Expatriated? But Failed to File Form 8854?  IRS Provides a Fix!

2020 looks promising in more ways than one. First, on a professional level I was delighted and proud to be named, for the 4th year running, to Forbes Top 100 Must Follow Tax Twitter Accounts for 2020. Please do encourage your friends and colleagues to follow me on Twitter and to subscribe to my US tax blog.  All the US tax information you need, delivered weekly to your inbox at no charge.

For my readers, there’s a chance to start with a clean slate for those who expatriated but failed to do everything “right.”  Penalty-free relief may be possible EVEN IF you have previously filed income tax returns as a US citizen or resident.  Here’s the scoop —

In early September 2019, the Internal Revenue Service (IRS) announced Relief Procedures for Certain Former Citizens that will enable certain individuals who relinquished (or considering relinquishing) their US citizenship to come into compliance with their US tax and filing obligations.  In an unprecedented move by the IRS, individuals qualifying for this procedure will not have to pay any back taxes otherwise owed, or any penalties or interest! My blog post here provides all of the details.

Please note, the Relief Procedures may be terminated by the IRS, so qualifying individuals are well advised to take advantage of them sooner rather than later.

One very significant requirement of the Relief Procedure mandated that the individual had never filed US resident tax returns. In other words, the taxpayer must not have had any tax filing history as either a US citizen or US resident. This requirement left out in the cold individuals who gave up their US citizenship and who had filed prior US income tax returns, but who failed to file IRS Form 8854 “Initial and Annual Expatriation Statement”.

Failure to file Form 8854 means that the individual can be treated as a so-called “covered expatriate”. If an individual is treated as a “covered expatriate”, very harsh tax consequences result including imposition of an “Exit Tax” on a “pretend” sale of the individual’s worldwide assets, possible immediate taxation of certain pension plans and annuities, as well as imposition of a 40% transfer tax on any US person who receives a gift or inheritance from the covered expatiate in the future.  Full details about “covered expatriate” status are available at my blog post here.

Expanded Relief for Expatriates Who Failed to File Form 8854

In October, the IRS expanded the Relief Procedures to help individuals who expatriated and who had a US tax filing history, but failed to file Form 8854, as required.  This could mean relief from “covered expatriate” status  which in turn, means an escape from the very harsh tax consequences that come along with this toxic status. See FAQ 24 and 25 in the expanded IRS procedure here (further detail below).

In a nutshell, the expanded program applies to a former US citizen taxpayer who did not file Form 8854 if the individual (i) expatriated after March 18, 2010, (ii) had a net worth of less than US $2 million on the date of expatriation, and (iii) had an average annual US income tax liability for the 5 years prior to expatriation that did not exceed the relevant threshold as described in IRC §877(a)(2)(A).  This threshold is indexed annually for inflation. For example, for 2019, the “average annual net income tax” for the five taxable years prior to expatriation cannot exceed the threshold of US$168,000; for 2020, the threshold is US$171,000.

A special procedure must be followed.  The procedure will differ for taxpayers who were fully tax compliant (e.g., their prior filed US tax returns do not need amendment) versus those were who were not fully compliant.

Fully Tax Compliant – Only Needs to File Form 8854

If the taxpayer had full prior tax compliance but failed to file Form 8854, see FAQ 24 of the IRS procedure, excerpt below:

To file pursuant to FAQ 24, you may send your completed Form 8854 to the address in FAQ 14. Please write in red ink on the top of your late Form 8854 “FAQ 24.” Sign the Form 8854 on page six. You must provide a statement of reasonable cause explaining all facts and circumstances relating to your late filing of the Form 8854.You must sign your statement of reasonable cause under penalties of perjury. Late Forms 8854 submitted under FAQ 24 will satisfy the tax compliance certification requirement and not be automatically subject to IRS audit. But they may be selected for audit under the existing audit selection processes applicable to any U.S. tax return and may also be subject to verification procedures in that the accuracy and completeness of submissions may be checked against information received from other sources. Unlike in the context of the Relief Procedures, by filing under FAQ 24 you will not receive a response from the IRS acknowledging receipt nor a denial letter. (Added 10/22/2019)

Not Fully Tax Compliant, Returns to be Amended and Needs to File Form 8854

If the taxpayer who failed to file Form 8854 filed prior tax returns but these need amendments (to report additional income, for example), relief is still possible pursuant to FAQ 25, excerpted below:

First, follow normal procedures for filing amended income tax returns.  If you feel you have reasonable cause for your filing errors, please attach a statement of reasonable cause to your submissions.  After filing complete and accurate amended income tax returns (including the necessary Form 8854 in the year of expatriation), you may also send a copy of your completed Form 8854 to the address in FAQ 14. Please write in red ink on the top of your late Form 8854 “FAQ 25.” Sign the Form 8854 on page six. You must provide a statement of reasonable cause explaining all facts and circumstances relating to your late filing of the Form 8854. You must sign your statement of reasonable cause under penalties of perjury. Late Forms 8854 submitted under FAQ 25 will not be automatically subject to IRS audit. But they may be selected for audit under the existing audit selection processes applicable to any U.S. tax return and may also be subject to verification procedures in that the accuracy and completeness of submissions may be checked against information received from other sources. Unlike in the context of these procedures, by filing under FAQ 25 you will not receive an automatic response from the IRS acknowledging receipt nor a denial letter. (Added 10/22/2019)

Penalties?

Please carefully note for FAQ 25, the fact that the amended returns are submitted through normal processing procedures means that the IRS can impose accuracy-related penalties in such cases, unless it agrees with the taxpayer that the errors were due to “reasonable cause”. Therefore the individual using FAQ 25 will be liable for all back taxes, interest, and possibly penalties associated with the amended returns.

Whether a taxpayer is subject to an accuracy-related penalty due to an understatement of tax has now become the most litigated tax issue. The IRS wins a large majority of the cases, but some taxpayers can avoid an accuracy-related penalty by arguing they meet the stringent reasonable cause exception to the penalty.  Whether the exception applies is determined by examining all of the facts-and-circumstances.

It is clearly advisable to consult a tax professional to assist in preparing the “reasonable cause” statement.

Do You Qualify?

If you think you may qualify for these procedures, relief from “covered expatriate” status is well worth the effort.  This is especially true if you have US family members who may receive gifts or bequests from you in the future.  Don’t let “covered expatriate” status shrink the future gifts or inheritance you provide to your loved ones by that whopping 40% transfer tax.

Green Card Holders Need Not Apply (Yet)

Significantly, the Procedures as they now stand apply only to US citizens and not to green card holders who were Long Term Residents (LTR).  I do not understand why this is so, since LTRs are treated the same as US citizens when it comes to the tax issues associated with expatriation. I understand the IRS is currently planning some similar procedures for green card holders.  I will keep my readers apprised of developments.

Posted February 6, 2020

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