relinquish green cards at a US Consulate or Embassy. Social media also helps the IRS in its tracking efforts.
Individuals with concerns should not wait until this program is rolled out! If you have issues with tax returns in the 5 year period prior to your expatriation, or your expatriation year tax returns and Form 8854, or tax returns that may have been required in subsequent years, you need to take action before detection by the IRS. By doing so, there is a chance for mitigation or non-application of relevant penalties, as well as for avoiding “covered expatriate” status for tax noncompliance.
This is an area in which I have years of experience; contact me for assistance.
Expatriation – Your US Tax Obligations
So, if you have expatriated (or are considering expatriation), the IRS is looking closely if you have done (or will do) what the US tax laws require. Individuals in the crosshairs of the latest “campaign” must ensure they have a complete understanding of the laws regarding “expatriation”. The individual must carefully examine the rules for tax filings that are required (for example, Form 8854 and the final income tax returns reflecting dual status tax years). If the individual is married to a non-US spouse, and living in (or previously lived in) a community property jurisdiction, further complexities arise. (See my blog post here). All of these issues (as well as possible tax planning for those considering expatriation) should be discussed with a tax professional to make sure all is in order before the IRS comes calling.
Here’s some basic information about expatriation, “covered expatriate” status and its often deadly tax consequences:
Am I a “Covered Expatriate”?
Under the US expatriation rules, an individual will be treated as a “covered expatriate” if any of the following tests apply:
- The individual’s average annual net income tax for the 5 years ending before the date of expatriation or termination of residency is more than a specified amount that is adjusted for inflation (US$168,000 for those expatriating 2019). Remember, this means the average income tax paid by the individual, not his average income!
- The individual’s net worth is $2 million or more on the date of expatriation or termination of residency.
- The individual fails to certify on Form 8854 that he or she has complied with all US federal tax obligations for the 5 years preceding the date of expatriation or termination of residency.
The tax certification requirement is usually the most troublesome provision for so-called “Accidental Americans” who reside outside the US, and are often blissfully unaware of their US tax filing duties until they learn of their unpleasant surprise.
What Happens If I Am a “Covered Expatriate?”
If any one of the three tests is triggered, the individual is classified as a so-called a “covered expatriate”.
Under the “Exit Tax” or “Mark-to-Market” regime, generally, all property owned by the covered expatriate worldwide is treated as sold for its fair market value on the day before the expatriation date. This ‘phantom’ gain is then taken into account for the tax year of the deemed sale and subject to tax, usually at capital gains rates.
An exception for a certain amount of gain (which is adjusted annually for inflation) is provided in the tax law. On account of this exception, some individuals may not be impacted by the “Exit Tax”, but the calculations and how it works are not simple, so professional advice should absolutely be taken on this issue. In general terms, the amount of gain that can escape tax is US$725,000 for 2019. In addition, a 3.8% “net investment income tax” will likely also apply to this deemed gain if certain modified adjusted gross income thresholds are met.
The Exit Tax must be computed via one’s Form 1040 with the gain or loss being reported on the relevant part of the 1040 for the part of the year that the taxpayer is still considered a US person. You can read more here about the 3.8% surcharge and how it impacts US persons abroad.
The tax burdens don’t stop there. Onerous tax rules apply to the covered expatriate’s deferred compensation plans and specified tax deferred accounts.
Special Transfer Tax
In addition to the Exit Tax, US recipients of any gift or bequest at any time in the future from the “covered expatriate” will be hit with a special tax upon receiving that gift or inheritance under Code Section 2801. In essence, this is an alternative way for the US to recoup US Gift or Estate taxes that it would otherwise have received (upon the making of lifetime gifts, or upon death) had the individual not given up his US citizenship or long-term residency. Currently, the tax rate is 40% and must be paid by the US recipient on the value of the gift or bequest from the covered expatriate (e.g., if the covered expatriate leaves a $1,000,000 bequest to his US citizen son, the son must pay $400,000 to the IRS pursuant to Section 2801. Ouch!).
US recipients of a gift or bequest from a former American should be ready for what appears will be an uphill battle with the IRS about the taxability of their gift or inheritance, since the burden of proving that the person was not a “covered expatriate” is firmly placed on the recipient. Do you know how to protect US recipients of your gifts/ bequests from a 40% take by the IRS? Contact me about what should be done now in order to prepare for this likely scenario; I am available to discuss possible planning to avert a tax disaster.
Possible Bar from Re-entry to the USA
Aside from the tax consequences of expatriation, current US immigration laws provide that former US citizens who are deemed to have renounced their US citizenship for tax avoidance purposes may be banned from entering the US by including them in a class of “inadmissible” aliens. This law is commonly referred to as the “Reed Amendment” and was enacted in 1996. [Public Law 104-208, § 352; INA § 212(a)(10)(E); 8 USC § 1182(a)(10)(E)]. Immigration guidelines have never been established for what is meant by “tax avoidance” and doubts as to its constitutionality have been expressed by legal scholars.
Enforcement of the Reed Amendment is unclear but be aware that there are certainly other ways to keep expatriates out of the country by denying issuance of the visa (or entry under ESTA / visa waiver programs) on some other grounds. The visa process is discretionary with the consular officer and those denied a visa may never come to fully understand why this was so. (Similarly with admission at the border under a visa waiver program).
Some mystery surrounds the case of Roger Ver, the virtual currency millionaire commonly known as “Bitcoin Jesus”. Ver was denied re-entry to US after taking on Saint Kitts’ citizenship and then expatriating.
A fascinating interview with a former IRS Chief Counsel attorney on this entire topic of the Reed Amendment is at my blog post here.
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Posted August 8, 2019