By: William Bricker, Juliya Ismailov, Inhyuk Yoo & Linda Galler
U.S. tax issues facing accidental citizens of the United States have received much publicity over the last several years. These are individuals born in the United States to a parent or parents who are foreign citizens residing temporarily in the United States, or born outside of the United States to a parent or parents who are U.S. citizens residing abroad, in either case having little or no contact with the United States over the years.
However, few people are aware that noncitizens of the United States can, and often do, encounter U.S. tax problems as “accidental expatriates.” Namely, a person can accidentally expatriate if, after a lengthy period of being a Lawful Permanent Resident (i.e., a “Green Card” holder), he/she:
chooses to abandon his/her Green Card (by filing Form I-407), which results in the same tax treatment as having it revoked by U.S. immigration authorities for criminal conduct, immigration fraud, or long-term absence from the U.S., or
takes a “treaty position” (by filing Form 8833) that he/she is a tax resident of a foreign jurisdiction as a result of having a closer connection to that jurisdiction.
Unbeknownst to him/her, such actions may forever tangle such “accidental expatriate” in the nets of U.S. taxation.
Tax Consequences for a Covered Expatriate
U.S. Income Tax
An expatriate who meets any of the criteria below is considered a “Covered Expatriate” (Section 877(a)(2)) for U.S. tax purposes:
average annual net income tax liability for the past 5 tax years of more than $172,000 (as of 2021), adjusted for inflation;
net worth of $2 million or more, or
failure to certify under penalties of perjury (by filing Form 8854) compliance with all U.S. tax obligations for the past 5 tax years.
A Covered Expatriate has to pay an “exit tax” under Section 877A of the Internal Revenue Code on the net unrealized gain on her/her worldwide properties as if such properties had been sold at their fair market value on the day before such person is deemed to have expatriated (the “Deemed Sale”).
There is a $744,000 (adjusted for inflation) exclusion from gross income that is generated by reason of the Deemed Sale. There are exceptions from taxation for certain deferred compensation, tax-deferred accounts, and interests in non-grantor trusts.
A Covered Expatriate can irrevocably elect to defer the tax on a given property to the date it is sold if he/she provides “adequate security” (such as a bond) to the U.S. Treasury and pays interest on the deferred tax. As a practical matter, few taxpayers will try this approach.
U.S. Transfer Taxes
For U.S. transfer (i.e., estate and gift) tax purposes, a gift or bequest from a Covered Expatriate to a “U.S. recipient” will be taxed at the highest applicable U.S. gift or estate tax rate (without any applicable exclusion amounts) to the recipient of the gift or bequest (normally the tax is imposed on the transferor). Generally, gifts to a spouse or charitable organization are exempt from this rule.
For this purpose, a “U.S. recipient” is a U.S. citizen or resident, including a U.S. domestic trust. A U.S. resident for transfer tax purposes is someone domiciled in the U.S. and does not necessarily need to be a U.S. income tax resident.
The transfer tax consequences for the Covered Expatriate can be deceptively far-reaching. For example, transfer taxes apply to all property owned by the Covered Expatriate even if the property: (i) was acquired after he/she expatriated, (ii) is a foreign-situs property, or (iii) is an intangible generally not subject to U.S. gift tax if gifted to a nonresident alien.
Given the lasting tax consequences for a long-term Green Card holder of voluntary abandonment or taking a treaty position as a tax resident of a non-U.S. jurisdiction, those considering such actions should consult tax counsel to minimize their exposure to the U.S. tax by accidentally becoming a Covered Expatriate.