Expat Tax Info from Barron HarperRenouncing US Residence Status
By Barron Harper
Renouncing US Residence Status
The spectacle that confronts American deemed residents in both expatriating and complying with US tax and information filing requirements is onerous. In recent years the Internal Revenue Service has imposed a system of tax laws and penalties on American citizens and residents that is complex and bewildering.
The process of expatriation begins with a determination of status. The Internal Revenue Service guidelines for Long Term Residency basically state that ‘If you were a dual resident of the United States and a country with which the United States has an income tax treaty, the date you commence to be treated as a resident of that country is determined by the treaty and your giving notice to the Secretary of such treatment.’ (page 1, Form 8854 instructions)
What does the treaty between the United States and France state? Article 1 defines the scope of residency as it applies to persons who are residents of one or both countries. Article 4 1) states: ‘The term ‘resident of a Contracting State’ means any person who, under the laws of that State, is liable for tax therein by reason of his domicile, residence … But this term does not include any person who is liable to tax in that State in respect only of income from sources in that State …’ Article 4 1a): ‘France shall consider a US citizen or alien admitted to the United States for permanent residence (green card holder) to be a resident of the United States for the purposes of paragraph 1 only if such individual has a substantial presence in the United States or would be (considered) a resident of the United States’ … (Green Card holder).
The apparent lack of clarity of this part of the treaty may inevitably lead the reader to conclude that he cannot be a resident of the United States for tax purposes. But the US tax authority considers any Green Card holder a US resident for tax purposes whose Green Card has not been 1) judicially or administratively taken away, or who 2) has not filed application with the USCIS or US consular officer. The date of expatriation would be when 1) Form I-407 is filed with a US consular or immigration officer and the Department of Homeland Security which then determines that you have abandoned your lawful permanent resident status, and 2) you notify the IRS that you are a resident of a treaty country by filing Forms 8833 and 8854.
The IRS defines a Long Term Resident (LTR) as ‘any lawful permanent resident of the United States in at least 8 of the last 15 tax years ending with the year your status as LTR ends. You are a lawful permanent resident of the United States if you have been given the privilege, according to US immigration laws, of residing permanently in the United States as an immigrant. You generally have this status if you have been issued an alien registration card (green card)’. Otherwise Form 8854 is not required.
Form 8854 is required to establish 1) if your average annual net income tax liability for the 5 tax years ending before the date of your expatriation is more than the $145,000; 2) your net worth is $2 million or more on the date of expatriation; or 3) you fail to certify that you have complied with all your federal tax obligations for the 5 tax years preceding the date of expatriation. If any one of these three criteria apply, you are considered a ‘covered expatriate’.
As a covered expatriate, you would be subject to income taxes on the net unrealized gains in your property as if the property had been sold for its fair market value on the day before your expatriation date (mark to market tax). The net gain that you would include in your income is reduced (but not below zero) by $627,000. Mark to market tax does not apply to 1) eligible or 2) ineligible deferred compensation items or 3) tax deferred accounts. 1) and 3) would instead be subject to withholding at source (30%) whereas you would be treated as receiving the present value of 2) as of the day before the expatriation date.
You can elect to defer the payment of any taxes on the deemed sale of property. The deferral continues with interest until date of death or you sell the property. A security must be provided for the property in order to qualify for the deferral. And you must waive any right under treaty that would preclude assessment or collection of the tax.
The 8854 form requires that an expatriating LTR fill out Parts I, IV and V. Among the information that must be provided on this form is the income tax liability for the preceding 5 years before expatriation, an accounting of deferred compensation items, a listing of the fair market values of assets and liabilities worldwide as of the end of the year in which this form is filed, and a reporting of all items of income for the year in which the form is filed.
Tax and Information Filing Requirements
Non-resident aliens are subject to income taxes on US source income. Resident aliens are, however, subject to tax in the same manner as a US citizen. This means that you must report all interest, dividends, wages, or other compensation for services, income from rental property or royalties, and other types of income on your US tax return. You must report these amounts from sources within and outside the United States (worldwide income).
In order to prevent or minimize double taxation, resident aliens can invoke Form 8833 – Treaty Based Position – to exclude foreign-source income from US income according to treaty definition. For instance Article 18 of the treaty between France and the United States clarifies that taxation applies to the country from which the pension is paid whereas Article 10 mandates or minimizes taxation as regards residency. Resident aliens and US citizens can also take a Foreign Tax Credit against the income taxed in the foreign country of residence. As long as the income taxes assessed in the foreign country are greater than those in the United States, the FTC can potentially eliminate US income taxes on foreign-source income.
Another filing requirement imposed on US citizens and deemed residents is the Foreign Banking Account Report (FBAR). This annual report requires that filers with signature authority over foreign account holdings report: name, address and account number of foreign financial institution(s), and maximum balance(s).
Starting in 2012 filers will also be required to complete a report listing the value of specified financial assets if the value of those assets exceeds a reporting threshold: $50,000 - $600,000 according to US or foreign residence and tax filing status. This report will be due with the tax return. In 2014 this law will require that all foreign financial institutions, including banks, brokers, pension funds, insurance companies, hedge funds, mutual funds and trusts report to the IRS the holdings of their clients who are US persons.
At the heart of the expatriation issue is extricating one’s self from US tax and reporting requirements. Item 3 under the Form 8854 rules defining a ‘covered expatriate’ means that any expatriating filer who fails to file a tax return for the past 5 years reporting his worldwide income is not in compliance with US tax laws. Failing to be compliant in filing Form 8854 can produce dire tax consequences, according to the IRS.
We would all prefer a simpler and understandable tax system. But sometimes information, however antagonizing, makes for the best protection.