Renunciation of United States citizenship or abandonment of United States lawful permanent resident (“green card”) status is a major event in an individual’s life. Nonresidents of the United States can shed their obligation to file U.S. tax returns and pay U.S. taxes under the Internal Revenue Code, and their obligation to file FinCEN Forms 114, Report of Foreign Bank and Financial Accounts, “FBARs” under the Bank Secrecy Act by expatiating from the United States.
Legal Expatriation
To expatriate, a United States citizen living abroad contacts a U.S. consulate office and makes an appointment to expatriate. At the appointment, a consulate employee interviews the citizen, to ascertain the citizen’s intent to expatriate. If the consulate employee is satisfied of the citizen’s intent to expatriate, he gives the citizen a U.S. Department of State, Bureau of Consular Affairs, Form DS-4079, Request for Determination of Possible Loss of United States Citizenship, to complete and return. At the return appointment, the citizen delivers the completed and signed Form DS-4079 to the consulate officer, and takes the oath of renunciation.
A lawful permanent resident of the United States expatriates by completing United States Citizenship and Immigration Services (“USCIS”) Form I-407, Record of Abandonment of Lawful Permanent Resident Status, and sending it to the USCIS with a cover letter and his green card.
Tax Effects of Expatriation
Renunciation of citizenship or abandonment of a green card does not complete expatriation from the United States. The individual must deal with the tax effects of expatriation.
IRC § 877A(a)(1) provides that all property of a covered expatriate shall be treated as sold on the day before expatriation for its fair market value. Gain or loss realized on the deemed sale is currently recognized, although the expatriate may by election defer recognizing it as to specific property until such property is disposed of.[1] A covered expatriate electing to defer expatriation tax must post adequate security with the Internal Revenue Service.[2] Deferred tax accrues interest at the underpayment rate.[3]
There is an exclusion from gross income for net gain on the deemed sale of a covered expatriate’s property.[4] The exclusion is indexed annually for inflation.[5] For expatriations occurring in 2021, the exclusion was $744,000.[6]
An issue that has come up is the making of bona fide gifts for the purpose of avoiding tax on deemed sale of a covered expatriate’s property. To the extent such gifts exceed the unified credit amount available to the covered expatriate-donor under IRC § 2505, the covered expatriate-donor would incur gift tax on the gifts.
The deemed sale of the covered expatriate’s property does not apply to a “deferred compensation item” or to a “specified deferred tax account.”[7] A deferred compensation item means—
- a retirement plan described in IRC § 401(a) which includes a trust exempt from tax under IRC § 501(a);
- an annuity plan described in IRC § 403(a);
- a plan established for its employees by the United States, by a State or political subdivision thereof, or by an agency or instrumentality of any of the foregoing;
- an annuity contract described in IRC § 403(b)
- a simplified employee pension within the meaning of IRC § 408(k);
- a simple retirement account within the meaning of IRC § 408(p);
- any interest in a foreign pension plan or similar retirement arrangement or program;
- any item of deferred compensation; and
- any property, or right to property, which the individual is entitled to receive in connection with the performance of services to the extent not previously taken into account under IRC § 83 or in accordance with § 83.[8]
Deferred compensation does not include any item to the extent it is attributable to services performed outside the United States while the individual performing the services was neither a citizen nor a resident of the United States.[9] The United States cannot lawfully tax suh income.
A specified deferred tax account means an individual retirement account described in IRC § 408(a) or an individual retirement annuity described in IRC § 408(b).[10]
If deferred compensation is an “eligible deferred compensation item,” the payor shall and pay over to the United States a tax equal to 30 percent of any taxable payment made with respect to such item.[11] An eligible deferred compensation item is any deferred compensation item with respect to which—
(1) the payor is (a) a United States person, or (b) a person who is not a United States person, but who elects to be treated as a United States person, and who meets such requirements as the Internal Revenue Service may provide to assure that the payor will be able to meet the requirements of withholding, and
(2) the covered expatriate (a) notifies the payor of his status as a covered expatriate, and (b) makes an irrevocable waiver of any right to claim any reduction under any treaty with the United States in withholding on such item.[12]
A “taxable payment” means with respect to a covered expatriate any payment to the extent it would be includible in the gross income of the covered expatriate if such expatriate continued to be subject to tax as a citizen or resident of the United States.[13] A deferred compensation item shall be taken into account as a payment for this purpose when the item would be so includible.[14]
In the case of a deferred compensation item which is not an eligible deferred compensation item (“a “non-eligible deferred compensation item”), the covered expatriate shall be treated as receiving distribution of an amount equal to the present value of the covered expatriate’s accrued benefit under such plan on the day before the expatriation date.[15] No early distribution tax shall apply by reason of such treatment.[16]
In the case of a non-eligible deferred compensation item consisting of property, or the right to property, which the covered expatriate is entitled to receive in connection with performance of services, and which was not previously treated as currently taxable under IRC § 83 (i.e., was not treated as becoming transferrable and not subject to substantial risk of forfeiture under IRC § 83), the rights of the covered expatriate shall be treated as becoming transferrable and not subject to substantial risk of forfeiture (i.e., as currently taxable) under IRC § 83 on the day before the expatriation date.[17] No early distribution tax shall apply by reason of such treatment.[18]
In the case of a specified deferred tax account, the covered expatriate is treated as receiving distribution of his entire interest in such account on the day before the expatriation date.[19] No early distribution tax shall apply by reason of such treatment.[20]
Such are the consequences of covered expatriate status. Who, then, is a covered expatriate? A covered expatriate is an expatriate who meets any of the following three tests:
- The Individual’s average annual United States income tax for the preceding five years exceeds a threshold, which is indexed annually for inflation. For expatriations occurring in 2021, the threshold was $172,000.
- The individual’s net worth is at least $2,000,000.
- The individual fails to certify under penalty of perjury that he has complied with the United States Internal Revenue Code for the preceding five years.[21]
An “expatriate” for this purpose means an individual who renounces citizenship in the United States.[22] For this purpose long-term resident of the United States who ceases to be a lawful permanent resident of the United States is treated in the same manner as a citizen of the United States who renounces citizenship.[23] “Long-term resident of the United States” for this purpose means an individual who was a lawful permanent resident of the United States in at least eight of the 15 taxable years preceding abandonment of the individual’s lawful permanent resident status. For this purpose an individual shall not be treated as a lawful permanent resident of the United States for any taxable year if such individual is treated as a resident of a foreign country for that taxable year under the provisions of a tax treaty between the United States and the foreign country, and the individual does not waive the benefits of such treaty applicable to residents of the foreign country.[24]
The tax consequences of covered expatriate status are reportable on the covered expatriate’s final Form 1040, U.S. Individual Income Tax Return.
Example
Edward is a native-born citizen of the United Kingdom. In 1995, at age 24, he moved to the United States. While residing in the United States, Edward became a lawful permanent resident. Edward moved back to the United Kingdom in 2004. Since then he has resided in the United Kingdom, and he has made only sporadic and brief visits to the United States. In December, 2020, Edward abandoned his green card. In 2021, Edward filed his 2020 Form 1040, U.S. Individual Income Tax Return, his final Form 1040.
The United States-United Kingdom Income Tax Treaty of 2001 (the “Treaty”), Article 4, paragraph 2 provides:
“An individual who is a United States citizen or an alien admitted to the United States for permanent residence (a “green card” holder) is a resident of the United States only if the individual has a substantial presence, permanent home or habitual abode in the United States and if that individual is not a resident of a State other than the United Kingdom for the purposes of a double taxation convention between that State and the United Kingdom.“
Since relocating to the United Kingdom in 2004, Edward has not had a substantial presence, permanent home, or habitual abode in the United States. Therefore, for purposes of the Treaty, Edward has not been a resident of the United States since 2004. Therefore, Edward is not deemed to have been a “long-term-resident” of the United States, and thus not an expatriate nor a covered expatriate, when he abandoned his green card in 2020.
Reporting
An expatriate (“nonresident alien individual”) must file Form 1040 for his final taxable year as a citizen or lawful permanent of the United States. Contemporaneous with filing his final Form 1040 the expatriate must also file Form 8854, Initial and Annual Expatriation Statement. Thereafter, the expatriate will not need to file Form 1040, or FinCEN Form 114, Report of Foreign Bank and Financial Accounts (“FBAR”).
Form 8854 Part II, Sections A and B, identify whether the expatriate is a covered expatriate. If the expatriate is a covered expatiate, Form 8854, Part II, Section C asks additional questions, with consequences. Form 8854, Part II, Section C, Line 1a asks whether the expatiate has any eligible deferred compensation items, then checking “Yes” on Part II, Section C, Line 1a constitutes an irrevocable waiver to claim any reduction of withholding for such eligible deferred compensation item under any treaty with the United States.
Form 8854, Part II, Section C, Line 1b asks whether the expatiate has any ineligible deferred compensation items. If the answer is “yes,” Part II, Section C, Line 1b reminds the covered expatriate to include in income the value of the account as of the day before the expatriation date.
Form 8854, Part II, Section C, Line 1c asks whether the covered expatriate has any specified deferred tax accounts. If the answer is “yes,” Part II, Section C, Line 1c reminds the covered expatriate to include in income his entire interest in the account on the day before the expatriation date.
In Form 8854, Part II, Section C, Part 2, the covered expatriate schedules gain on deemed sale mark-to-market property on the day before expatriation.
In Form 8854, Part II, Section C concerns an election to defer tax under Internal Revenue Code § 877A(b). Form 8854, Part II, Section C provides that an election to defer tax is an irrevocable election to waive any right under any treaty of the United States to prevent assessment or collection of tax under Internal Revenue Code § 877A.
A nonresident alien individual remains subject to U.S. income tax, but only on certain kinds of income. A nonresident alien individual is subject to U.S. income tax at the fixed rate of 30 percent (or at a lower rate pursuant to treaty) on interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable periodic gains, profits, and income received from sources within the United States, provided such income is not effectively connected with the conduct of a trade or business within the United States.[25] A nonresident alien individual who is present in the United States for 183 or more days during the taxable year is also subject to U.S. income tax at the rate of 30 percent (or at a lower rate pursuant to treaty) on the excess of gains over losses on sales of capital assets during the year.[26]
A nonresident alien individual is subject to U.S. income tax at the same graduated rates applicable to citizens or residents of the U.S. on income which is effectively connected with the conduct of a trade or business within the United States.[27]
A nonresident alien individual incurring U.S. income tax for a taxable year files not a Form 1040 but a Form 1040NR, U.S. Nonresident Alien Income Tax Return.[28]
Of course, a nonresident alien individual who satisfies the substantial presence test for a given year will be subject to U.S. income tax on his worldwide income for that year, as any other resident or any citizen of the U.S.[29] “Resident” of the U.S. means either a lawful permanent resident of the U.S. (“green card” holder), or an individual who satisfies the substantial presence test.[30] Under the substantial presence test, an individual is a resident of the United States for a given calendar year if the individual satisfies two tests:
In the case of days in: The applicable multiplier is:
The current year 1
First preceding year 1/3
Second preceding year 1/6[31]
An individual shall not be treated as meeting the substantial presence test for the current year if such individual is present in the United States for fewer than 183 days during the current year, and it is established that such individual has a tax home in a foreign country, and has a closer connection to such foreign country than to the United States.[32] An individual’s “tax home” is akin to his domicile.[33]
In addition, there are specific exemptions from the substantial presence test for presence in the U.S. by foreign government-related individuals, teachers or trainees, and professional athletes temporarily in the U.S. to compete in a charitable sports event.[34]
Summary
Upon renouncing United States citizenship or abandoning status as a lawful permanent resident of the United States, an expatriate must file Form 8854 and a final Form 1040. If the Form 8854 shows that the expatriate is a covered expatriate, he must report the deemed transactions and the tax resulting from such status on his final Form 1040. If, going forward, the expatriate satisfies the substantial presence test for a given year, he will be subject to U.S. income tax on his worldwide income for that year.
[1][1] IRC § 877A(b)(1).
[2] IRC § 877A(b)(4).
[3] IRC § 877A(b)(7).
[4] IRC § 877A(a)(3)(A).
[5] IRC § 877A(a)(3)(B).
[6] Instructions to 2021 Form 8854, Initial and Annual Expatriation Statement.
[7] IRC § 877A(c)(1), (2).
[8] IRC §§ 877A(d)(4), 219(g)(5).
[9] IRC § 877A(d)(5).
[10] IRC § 7701(a)(37).
[11] IRC § 877A(d)(1)(A).
[12] IRC § 877A(d)(3).
[13] IRC § 877A(d)(1)(B).
[14] Id.
[15] IRC § 877A(d)(2)(A)(i).
[16] IRC § 877A(d)(2)(B).
[17] IRC § 877A(d)(2)(A)(ii).
[18] IRC § 877A(d)(2)(B).
[19] IRC § 877A(e)(1)(A).
[20] IRC § 877A(e)(1)(B).
[21] IRC § 877 (a)(2).
[22] Id.
[24] IRC § 877(e)(2).
[25] IRC § 871(a)(1)(A).
[26] IRC § 871(a)(2).
[27] IRC § 871(b)(1).
[28] Instructions to 2021 Form 1040NR, U.S. Nonresident Alien Income Tax Return, at p. 8.
[29] IRC § 7701(a)(30)(A).
[30] IRC § 7701(b)(1)(A)(i), (ii).
[31] IRC § 7701(b)(3)(A)
[32] IRC § 7701(b)(3)(B). An individual’s “tax home” see IRC § 911(d)(3) and Treas. Reg. 1.911-2(b).
[33] The term “tax home” means, with respect to any individual, such individual’s home for purposes of IRC § 162(a)(2) (relating to traveling expenses while away from home). IRC § 911(e)(3). Treas. Reg. 1.911-2(b) provides in part:
[A]n individual’s tax home is considered to be located at his regular or principal (if more than one regular) place of business or, if the individual has no regular or principal place of business because of the nature of his business, then at his regular place of abode in a real and substantial sense. An individual shall not, however, be considered to have a tax home in a foreign country for any period for which the individual’s abode is in the United States.
[34] IRC § 7701(b)(5).