ABANDONING RESIDENCE
The logical follow-up to a discussion of establishing residency is a brief
explanation of how residence may be abandoned. A taxpayer is taxed as a resident
alien under the “green card” test only while he or she maintains the green card
or lawful-permanent-resident status. Regulations provide that, for tax purposes,
lawful-permanent-resident status is deemed to continue unless it is rescinded or
administratively or judicially determined to have been abandoned.
⑾ A resident
alien under the substantial-presence test need only leave the U.S. and reduce
the time spent in the country in order to become a non-resident. On the other
hand, a green-card holder must have a judicial or administrative determination
of abandonment, or commence an action to be treated as a resident of a foreign
country under a tax treaty and not waive such treaty benefit. Green card holders
who are long-term residents may be subject to the expatriation tax discussed
below.
Procedure
Regulations specify what constitutes such an abandonment and also spell
out the procedure required for the taxpayer to initiate abandonment. Lawful
permanent resident status is deemed abandoned when an application is filed with
either USCIS or a consular officer. The application can be made either by form
or in a letter stating the intent to abandon resident status and enclosing the
alien registration receipt card. A letter is effectively filed if it is sent by
certified mail, return-receipt requested (or a foreign country's equivalent).
Internal Revenue Service (IRS) regulations give clear procedural guidelines for
filing an abandonment application by letter. The regulations state that the
taxpayer should keep a copy of the letter and proof of mailing and receipt.
Since abandonment of residence by an immigrant extinguishes the status of lawful
permanent residence, care should be exercised in making residency elections for
tax purposes. Possible consequences of electing non-resident-alien tax status
include the simultaneous termination of status as a lawful permanent resident.
Special rules also apply to taxpayers who switch between resident and
non-resident status. A U.S. resident for three or more consecutive years who
becomes a non-resident and then becomes a U.S. resident again during the three
years after leaving the United States is subject to tax on the intermediate
years as if the individual were a citizen who had lost citizenship and taxed
under IRC§877. That is, he or she has to pay the higher of the tax due as a
resident and the tax due as a non-resident. Unlike expatriated citizens, however,
there is no requirement of tax-avoidance motives.
Expatriation Taxes
Regarding expatriation taxes, IRC §§877 and 877A provide that where
certain taxpayers have lost or renounced their U.S. citizenship or long-term
U.S. residents terminate their resident status, they will be subject to a
special tax regime.
⑿ Long-term residents are defined as individuals who were
lawful permanent residents in at least eight out of the last fifteen tax years,
ending with the tax year in which the residency ended. Years in which
individuals are residents for tax purposes under the physical presence test or a
treaty, without a green card, do not count. For years in which the lawful
permanent resident was a resident in a foreign country under a tax treaty whose
benefits were not waived, the years do not count. Note that the eight-year
requirement can be met within six years and two days if a lawful permanent
resident filing on a normal calendar year received a green card effective
December 31 in a prior year.
Three Time Periods
Three time periods are particularly important for expatriate taxes:
expatriation before June 4, 2004, expatriation during the period beginning June
4, 2004, and ending June 16, 2008, and expatriation after June 16, 2008 through
present day.
If a taxpayer expatriated before June 4, 2004, he or she is assumed to have a
principal purpose of tax avoidance under certain conditions unless he or she
submitted a ruling request within one year of expatriation and received a
determination that the expatriation was not for the principal purpose of tax
avoidance. The two conditions that triggered the definition of a “covered
expatriate” were an average annual tax liability of $100,000 over the prior five
years or a net worth exceeding $500,000. The amounts were adjusted annually for
inflation, up to $124,000 and $622,000 respectively by 2004. The tax computation
is the same as for expatriation after June 3, 2004, and before June 17, 2008.
Expatriation rules after June 3, 2004, had similar inflation adjustments for the
average annual net tax for the five prior years, up to $139,000 by 2008, but the
net worth measurement was fixed at $2 million. In addition, under a third
condition, the rules would apply if a taxpayer failed to certify on IRS Form
8854 that he or she had complied with all federal tax obligations for the five
years preceding expatriation or termination of residency. Certain dual citizens
and minors may qualify for an exception based on the first two conditions as
long as the certification was filed.
⒀ If the expatriation tax applies, a
taxpayer is generally subject to tax on U.S.-source income as if a resident,
unless he or she would be subject to a higher (30%) rate on certain incomes. The
tax continued for ten years and was paid by filing a U.S. non-resident tax return
for each of the ten years following expatriation.
For expatriation after June
16, 2008, the five-year average tax amount was indexed to $145,000, while the $2
million dollar net worth and certification requirements using Form 8854
remained. However, the focus of the tax provision changed from taxing certain
post-residency income to creating an “exit tax.” The tax is now imposed on all
worldwide net appreciated assets, retirement plans, IRAs, college savings plans,
and health savings accounts. Income subject to the tax is computed as if all
worldwide assets, including residences, are sold on the day prior to
expatriation at the market value. Gains and losses are netted. Only the net
gains in excess of $600,000 (indexed to $626,000 for 2009 and $627,000 for 2010)
are added to income on the tax return.
Exceptions to the “Covered Expatriate” Definition
There are different exceptions where an individual is not covered under the
definition of “covered expatriate” compared to the prior law.
⒁ Certain
specific dual citizens and certain citizen minors may qualify for exceptions to
the “covered expatriate” definition. The deemed-sale rules do not apply to
certain property such as deferred compensation items, specified tax deferred
accounts, and interests in a non-grantor trust.
⒂ The first two items may be
subject to withholding at source instead, while the last is treated as if there
was a complete distribution on the day before the expiration date. Notification
to the payer in regard to modified withholding taxes is made by way of new form
W-8CE—Notice of Expatriation and Waiver of Treaty Benefits. A non-resident alien
who became a resident of the United States must compute gains using a cost basis
for property that is not less than the fair market value on the day he or she
first became a resident, unless the new resident irrevocably elects otherwise.
⒃ This step-up in basis does not apply for any U.S. real property interests or
U.S. business property, since the eventual sale would deal with any taxes on a
non-resident basis. Taxpayers can make irrevocable elections to defer payment of
tax on the deemed sales, which also includes the requirement to provide adequate
security to cover the tax, until that property is sold, but interest on the tax
accumulates during the period tax is deferred. The election to defer can be made
on a property-by-property basis, and election includes an irrevocable waiver of
any future right under a tax treaty that would preclude assessment or collection
of the tax. The Internal Revenue Service (IRS) issued guidance on the exit tax
imposed on covered expatriates in November 2009. The notice does point out that
a taxpayer will be a covered expatriate even if he or she does not meet the net
worth or net income test and simply fails to timely file certification of
federal tax compliance on Form 8854. For that reason alone the importance of
timely filing Form 8854, for any expatriate, cannot be understated. The notice
also provides further guidance on determining fair market value.
Tactical Considerations
Finally, tactical considerations should be kept in mind when approaching
tax services for aliens and expatriates. A non-resident alien concerned about
U.S. taxation should review his or her worldwide tax situation before becoming a
U.S. resident-under either the “green card” test or the substantial-presence
test. This analysis would include a review of: worldwide income, assets, and
business operations; income tax liabilities in the foreign country or countries
of residence and citizenship; the impact of any treaties; estate planning goals;
and the expatriation tax consequences. U.S. residents may be subject to tax
under Subpart F on undistributed retained earnings of certain foreign
corporations which they hold stock in, directly or indirectly, even when they
receive no actual income. If a foreigner is interested in remaining a
non-resident alien, then a close watch should be kept on time spent in the
United States. Timing can have a great impact on tax liability. On the other
hand, very significant tax benefits can become available for non-residents who
make the “dual-status resident” or “full-year resident” elections. Qualified
professional tax assistance is necessary if overall tax liability is to be
minimized, since there are no general guidelines that can be followed to make an
easy determination of the most beneficial tax elections.
⑾ See Treas. Reg. §
301.770(b)-1(b).
⑿ See IRC §§ 877, 877A.
⒀ See IRC § 877(c).
⒁ See IRC §
877A(g)(1)(B).
⒂ See IRC § 877A(c).
⒃ See IRC § 877A(b)(2).