Editor: Susan Minasian Grais, CPA, J.D., LL.M.
On Sept. 6, 2019, the IRS released its Relief Procedures for Certain Former Citizens and frequently asked questions (FAQs) (available at www.irs.gov, which allow qualifying former U.S. citizens who have relinquished (or current U.S. citizens who intend to relinquish) their U.S. citizenship to comply with their U.S. income tax and reporting obligations without paying any unpaid taxes and penalties. The relief procedures apply to individuals with a net worth below $2 million (both at the time of expatriation and the time of their submission under these procedures) and an aggregate tax liability of $25,000 or less for the year of expatriation and the five prior years. The failure to file returns and pay the required taxes must have been nonwillful.
Individuals who qualify and elect the relief procedures will not be taxed as "covered expatriates" under the U.S. exit tax regime. The relief procedures also allow qualifying individuals to expatriate without entering into the Streamlined Foreign Offshore Procedures or the Streamlined Domestic Offshore Procedures. The streamlined procedures remain an option for higher-net-worth individuals to remedy tax noncompliance preceding expatriation but require the payment of several years of back taxes and, in some cases, an offshore penalty. The main benefit of the relief procedures is that they simplify the expatriation process and make it less costly for those with minimal U.S. income tax liabilities.
Some U.S. citizens born in the United States to foreign parents or outside the United States to a U.S. citizen parent may not be aware of their status as a U.S. citizen or that they have U.S. income tax and information return filing obligations. Often, individuals are alerted to their U.S. citizen status because the Foreign Account Tax Compliance Act (FATCA), enacted on March 18, 2010, as part of P.L. 111-147, generally requires foreign financial institutions (FFIs) to report certain information about their U.S. citizen customers' accounts. A customer who is identified by an FFI as a U.S. citizen due to place of birth, but who is no longer a U.S. citizen, can provide the FFI with proof of loss of U.S. citizenship for FATCA purposes. Accordingly, some individuals seek to minimize their compliance obligations and U.S. tax burdens by renouncing their U.S. citizenship.
Individuals who renounce their U.S. citizenship may be subject to special expatriation tax regimes under Sec. 877A; their heirs also could be subject to tax under Sec. 2801 if they receive gifts or estate transfers from covered expatriates. A covered expatriate is an expatriate who:
- Has an average net income tax for the five years preceding expatriation of at least $124,000 (indexed for inflation; $168,000 in 2019) (average-income-tax-liability test);
- Has a net worth of $2 million or more as of the date before expatriation (net-worth test); or
- Fails to certify on Form 8854, Initial and Annual Expatriation Statement, that he or she has complied with all U.S. tax obligations for the previous five years (certification test) (Sec. 877(a)(2)).
An exception applies for certain citizens who became citizens of the United States and another country at birth, and may allow them to consider only whether they meet the certification test in determining their covered expatriate status (see Sec. 877A(g)(1)(B)(i)).
IRS relief procedures
The relief procedures and FAQs provide a method for certain U.S. citizens expatriating after March 18, 2010, to comply with their U.S. tax obligations without having to remit any unpaid taxes or penalties or being classified as a covered expatriate. These procedures may be used only by taxpayers whose failure to file required tax returns (e.g., income tax returns, applicable gift tax returns, or information returns) and pay any taxes and penalties was due to nonwillful conduct. Nonwillful conduct generally is considered to include conduct that is due to negligence, inadvertence, or mistake, or conduct that results from a good-faith misunderstanding of the law's requirements.
To qualify for the relief procedures, an individual must:
- Have no U.S. income tax filing history as a U.S. citizen or resident (this requirement will be satisfied if the individual previously filed Form 1040-NR, U.S. Nonresident Alien Income Tax Return, under the good-faith belief that he or she was not a U.S. citizen);
- Not exceed the threshold in the average-income-tax-liability test;
- Have a net worth of less than $2 million at both the time of expatriation and the time of making a submission under the relief procedures; and
- Have a total tax liability of $25,000 or less for the tax year of expatriation and the five prior years in aggregate (this calculation includes all applicable deductions, exclusions, exemptions, and credits, including foreign tax credits, but excludes the application of Sec. 877A and any penalties and interest; the total aggregate tax liability is calculated without consideration of any taxes withheld on the taxpayer's behalf).
Taxpayers using the relief procedures must include the following documents with their submission:
- U.S. State Department Form DS-4083, Certification of Loss of Nationality of the United States, or a copy of a court order canceling a naturalized citizen's certificate of naturalization;
- Copy of the individual's (1) valid passport or (2) birth certificate and government-issued identification;
- Dual-status return for the year of expatriation, including Form 1040-NR, Form 8854, and any other required information returns; and
- Forms 1040, U.S. Individual Income Tax Return, and applicable information returns for the five tax years preceding the tax year of expatriation.
Notably, submission of delinquent FinCEN Forms 114, Report of Foreign Bank and Financial Accounts (FBAR), is not required under the relief procedures; however, the IRS notes that individuals should comply with all FBAR filing requirements. If delinquent FBARs are submitted before or contemporaneously with a submission under the relief procedures, no FBAR filing penalties will be assessed. If delinquent FBARs are not filed before or at the same time as the relief procedures submission, and the IRS selects the individual for examination, FBAR penalties (which can be significant) may be assessed. (FBARs, even if delinquent, must be filed electronically with Treasury's Financial Crimes Enforcement Network (FinCEN). To avoid the imposition of penalties, FBARs filed in connection with the relief procedures should include "Relief for Certain Expatriates procedures" as the reason for filing late.)
The IRS will review submissions to confirm eligibility and will notify taxpayers when their submission is determined to be complete. The IRS requests that taxpayers wait at least two months before contacting the agency regarding updates on their submission. Submissions under the relief procedures will not be automatically subject to IRS audit but may be selected for examination under existing selection processes.
The relief procedures do not include a termination date, but the IRS indicates that an announcement will be made before they are terminated.
The relief procedures are a welcome remedy for certain current and former U.S. citizens who were unaware of their U.S. tax filing requirements. However, the relief procedures will only apply to a narrow group of individuals with (1) an aggregate tax liability of $25,000 or less for the year of expatriation and the five tax years preceding expatriation and (2) a net worth of less than $2 million. Unfortunately, the relief procedures do not apply to U.S. lawful permanent residents (i.e., green-card holders) who cease to be treated as lawful permanent residents and may be subject to the exit tax under Sec. 877A.
Individuals who renounce their U.S. citizenship or surrender their green cards can be caught unaware of the significant tax implications of such a decision.
Susan Minasian Grais, CPA, J.D., LL.M., is a managing director at Ernst & Young LLP in Washington, D.C.
For additional information about these items, contact Ms. Grais at 202-327-8788 or firstname.lastname@example.org.
Contributors are members of or associated with Ernst & Young LLP. Versions of many of these items were previously published as Ernst & Young Tax Alerts.