Failure to File IRS Form 8854 after Surrendering a Green Card or after Expatriation

I was sharing with my colleague that we have had 5 inquiries this week on a single topic. US exposed persons who gave up US passports or Green Cards but failed to file Form 8854 –

Initial and Annual Expatriation Statement – https://www.irs.gov/forms-pubs/about-form-8854

1. Is it the end of the world?

No

2. Does it mean they continue to be subject to US taxes?

On their US source income? Yes

On worldwide income? Usually- No

3. Would they be subject to penalties?  Potentially yes

I’ll first provide some technical background.

The tax consequences associated with expatriating changed significantly with the enactment of the Heroes Earnings Assistance and Relief Tax Act of 2008 (P.L. 110-245, 6/17/08; the “HEART legislation”). U.S. citizens seeking to terminate their citizenship and long-term residents seeking to return their green card (collectively, “expats”) are no longer subject to an alternate U.S. income tax regime for ten years following the date of expatriation. Instead, section 301 of the HEART legislation added two new sections to the Code: a new income tax provision, Section 877A, that subjects certain expats to an exit tax; and a new transfer tax provision, Section 2801, pursuant to which the U.S. recipients of gifts and bequests from certain expats could be subjected to gift or estate tax. In addition, other Code provisions were revised to be consistent with the new approach.

In an effort to clarify issues generated by the HEART legislation and to implement the new statutory provisions, the IRS issued Notice 2009-85, 2009-45 IRB 598. The Notice, 65 pages in all, contains 58 pages of guidance applicable to Section 877A, including several examples. It also includes two appendices that add seven more pages. The Notice does not make any changes with respect to Section 877, which remains applicable to those expats who expatriated prior to 6/17/08, or provide any guidance with regard to Section 2801. Taxpayers may rely on the terms of the Notice pending the issuance of Regulations.

COVERED EXPATRIATE

The exit tax applies to “covered expatriates,” which can include U.S. citizens who expatriate and green card holders who relinquish their green cards after having been a permanent U.S. resident for at least eight of the 15 years prior to expatriating (including the year of expatriation). To be classified as a covered expatriate under Section 877A(g)(1)(A), the expat must have either:

1. A net worth of at least $2 million on the date of expatriation (the “net worth test”), or
2. As of 2009, an average annual net income tax for the five tax years prior to expatriation greater than $145,000 (this amount is adjusted periodically for inflation) (the “income tax test”).

Nevertheless, an expat can be classified as a covered expatriate even if the expat does not satisfy the net worth test or the income tax test. Any expat seeking to expatriate after 6/17/08 must certify under penalties of perjury that the expat has been compliant with the U.S. tax laws for the five-year period prior to expatriation (the “certification test”). The certification test is satisfied by filing Form 8854 (discussed below under “Compliance”). Failure to satisfy the certification test and file Form 8854 will result in the expat’s being classified as a covered expatriate and subject to the exit tax, irrespective of the net worth test or the income tax test.

So, in summary, the failure to file Form 8854 means you will be treated as a “covered expatriate” (even if you do not meet the dollar thresholds set out previously) with the attendant onerous tax results.  But note that you will NOT continue to be treated as a US citizen or resident liable for income tax on your worldwide income.

Read more here – https://www.mooresrowland.tax/2018/03/surrendering-us-passport.html

Now how should a taxpayer proceed?  It depends on WHEN they actually expatriated or surrendered their Green Card.  But the steps should be as follows –

1. Ensure that the tax returns for the 5 years preceding the event are in order.  The FBARs for should also be correctly efiled.

2. An amended return for the year of the event is needed.  The form 8854 is attached.

3. The late Form 8854 might trigger a $10,000 penalty under Internal Revenue Code Section 6039G(c)(2).  Therefore a “Reasonable Cause” statement may need to be attached

4. As of September 2019, for former citizens?  It is possible to claim relief under a new IRS initiative explained here:

IRS offers tax relief to expats who renounce U.S. citizenship

To Whom does the Expat Relief Apply

The Expat Relief is designed to address two distinct but interrelated issues:

(i) a taxpayer’s noncompliance with U.S. income tax return filing requirements

as well as

(ii) a taxpayer’s failure to file Form 8854.

While the failure to file tax returns leaves the statute of limitation open indefinitely in which the IRS could assess and collect the tax.  The interesting aspect of the Expat Relief is that in some ways it is more limited than the existing options that are available through the Streamlined Foreign Offshore Procedures and Section 877A.

The Expat Relief is only available to individuals. It does not apply to any U.S. entities or to long term permanent residents (i.e., those with green cards). Only a certain group of U.S. citizens who expatriated after March 18, 2010 will be eligible to satisfy the eligibility criteria. Moreover, such individuals must meet these requirements:

1. No U.S. income tax returns were filed as a U.S. citizen or resident (i.e., no Forms 1040). If an individual filed a Form 1040NR with the good faith belief that he/she was not a citizen, the Expat Relief is still available.
2. Their average annual net income tax for the five years prior to expatriation must not exceed the annual threshold in Section 877(a)(2)(A). For 2019, the threshold is $168,000. Notwithstanding this amount, the Expat Relief states that the individual’s aggregate income tax liability after applying all deductions, exclusions, exemptions, and credits for all six years of income tax returns being filed, must not exceed $25,000. Therefore, there does not appear to be any reason to reference the Section 877(a)(2)(A) amount, which is completely irrelevant when the total aggregate tax must not exceed $25,000.
3. Their net worth must be less than $2 million on the date of the expatriation and the date that the Expat Relief submission is filed.
4. Their failure to comply with the Code was due to non-willful conduct. Similar to the manner in which it is defined in the Foreign Streamlined procedures, non-willful conduct means, “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.”

What is Required to be Filed

The following documents need to be sent to the IRS:

1. Loss of Nationality: Expat Relief is premised upon the individual already having relinquished their citizenship under the Immigration and Nationality Act. Therefore, the Expat Relief is only available to individuals who have already expatriated. As such, they must provide a copy of Form DS-403, which is the Certificate of Loss of Nationality of the United States to the IRS, and the form must be stamped Approved by the Department of State. This document is only available to those who paid the $2,350 U.S. consular fee for “Administrative Processing of Request for Certificate of Loss of Nationality.”
2. Six years of tax returns: As noted earlier, five years of back tax returns inclusive of all information returns. The Expat Relief also indicates that unfiled gift tax returns can be filed through the submission. In the year of expatriation, there needs to be two tax returns. A Form 1040 reporting worldwide income up through the date of expatriation, and a Form 1040NR. Both returns should include all required information returns. Form 8854 must accompany the returns in the sixth year. To assist with the 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.”
3. Identification: For identification purposes, the individual must provide a copy of their valid passport or birth certificate and a government issued identification.

These documents need to be mailed to the IRS at the below address, which is the same one that was used for the numerous iterations of the Offshore Voluntary Disclosure Programs:

Internal Revenue Service

3651 South I-H 35

Mail Stop 4301 AUSC

Attention: Relief for Certain Former Citizens

Austin, Texas 78741

There is no payment required under the terms of the Expat Relief. Thus, no income tax liability, no interest, no late filing or late payment penalties. Similarly, there is no exit tax liability. IRS, however, indicates that the returns may be selected for audit under the normal section process. Additionally, IRS states that individuals who fail to meet the criteria and yet submit the above referenced documentation will be liable for all taxes, penalties and interest. Furthermore, the tax returns will be examined under normal procedures. Interestingly, unlike the terms of the Foreign or Domestic Streamlined programs, the IRS will acknowledge receipt of the submission after reviewing the submission package to make certain that it complies with the eligibility criteria.

Conclusion

The Expat Relief assists a certain number of noncompliant U.S. citizens residing abroad. Based upon the eligibility parameters, a successful entrepreneur or retired executive is unlikely to qualify by virtue of the $2 million net worth threshold. Similarly, an individual resident in a low or no tax jurisdiction will be unable to benefit from the foreign tax credit, and therefore exceed the aggregate tax liability of $25,000 over six years. However, such individuals could still qualify for the foreign earned income exclusion that might help reduce the taxable income to the required threshold.

For any U.S. citizens failing to qualify for the Expat Relief, but wish to receive the benefit, all is not lost. The Foreign Streamline program remains available. Although the IRS does not waive the actual tax in this program, it does waive all penalties. A taxpayer simply files three years of back tax returns inclusive of information returns and six years of FBARs. The taxpayer only pays the tax and interest due. Of course, this program is premised upon the individual’s noncompliance also being based upon non-willful conduct.

Moreover, if such taxpayer wishes to expatriate, it is possible to do so and avoid the exit tax. There are two exceptions that the taxpayer can meet so as to avoid being classified as a covered expatriate. Even if one of the exceptions is met, the individual must be compliant with his/her taxes for the past five years to successfully expatriate and avoid the exit tax. An individual can avoid being a covered expatriate even without meeting an exception. Such individual would need to have a net worth below $2 million and their average annual net income tax for the five years prior to expatriation must not exceed the annual threshold in Section 877(a)(2)(A). As noted above, for 2019, the threshold is $168,000. Consequently, the only thing the Expat Relief accomplishes that the existing Foreign Streamline program and Section 877A do not, is it may save the taxpayer the necessity of paying the income tax on the six years of filed tax returns.