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“Residency-Defined Immigration vs. Taxation” and Expatriate Tax Consequences (II)

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 Regulations provide that, for tax purposes, lawful-permanent-resident status is deemed to continue unless it is rescinded or administratively or judicially determined to have been abandoned.
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.

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.
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.
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.
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. 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. 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.

See Treas. Reg. § 301.770(b)-1(b).
See IRC §§ 877, 877A.
See IRC § 877(c).
See IRC § 877A(g)(1)(B).
See IRC § 877A(c).
See IRC § 877A(b)(2).

Source: AILA
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