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IRS Relief For Former Citizens

IRS Relief For Former Citizens
Ines Zemelman, EA
04 November 2019

Relinquishing United States citizenship is a serious matter, and involves decisions that are irrevocable. Of course, there are tax implications to doing this as well. Anyone considering this is encouraged to speak with a specialized legal professional prior to making final decisions. The IRS has procedures to handle these matters. To aid in decision making, below is some information about tax compliance and how to avoid becoming a “covered expatriate”.

Background

United States citizenship is defined by the US Constitution in the Fourteenth Amendment, where it states that “all persons born or naturalized in the United States” are United States citizens. While there are exceptions for high-level diplomats, everyone born within the US becomes a US citizen at birth. Similarly, people born to US citizens outside of the United States are almost always US citizens.

There are some United States citizens who are not even aware of their citizenship status because they were born to foreign parents in the US, or to US citizens outside of the United States. Even if they are aware of their citizenship status, they may not be aware of the tax implications. Every United States citizen, no matter where they live, must report their income and pay taxes on all of the money they earn everywhere in the world, even on foreign assets.

The Foreign Account Tax Compliance Act, commonly known as FATCA, became law in 2010. This act requires financial institutions throughout the world to determine if their clients are United States citizens, and report information to the Internal Revenue Service about their account. If their financial institution determines a customer is a US citizen, that customer must either provide their Social Security Number or provide documentation to counter that determination if they are not a US citizen. This is usually all done via a customer self-certification at the time of account opening.

Relinquishing Citizenship

The process of relinquishing United States citizenship is detailed in 8 USC 1481, Section 349, the Immigration and Nationality Act. The US Department of State has authority over this process. A citizen who wants to relinquish citizenship must commit an “expatriating act” voluntarily and having the intent to do so. A common way to do this is by taking an oath in person with a consular or diplomatic officer.

Although there is a mandatory fee of $2,350 for relinquishing citizenship, United States income tax compliance is not required prior to relinquishing of citizenship, nor is the obtaining of a Social Security Number.

There are, however, tax consequences related to the decision. The law requires compliance with US tax law in the year the expatriation occurs, as well as in the five previous tax years. There are a special group of tax rules for former US citizens (“covered expatriates”), who are considered to have disposed of their worldwide assets the day prior to their expatriation, and who must pay an exit tax based on their gain. There are also taxes on deferred compensation and distributions from trusts. With a few exceptions, taxpayers are “covered expatriates” if:

  1. Their average net annual income tax liability for the previous five years exceeds a certain amount (USD 168,000 is 2019), known as the “average income tax liability test”
  2. They have a minimum of USD 2 million net worth on their expatriation date, known as the “net worth test”, or
  3. They cannot certify that they are compliant with their federal tax requirements for the previous five years, known as the “certification test”

For the certification test, taxpayers are required to file Form 8854, Initial and Annual Expatriation Statement. The certification implies that all tax returns have been accurately filed for the previous five years.

Alternative Compliance

The Internal Revenue Service has an alternative method for compliance with the certification process if the taxpayer expatriates later than March 18, 2010. This alternative method is available only to United States citizens who:

  • Have a net worth under USD 2 million when they expatriate and when they make use of this alternative compliance method, and
  • A total tax liability no greater than USD 25,000 for the year they expatriation and for the five previous years

The alternative compliance method is only available to taxpayers who failed to file their tax returns (income tax, gift tax, FinCEN, and information returns) and pay their taxes and any penalties because of non-willful actions. This includes misunderstandings of law in good faith.

Comparison of Table between RP & Streamlined Procedure

Question

Relief Procedure (RP)

Streamlined Foreign Offshore (SFOP)

To whom does this Relief apply?

This relief applies for a certain number of non compliant US citizens residing abroad. It does not apply to any U.S. entities or to long term permanent residents.  Only a certain group of U.S. citizens who expatriated after March 18,2010

The modified streamlined filing compliance  procedure applies for individual taxpayers, including estates of individual taxpayers. It applies for both U.S. individual taxpayers residing in the U.S and residing outside the US. i.e “Streamlined Foreign Offshore Procedures” and “Streamlined Domestic Offshore Procedures”

What is the purpose of using this process?

This procedure  relieves certain US citizens of having to pay tax, interest, penalties and the exit tax upon their relinquishing their citizenship

This procedures for filing amended or delinquent returns and terms for resolving their tax and penalty procedure for filing amended or delinquent returns and terms for resolving their tax and penalty obligations.

 

Who is eligible for this criteria?

These procedures are available only to 1.Individuals who relinquished citizenship after Mar 18,2010. (note:SSN is not must for these procedures)

2.Individual has no filing history as a U.S. Citizen or resident(note: if the individual mistakenly  filed 1040NR in the past as NR, this does not make the individual ineligible for the program).

3.US citizens with a net worth of less than $2 million at the time of expatriation and at the time of making their submission under these procedures and

4.An aggregate tax liability of $25,000 or less for the taxable year of expatriation and the five prior years.

5. They should not be “covered expatriates” under IRC 877A, i.e average annual net income tax for the 5yrs prior to expatriation must not exceed the threshold is $168,000and will not be liable for any unpaid taxes

and penalties for these years or any previous years

6. Failure to comply with the Internal Revenue Code was due to non- wilful conduct

These procedures are available only to

1.U.S. taxpayers who have valid SSN/ITIN and do not have a home in the US.

2. Do not have to have filed all prior year tax returns

3.Meet the 330-day foreign residence test/ Non residence criteria

4.Qualify as Non-Wilful.

 

 For U.S. citizens who fail to meet the residency test, then they can opt for Streamlined Domestic offshore procedure

Tax Return Submission procedures

These taxpayers need to file six years of returns along with all required information returns. The six years is really five years of back tax returns with the sixth comprising the final tax return for the year of expatriation. (1040NR- Dual status)

Need to file FBAR , only if you have a requirement.

If you do not have an SSN, you still must file an FBAR when you have an FBAR filing requirement using your non-US tax identification number from the resident country.

For Streamlined Foreign Offshore procedures, need to

 

1. File original or amended tax returns for the last 3 years with all required information returns.
2. File FBAR for six years

 

For Streamlined Domestic offshore Procedures, need to

1. File amended tax returns with all required information returns
2. File Delinquent or amended FBAR for the past six years

Headings/ Explanation to add on the documents

To assist with the above processing, on the top of the first page of each of these documents submitted, the individual should write in red ink, “ Relief for certain Former Citizens

If you are filing FBAR, select other as the reason for Filing late and enter “ Relief for certain Expatriates Procedures”

Indicate at the top of the first page of each delinquent or amended tax return, the individual should write in red ink “Streamlined Foreign offshore” or “Streamlined Domestic offshore” based upon the case.

 In FBAR form select other as the reason for filing late and enter “ Streamlined Filing Compliance Procedure

Special Forms to attach with the tax returns

To meet the requirements of the certification test, Individuals must file a Form 8854, Initial and annual expatriation statement with their tax return for the year of expatriation (Form 8854 Instruction) and Certify compliance for the prior five tax years.Need to attach a copy of Form DS-403 the certificate of loss of nationality of the United states to the IRS.

Certification Form 14653 for streamlined Foreign offshore procedures and Certification Form 14654 for Streamlined Domestic offshore procedures. The purpose of this form is to certifying that you are eligible for streamlined procedures, failure to report all income, pay all taxes and submit all required information returns including FBAR’s resulted from Non-wilful conduct and miscellaneous offshore penalty is accurate

Fines and Penalties

 

If you are eligible to use these procedures, the IRS will not assert any penalties. The purpose of these procedures is to provide relief for certain former Citizens.

No FBAR penalties

Under Streamlined Foreign offshore procedures, Individuals are not subject to failure to file and pay penalties, accuracy-related penalties, information return penalties or FBAR penalties. Any previously assessed penalties with respect to those years, however will not be abated.

 

Under Streamlined Foreign Domestic Procedures, Same applicable as foreign offshore procedures. But in addition the individual will be subject only to the title 26 Miscellaneous offshore penalty (5% streamlined penalty)

Q and A

Question

Explanation

How long are these relief procedures available?

There is not a specific date when these procedures will no longer be available, although the IRS has said they will give notice before terminating them.

Who can use these relief procedures?

The relief procedures are limited to taxpayers who have been out of compliance because of non-willful errors. Taxpayers must meet all of these criteria:

- The taxpayer has relinquished their United States citizenship on or after March 18, 2010
- The taxpayer does not have a US resident or US citizen tax filing history
- For a period of five tax years prior to the date of the taxpayer’s expatriation, the threshold for average annual income tax in IRC 877(a)(2)(A) was not exceeded
- When the taxpayer expatriated, and when submitting under the relief procedures, their net worth was under $2,000,000
- For the 5 tax years prior to expatriation, and for the year in which the taxpayer expatriated, their total aggregate tax liability was no more than $25,000.
- The taxpayer will submit all required tax returns, including required information returns. Specifically, the year of expatriation and the five prior tax years.

These procedures are available only to taxpayers whose lack of compliance was non-willful. The taxpayer must strictly meet the eligibility criteria.

Does filing a 1040NR in good faith prevent a taxpayer from using these procedures?

No. If the taxpayer, in good faith, believed they weren’t a United States citizen and filed Form 1040NR, they may still use these relief procedures.

Are there exceptions to the net worth limit of $2,000,000?

No. These relief procedures require that this threshold is met without exception, including those in IRC 877A(g)(1)(b).

Can these relief procedures be used by trusts, partnerships, corporations, and estates?

No. Only individual taxpayers may use these relief procedures.

Can a taxpayer still use these procedures if they renounced their United States citizenship in the past and were not compliant with tax requirements?

Yes, assuming the date they relinquished their United States citizenship was no earlier than March 18, 2010. This is officially reflected on Form DS-4083, “Certificate of Loss of Nationality of the United States”.

What penalties will be assessed for either the tax returns or information returns?

None. If a taxpayer is eligible to take advantage of the relief procedures, there will be no penalties. These relief procedures are specifically designed to prevent taxpayers from being penalized.

If a taxpayer makes a relief procedure submission, but is not eligible, what happens?

The taxpayer’s returns will be processed like any tax return would be. If that results in taxes, interest, and/or penalties, they will be assessed.

What are some examples of how the criteria for eligibility will work?

These are all hypotheticals. Note that the actual tax return calculations can be nuanced and complex. Please use these as general guidance only.

 

Situation 1, Total tax liability is below the threshold

 

Jack’s parents are not United States citizens, but Jack was born while they were in the United States for college. They all returned home to Country X. Jack lives in Country X and works there.

 

Jack received his Certificate of Loss of Nationality when he renounced his US citizenship on November 15, 2019. He has never submitted a United States tax return, nor does he have a Social Security Number. Under these procedures, he is required to report his income from all worldwide sources using Form 1040, and must do this for 2019, 2018, 2017, 2016, 2015, and 2014.

 

He submits these forms with the following total tax:

  • 2019 tax year - Form 1040NR with Form 1040 attached - tax of USD 1,000
  • 2018 tax year - Form 1040 - tax of USD 4,800
  • 2017 tax year - Form 1040 - tax of USD 4,800
  • 2016 tax year - Form 1040 - tax of USD 4,800
  • 2015 tax year - Form 1040 - tax of USD 4,800
  • 2014 tax year - Form 1040 - tax of USD 4,800

 

He has used his best judgement in good faith to calculate these amounts. But, he mistakenly reported his mutual fund income from foreign sources on the wrong form (Form 1040 instead of Form 8621) and did not submit the correct form when he filed his return. When Jack adds up his total tax from all six returns it totals USD 25,000. This is within the required limits, so Jack can use these relief procedures.

 

Situation 2, Total tax liability is above the threshold

 

In this situation, assume the same facts as in Situation 1, except that Jack’s total tax is just over the USD 25,000 threshold. Jack cannot use these relief procedures. If Jack submits using the relief procedures, the Internal Revenue Service will process them using their normal procedures. Jack will then be held liable for taxes and penalties, as well as interest. Under other IRS procedures, he can ask for relief using the First Time Abate Policy and claim reasonable cause. He could also potentially qualify for an Offer in Compromise.

 

Situation 3, Total net worth is below the threshold

 

Beth’s parents, who are not United States citizens, were working in the US on an assignment from a global company. Beth was born during their stay in the United States. While they were in the US, they bought a house there. The entire family left the US and returned to Country X, but retained their house and rented the house to tenants. Beth works in Country X and lives there. Beth inherited her parents rental home when they died, which had a USD 300,000 fair market value.

 

Beth plans to renounce United States citizenship, and then use these relief procedures to become compliant with US tax law. She has never submitted a United States tax return, nor does she have a Social Security Number. She is required to report worldwide income, including any she receives from the rental house in the United States.

 

Beth renounces United States citizenship in December of 2019. If her total aggregate tax for 2014 - 2019 is under USD 25,000, with a net worth below USD 2,000,000, she is eligible to use these relief procedures.

 

Situation 4, Total net worth is above the threshold

 

In this situation, assume the same facts as in Situation 3 above, except that the rental house is valued at USD 2,500,000 making Beth’s net worth over the USD 2,000,000 threshold. She is not eligible for these relief procedures.

 

Situation 5, No United States citizen or resident filing history

 

In this situation, assume the same facts as in Situation 3 above, except that Beth filed Form 1040NR for the 2012 tax year. She reported her rental income from the house, and did not have any other US source income. Her 2012 tax filing was done in good faith under the assumption she wasn’t a United States citizen. Beth can use these relief procedures.

How does a taxpayer renounce their United States citizenship?

The United States Department of State is responsible for this procedure. Visit this page for information.

What documents are required for these relief procedures?

1. Form DS-4083, Certificate of Loss of Nationality of the United States, or a copy of the court order that cancels a certificate of naturalization. The date is required to be after the 18th of March, 2010. Form DS-4083 must have the Department of State “Approved” stamp.
2. A copy of either a current passport, OR a birth certificate along with government-issued ID.
3. For the year expatriation occurred, a “dual status” return, which includes Form 1040NR and all required attachments and information returns, including:
- Form 1040
- Form 8854
- Any other required forms, including Form 8938

More information is available in Notice 2009-85.

4. For the 5 tax years prior to the expatriation year, Forms 1040 and all required attachments and information returns.

 

The words, “Relief for Certain Former Citizens” should be written in red across the first page of all documents.

If a taxpayer’s returns completed under these relief procedures show an amount due, do they need to submit a check?

No. There is no payment required if a taxpayer is eligible for these relief procedures.

What happens if a taxpayer had United States tax withheld during the relevant tax years?

Tax withholding is not considered. The relief procedures are concerned with the total aggregate tax liability. Any withholding is irrelevant.

Where does a taxpayer submit their returns under these procedures?

The returns should be sent to:

Internal Revenue Service

3651 South I-H 35

Mail Stop 4301 AUSC

Attn: Relief for Certain Former Citizens

Austin, TX 78741

 

The words, “Relief for Certain Former Citizens” should be written in red across the top of every return.

Does a taxpayer need prior approval for using these relief procedures?

No. As long as the criteria for this relief procedure are met, the taxpayer should simply submit the necessary documents.

Does a taxpayer need a Social Security Number to take advantage of these relief procedures?

No. Taxpayers can still submit under these relief procedures. They should simply leave any boxes blank that ask for a Social Security Number. Taxpayers do not need to apply for a Social Security Number solely for purposes of these procedures. However, if a taxpayer has an ITIN, they should include it on their submission.

Will a taxpayer automatically be audited because they use these relief procedures?

No. Returns filed under the relief procedures may be chosen for audit, but only based on existing processes, not because they were submitted under the relief procedures.

Do these relief procedures require the filing of an FBAR?

You do not need to submit FBARs solely because of these relief procedures, but if you are required to file them you should. If you qualify for these relief procedures and submit your FBARs either with your relief submission or prior to the submission, the Internal Revenue Service will not assess penalties. If FBARs are not filed, penalties may be assessed apart from these relief procedures.

 

When filing FBARs, select “Other” for the late filing reason. Enter “Relief for Certain Expatriates procedures” in the explanation box.

Will the Internal Revenue Service notify taxpayers that they have properly complied with the relief procedures?

Yes. Following the IRS review of the taxpayer’s submission and confirmation that they meet the criteria, the IRS will send a letter to notify the taxpayer that their submission under these procedures was received.

When will the taxpayer receive the notification that their submission was received?

Although the IRS processes notifications as fast as possible, taxpayers should wait a minimum of two months prior to inquiring with the IRS about their submission.

What obligations does a taxpayer have after their expatriation?

For potential taxpayers who are not citizens of the United States, there are specific rules that determine if they are resident or nonresident aliens for purposes of tax liability. For more information, taxpayers should reference Publication 519.

Can a taxpayer change their mind about their submission under these relief procedures after making it?

No. Unless the State Department determines that United States citizenship was not properly lost, the decision is irrevocable. No procedure exists to retract a tax return, although taxpayers can usually file an amended return.

If a taxpayer has questions about these relief procedures, who should they call?

Although the Internal Revenue Service cannot provide legal or tax advice, questions can be asked about the mechanics of making submissions under these relief procedures. Taxpayers can call 267-466-0020.

 

Ines Zemelman, EA
founder of Taxes for Expats