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What Are the Implications of U.S. Expats Giving Up Their Citizenship?
 

By Elaine M. Kumpula and Kenneth S. Levinson  4/30/2014
 

Record numbers of Americans and long-term lawful permanent residents (LPRs) are, respectively, relinquishing U.S. citizenship and surrendering their green cards. At least, that’s what a number of recent articles would have us believe. Why are they doing that, and what do potential expatriates need to know and plan for before making that move?

Background

U.S. citizens and LPRs are subject to tax on their worldwide income. Irrespective of where they live, how often (or not) they are physically present in the U.S., or the source of their income, U.S. citizens and LPRs must file U.S. tax returns as a U.S. resident every year and abide by other U.S. tax and reporting obligations. Among those obligations is the requirement to file an annual report relating to foreign bank and other accounts over which those U.S. persons have signature or other authority. This reporting obligation is embodied in the Report of Foreign Bank and Financial Accounts (FBAR). A host of other reporting obligations on U.S. tax returns being filed by these taxpayers is also required, most notably Form 8938, the Statement of Specified Foreign Financial Assets. Interestingly, this form is required of virtually all U.S. tax return filers, even U.S. tax “residents” who only meet the “substantial presence” test. It is also required of nonresident aliens.

In addition to the intrusive, time-consuming reporting required by law, added burdens are about to be imposed on U.S. transferors making many types of payments to accounts of U.S. persons in foreign financial institutions under the Foreign Account Tax Compliance Act (FATCA). This legislation, effective generally for certain payments made on and after July 1, 2014, imposes a broad obligation on U.S. transferors to withhold 30-percent tax on certain payments to foreign financial institutions (and other foreign entities) with respect to U.S. accounts held abroad, unless those recipient institutions or entities agree to disclose to the IRS comprehensive information about the U.S. account owners and various activities within the accounts. It is a complex, and controversial, piece of legislation that imposes new burdens on U.S. owners of foreign accounts and the foreign institutions themselves. While a more detailed discussion of FATCA is beyond the scope of this article, FATCA itself has been cited as a primary explanation for U.S. citizens and LPRs renouncing their citizenship or surrendering their green cards, respectively, in record numbers.

Why Are These Relinquishments/Green Card Surrenders Happening?

The many benefits of having U.S. citizenship or LPR status come with obligations, including the requirements to report worldwide income, and the ownership of, and activity within, various foreign accounts and assets. These obligations are, or should be, known by those persons, and certainly by their tax advisors. Whether or not they agree with the extraterritorial reach of U.S. tax law, it comes with citizenship, LPR status, and tax residency here. But, it is also true that many foreigners who come to the U.S. (and become naturalized citizens, LPRs, or even “residents” under our substantial presence test) do not personally understand the obligations relating to the broad requirements of U.S. tax reporting. Unfortunately, sometimes their tax return preparers do not either. This latter point is especially true when a citizen or LPR is based abroad for business and uses a local tax return preparer in that foreign country to help them comply with local filing requirements. If the local tax return preparer does not know or does not tell the citizen/LPR to be sure to check with a qualified U.S. tax return preparer regarding “pure” U.S. filing obligations, the opportunity for unintentional U.S. noncompliance expands exponentially. Unfortunately, we see this all too often.

Thus, U.S. filers either do not know about their U.S. filing requirements, or they are so frustrated and upset at the escalating time and effort to try to comply with them, that they don’t do so. U.S. taxpayers are also upset that they pay a very high tax rate—among the highest in the world currently in marginal tax terms—on their worldwide income. Lack of knowledge, anger at burdensome reporting, and resentment of high U.S. tax rates comprise three explanations for noncompliance.

There is, however, a fourth explanation for noncompliance. Some U.S. taxpayers, in truth, have affirmatively set up foreign accounts or structures in order to consciously shelter or hide funds or assets from the IRS, and do not intend to report those accounts, assets or income. All the voluntary self-reporting obligations in the world will not change that mindset. These taxpayers’ complaints about FBAR and FATCA reporting obligations are disingenuous. At the same time, the new FATCA rules and disclosure/withholding tax requirements will have a chilling effect on this group’s blatant tax and reporting evasion efforts.

Three basic types of responses to this fourth group relate to FATCA:

  • First, the foreign financial institutions could decline to identify the U.S. account owners, in which case the 30-percent U.S. withholding tax would be due by the U.S. withholding agent/transferor.
  • Second, the foreign financial institution may decline to continue allowing U.S. persons to keep accounts there. We are in fact seeing much of this termination activity, and the refusal of many foreign banks to accept new accounts of U.S. owners. Those evicted U.S. owner/depositors will be seeking other banks abroad, banks that also are subject to the FATCA disclosure obligations.
  • Third, the U.S. persons involved get so fed up with the required U.S. reporting of offshore accounts, income and assets, the high U.S. tax rates, and the intrusive cooperation required of foreign financial institutions that they terminate their relationship with the U.S. entirely and seek other, more tax-friendly residence or citizenship.

It is the process of implementing and the consequences of this third response to which we now turn, the relinquishment of U.S. citizenship or the termination of LPR status.

Immigration Implications: Renunciation of U.S. Citizenship

The U.S. citizen who renounces citizenship and wishes to immigrate to the U.S. will be treated as a nonimmigrant and must apply for a nonimmigrant visa or travel to the U.S. on the visa waiver program, if they are a citizen of a visa waiver country. However, a former citizen who officially renounced U.S. citizenship and who is determined by the Department of Homeland Security (DHS) to have renounced citizenship for the purpose of avoiding taxation by the United States is inadmissible under the Immigration and Nationality Act (INA). This statutory provision became part of the law in 1996. It rarely comes into play now because the American Jobs Creation Act of 2004 amended the Internal Revenue Code (IRC), doing away with issues of intent to avoid taxation and inserting more objective rules. An updated version of the objective rules was retained in the current Exit Tax. With intent no longer at issue under the Exit Tax, the risk to any individual of being found to have renounced U.S. citizenship for tax purposes is very low. These days, the issue only comes up at the consulate at the time of renunciation. It is the rare individual who admits to a consular officer that he or she is renouncing U.S. citizenship to avoid taxes.

Relinquishment of U.S. Citizenship

Loss of U.S. citizenship can only occur through the voluntary performance of any one of seven enumerated expatriating acts along with the intention of relinquishing U.S. nationality. The seven expatriating acts are:

  • Obtaining naturalization in a foreign state, after having attained the age of 18.
  • Taking an oath or other formal declaration of allegiance to a foreign state, after having attained the age of 18.
  • Entering, or serving in, the armed forces of a foreign state if such armed forces are engaged in hostilities against the United States, or serving as a commissioned or noncommissioned officer.
  • Accepting, serving in, or performing the duties of any office of a government of a foreign state, after attaining the age of 18 if he/she has or acquires the nationality of such foreign state.
  • Making a formal renunciation of nationality before a diplomatic or consular officer of the United States in a foreign state, in such form and manner as prescribed.
  • Making formal written renunciation of nationality in the U.S. in such form and manner when the U.S. is at war as prescribed by the Attorney General.
  • Committing any act of treason against, or attempting by force to overthrow, or bearing arms against the United States, or violating or conspiring to violate various U.S. laws if convicted thereof by a court martial or by a court of competent jurisdiction.

In adjudicating potentially expatriating acts, the U.S. State Department has adopted an administrative presumption regarding certain acts and the intent to commit them. U.S. citizens who naturalize in a foreign country, take a routine oath of allegiance, or accept nonpolicy level employment with a foreign government need not submit evidence of intent to retain U.S. nationality. In these three classes of cases, intent to retain U.S. citizenship will be presumed. On the other hand, a person who affirmatively asserts to a consular officer, after he or she has committed a potentially expatriating act, that they do intend to relinquish U.S. citizenship will lose their citizenship. In other loss-of-nationality cases, the consular officer will determine whether or not there is evidence of intent to relinquish U.S. nationality.

If a U.S. citizen seeks to relinquish citizenship, formal renunciation is the most effective procedure because it demonstrates clear intent to relinquish U.S. citizenship. U.S. citizens seeking to renounce citizenship should contact the consulate at which they plan to renounce to understand the applicable process.

Abandonment of LPR Status

Lawful permanent residents who abandon their permanent resident status will be treated as nonimmigrants. Following abandonment, they will be required to apply for return under ESTA (if from a visa waiver country) or apply for an appropriate nonimmigrant visa to travel to the U.S. Unlike former U.S. citizens, LPRs who have abandoned their status do not face future inadmissibility issues.

LPR status can be lost unintentionally by remaining outside of the U.S. for more than one year, surrendering a green card when challenged at the border, or undergoing a final adjudication in court.

Voluntary abandonment of LPR status through filing Form I-407 with Customs and Border Protection (CBP) or a consulate is the route most selected by those intentionally abandoning such status. Form I-407 allows the individual to state when, why and how he or she is abandoning LPR status. For tax purposes, an LPR may only voluntarily abandon residency at the time of filing Form I-407 with CBP or a consular officer. Therefore, for tax purposes, indication of an earlier abandonment date will not be helpful when voluntarily abandoning LPR status. LPRs should also be cautioned to seek tax advice before filing Form I-407 so that possible tax liabilities can be reviewed and assessed before moving forward with abandonment.

Tax Implications

U.S. citizens or long-term permanent residents who relinquish or abandon their U.S. status must be cognizant of the tax impacts of such actions under the Internal Revenue Code generally and the HEROES Act. Briefly, Code §§877 and 877A require these two categories of persons (renouncing citizens and abandoning LPRs) to report and pay tax to the U.S. as if they had sold all of their worldwide property for fair market value the day before they renounce/abandon. They are obliged to pay tax on such “gain” in excess of an indexed threshold ($680,000 for 2014). However, they are only subject to this tax if they meet one of the following three provisions in 2014:

  • The citizen’s/LPR’s average annual net income tax for the five years ending before the date of expatriation or termination is more than $157,000.
  • Such person’s net worth is $2 million or more on the date of expatriation or termination.
  • The citizen/LPR fails to certify on Form 8854 that they have complied with all U.S. federal tax obligations for the five years preceding the date of expatriation or termination.

For LPRs, there is another possible exception to the application of the draconian tax consequences of abandonment: under Code §877(e)(2), “long term permanent residents” are subject to these taxation rules only if they were LPRs in “at least eight taxable years during the period of 15 taxable years ending with the taxable year during which” the termination or abandonment occurred. So, if an LPR is considering terminating that status, he or she should evaluate with their legal advisors whether they can (and should) do so before exceeding the “eight out of 15” year rule.

Quite a number of other significant provisions are triggered if the draconian tax consequences (deemed sale) apply to individual renouncing citizens or terminating LPRs, such as rules relating to deferred compensation, tax deferred accounts, gift and estate tax issues, etc.

If a citizen or LPR relinquishes or abandons their status, they are treated afterwards as any other nonresident alien for U.S. tax purposes, that is, they have U.S. tax due on U.S. source income and on income effectively connected with a U.S. trade or business. If they become a bona fide tax resident of a country that has a tax treaty with the United States, they are eligible for any subsequent treaty benefits as a resident of that treaty jurisdiction.

Conclusion

Renunciation of U.S. citizenship or abandonment or termination of LPR status should not be undertaken lightly, nor as an emotional response even to the perceived provocation that some U.S. taxpayers feel is visited upon them by the intrusive and time-consuming reporting obligations, worldwide tax scope and high tax rates of the U.S. There are significant tax consequences of the act itself, there are material limitations on the post-act travel opportunities restricting visits to the U.S. afterwards, and there are a multitude of issues associated with being a “stateless person” and of trying to assimilate into a new culture in another country that are beyond the scope of this article. Suffice it to say, anyone considering renunciation of U.S. citizenship or LPR status should talk to their immigration lawyer—and their tax advisor—first.

Elaine Kumpula, counsel, leads the global mobility section of Faegre Baker Daniels’ immigration and global mobility practice. Ken Levinson is a partner at Faegre Baker Daniels and leads the firm’s international tax practice; Ken specializes in tax, insurance and risk management and finance issues.

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