Tax and Estate Planning Issues Related to Expatriation and IRS Expatriate Relief Procedures
Tax and estate planning attorney, Misbah Farid, discuss Section 877A and Relief Procedures for Certain Former Citizens.
Transcript:
MISBAH FARID
Hello, and welcome to everyone. I am Misbah Farid, an attorney at Bilzin Sumberg in Miami, Florida. I focus my practice on tax and estate planning for high net worth individuals and their businesses, as well as estate and trust administration. I am joined by my colleague, Stephanie Diaz. Hi, Stephanie.
STEPHANIE DIAZ
Hi, Misbah. I am also an attorney at Bilzin Sumberg. I work with the international private client group in the firm, focusing on inbound planning and tax and estate planning for international high net worth individuals. Part of my practice includes issues that relate to expatriation, which will be the topic of today’s podcast.
MISBAH FARID
Can you explain these issues with expatriation?
STEPHANIE DIAZ
Sure. As you know, U.S. citizens are required to report and pay tax to the IRS, or Internal Revenue Service, for all their worldwide income, including on their income from foreign financial assets, regardless of whether they live in the U.S. or abroad. Some citizens find this to be a high price to pay if they don’t live in the U.S. or intend on living here in the future. To comply with existing tax law and to avoid significant tax liability under the Internal Revenue Code, or the Code, U.S. citizens who renounce or otherwise relinquish their citizenship must comply with federal tax requirements for the year of expatriation and for the five tax years prior to expatriation, which includes using their Social Security number as their identification number on federal tax returns. But, the main issue is treatment as a covered expatriate under Code Section 877A. This can be particularly punitive treatment. Individuals who are covered expatriates are treated as having disposed of all worldwide assets on the day before their expatriation date, are required to pay a mark to market exit tax on the gain resulting from the deemed disposition of their worldwide assets, subject of course to an exclusion amount, and are subject to additional tax consequences with respect to certain deferred compensation and trust distributions. With some exceptions, Code Section 877(a)(2) will treat an individual as a covered expatriate if they meet anyone of three tests, the first being an average income tax liability test. The individual with an average income tax liability for the five years preceding the year of expatriation that exceeds a specified amount, which is adjusted for inflation annually. For 2019, that amount is $168,000.00. There is also the net worth test. An individual that has a net worth of $2 million or more as of the expatriation date could be a covered expatriate. Or the certification test, whereby the individual cannot or does not certify under penalties of perjury on Form 8854 known as the Initial and Annual Expatriation Statement that the individual was complaint with all federal tax obligations for the five years prior to expatriation and the tax year that includes expatriation date. I’m sure you notice, Misbah, that’s any three tests. So there’s a lot of ways to get treated as a covered expatriate.
MISBAH FARID
I have noticed.
STEPHANIE DIAZ
But the IRS has recently issued relief procedures for certain former citizens as a means for satisfying the tax compliance certification process for citizens who expatriated only after March 18, 2010.
MISBAH FARID
So can anyone qualify for the relief?
STEPHANIE DIAZ
Unfortunately, no. The relief procedures are only available to U.S. citizens that have the net worth below $2 million, and that has to be both at the time of expatriation and at the time of their making the submission under the procedures, kind of a tricky problem to have, and have an aggregate tax liability of $25,000.00 or less. And that’s, of course, in the year of expatriation and the five prior years.
MISBAH FARID
That does sound a little tricky. What needs to be submitted by eligible expatriates to qualify for relief?
STEPHANIE DIAZ
There are three categories of items. It’s one, the certificate of loss of nationality, so that’s Form DS-4083, or in the case of naturalized citizens, that will be a court order canceling their naturalization certificate. They also need to include government-issued I.D., and the last category is tax returns. That’s going to be a dual-status return, including Form 1040-NR, plus all informational returns for the year of expatriation. It’s also important not to forget Form 8854 from the certification test mentioned earlier. And we’ll also need tax returns Forms 1040 with all required informational returns for the five tax years preceding the year of expatriation. An individual that submits this information and otherwise qualifies for the relief procedures won’t be a covered expatriate under 877A. So that means those kinds of onerous rules we talked about earlier won’t apply, and importantly, the individual doesn’t need to send in a check for the amount shown on the returns. Eligible individuals are not liable for any unpaid taxes and penalties for these years or any previous years. If an individual doesn’t qualify for the relief procedures but makes a submission under the procedures, the IRS will process the returns using normal procedures, but an individual may be liable for all taxes, penalties, and interests associated with the returns. I should mention though that although FinCen Form 114, more commonly known as the Foreign Bank Account Report, or FBAR, is not required under the relief procedures, but the IRS has confirmed that an individual filing under these procedures that was required during those years to file an FBAR should electronically file the FBARs with FinCen. The IRS won’t assert FBAR penalties, which we know can be expensive, to say the least, if an individual was eligible for these procedures and files FBARs either before or contemporaneously with the relief procedure submission.
MISBAH FARID
Yes. I’ve definitely heard that those penalties can be quite expensive. How long will these procedures be in place?
STEPHANIE DIAZ
The IRS hasn’t announced a specific termination date yet, but that’s not to say that they’ll be in place forever. Eligible individuals should definitely file as soon as possible.
MISBAH FARID
Got it. Can the estates of individuals qualify for the relief procedures?
STEPHANIE DIAZ
Unfortunately, no. These relief procedures are only available for individuals, which is actually a really interesting question because I should highlight that individuals may be U.S. citizens, due to special derivative citizenship rules, or for lack of a better word, be accidental citizens. Of course, the Fourteenth Amendment to the Constitution provides that all persons born or naturalized in the U.S. are citizens of the U.S. But a person born abroad to a U.S. citizen parent, or parents, acquires U.S. citizenship at birth if the parent or parents meet certain conditions specified in the U.S. Immigration and Nationality Act. It’s important to look out for these issues. So these citizens might be or are rather deemed citizens at birth, but they might not have a Social Security number, which under existing law can be a problem. Thanks to these new procedures, the IRS issued Frequently Asked Questions. In FAQ 16, the IRS confirms that if an individual doesn’t have a Social Security number, it’s not necessary to obtain one in order to submit under the relief procedures. A submission can be made, leaving the boxes blank where a Social Security number is requested. However, if an individual mistakenly applied for and received an ITIN or Individual Taxpayer Identification Number in the past, the ITIN should be included on a return submitted.
MISBAH FARID
Are submissions under these procedures automatically subject to audit examination?
STEPHANIE DIAZ
No, thankfully not automatically, but they can be selected for audit, and they are subject to verification, the same kind of procedures that would be with other returns. The IRS can definitely check for accuracy and completeness based on information they might get from other sources like a bank.
MISBAH FARID
Got it. Will the IRS respond to submissions under these relief procedures to confirm the status of the submission?
STEPHANIE DIAZ
Actually, yes. Unlike other compliance programs, the IRS will send a letter confirming receipt of a submission and whether the submission was complete after it’s been confirmed that the individual meets the eligibility mentioned early. That being said, it can take at least two months before the IRS sends such a letter, so I wouldn’t follow up with the IRS before then.
MISBAH FARID
Wow, Stephanie. Thank you so much. That was very interesting, and I personally learned quite a bit about expatriation today. And I also want to thank you, our listeners, for tuning in today.
STEPHANIE DIAZ Thank you.
