For today’s post, let me start with the Conclusion! If you expatriate after June 16, 2008 and you fail to file Internal Revenue Service (IRS) Form 8854 (Initial and Annual Expatriation Statement), you DO NOT have continued US income tax liability on your worldwide income. It’s that simple. You may have read or heard otherwise from other tax professionals – but they have given you “FAKE NEWS”. Now, let’s move on to the post!
Here is the scenario – US citizen relinquishes his US citizenship (whether by renunciation or by an expatriating act with the required intent to relinquish US citizenship); or, a long-term resident formally relinquishes the green card. In both cases this means in tax lingo that the individual has “expatriated”.
Assume in either case that the individual who expatriated for immigration law purposes, does not file Form 8854 as required in the year following the expatriation year.
Here is the issue – whether the failure to file Form 8854 keeps an individual who expatriated for immigration purposes, liable for US income tax as a US taxpayer?
I have seen quite a number of seasoned US tax professionals making the same mistake when it comes to this issue. In written articles, they state that this failure keeps the individual on the hook for US income taxes, in other words, that he or she has continued liability for US income tax on worldwide income until the proper paperwork is filed.
Many individuals who expatriated but did not file Form 8854 are now extremely concerned because they are aware that the IRS has initiated a campaign to closely examine and perhaps audit expatriates. I hope this blog post will allay many of their fears and set them on the right track.
The Correct Answer
The confusion arises simply because the expatriation rules contained in the US Internal Revenue Code (Code) have been amended numerous times. The various changes in the law have brought about different tax results depending on the date of one’s expatriation.
Here are the correct rules when it comes to a failure to file Form 8854:
If you expatriated on or after June 3, 2004 and before June 17, 2008 then the expatriation rules (e.g., contained in Code section 7701(n)) as enacted by the American Jobs Creation Act of 2004 (“AJCA”) will apply to you. In a nutshell, as relevant to filing the Form 8854, the law provided that until the expatriate filed Form 8854 and notified the Department of State or the Department of Homeland Security of the expatriation, the individual’s expatriation for immigration purposes did not relieve him of the obligation to file and pay taxes on worldwide income as a US citizen or “resident”. In other words, the individual remained liable as a US taxpayer on his or her worldwide income. If you are one of these individuals, your US tax liability will continue indefinitely until you take the required action!
This harsh ACJA rule was repealed a few years later by the Heroes Earnings Assistance and Relief Tax Act of 2008 (“HEART Act” or “Act”). The HEART Act is the current law today and it applies to any individual that expatriated after June 16, 2008. This Act drastically altered the playing field for individuals who “expatriate” after the magic date of June 16, 2008, that is, relinquish their US citizenship or terminate their long-term US residence. This dramatic change was accomplished by the addition of new sections 877A and 2801 to the Code, which, respectively, impose an “exit tax” (“mark-to-market”) and “transfer tax” regimes on such individuals who are called “covered expatriates”. You can read full details about these regimes at my blog posts here, here and here.
Under the HEART Act and reflecting current law, 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.
So, in summary, the failure to file Form 8854 means you will be treated as a “covered expatriate” (even if you do not meet the dollar thresholds set out previously) with the attendant onerous tax results of the “mark-to-market” and “transfer tax” regimes, mentioned above. You will NOT continue to be treated as a US citizen or resident liable for income tax on your worldwide income. That is old law, old news and it simply does not apply. Don’t be caught out by FAKE NEWS! If your tax advisor tells you that this old law applies to you and you have expatriated after June 16, 2008 – it’s time to find a more knowledgeable tax advisor. I am available to assist you!
You Can Fix it Now – File Form 8854
I will add here that filing Form 8854 late is not a death knell, either. The law does not state that a late filing of the Form results in “covered expatriate” status. However, the law does provide for a $10,000 penalty for failure to file the Form unless it is shown that such failure is due to reasonable cause and not to willful neglect.
Fixing the problem of an unfiled Form 8854 is even easier now that the IRS has just recently implemented certain Relief Procedures for Certain Former Citizens that will enable certain individuals who relinquished their US citizenship (not green cards) to come into compliance with their US tax and filing obligations without imposition of taxes or any penalties (including the $10,000 penalty). For some, these new procedures are a dream come true. If you want to take advantage of this temporary IRS relief, contact me for a consultation.
Posted September 19, 2019
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