Today the Treasury Department published the names of individuals who renounced their U.S. citizenship or terminated their long-term U.S. residency (“expatriated”) during the fourth quarter of 2013.
The number of published expatriates for the quarter was 630, bringing the total number of published expatriates in 2013 to 2,999. The total for the year shatters the previous record high of 1,781 set in 2011 and is a 221% increase over the 2012 total of 932.
We do not believe that the primary reason for the increase in expatriations is for political purposes or for individuals to reduce taxes. Instead, we believe that there are likely three principal reasons for the recent increases in the number of expatriations:
- Increased awareness of the obligation to file U.S. tax returns by U.S. citizens and U.S. tax residents living outside the U.S.;
- The ever-increasing burden of complying with U.S. tax laws; and
- The fear generated by the potentially bankrupting penalties for failure to file U.S. tax returns when an individual holds substantial non-U.S. assets.
The increase in expatriations may also be partly due to a 2008 change in the expatriation rules.
Increased Awareness
The U.S. is almost the only country in the world that requires its citizens that live permanently in another country to continue to file tax returns and pay taxes in the country of citizenship. Most people, especially those living abroad, are unaware of the unique way in which the U.S. taxes its citizens and long-term residents. Many believe that income earned from foreign sources is not subject to U.S. tax, and that while residing overseas there is no need to file U.S. tax returns. This is not an unreasonable belief, considering that most countries in the world operate in that way.
In the last several years, there has been increased publicity surrounding U.S. citizens who have actively attempted to hide assets overseas. The U.S. government discovered that UBS, Switzerland’s largest bank, actively aided its American clients in hiding assets from the I.R.S. In 2009, UBS entered into a deferred prosecution agreement with the U.S. Department of Justice which required, among other things, that UBS cease to provide services to U.S. clients with undeclared bank accounts. UBS additionally agreed to pay USD $780 million in fines and later agreed to disclose to the U.S. government the identities of more than 4,000 U.S. account holders suspected of evading taxes. The Department of Justice also publicizes its successful tax prosecutions, including prosecutions of many individuals that have attempted to hide assets overseas.
The I.R.S. has also highly publicized several offshore voluntary disclosure programs where U.S. persons can disclose previously unreported income and assets, and pay (potentially) reduced penalties with the implied agreement that there will not be a criminal prosecution.
The UBS scandal also spurred the 2010 enactment of the Foreign Account Tax Compliance Act (“FATCA”). FATCA will soon require many foreign financial institutions to report to the I.R.S. accounts held by U.S. taxpayers.
With the publicity surrounding these events (the UBS scandal, the offshore voluntary disclosure programs, and FATCA), U.S. citizens living outside the U.S. have become much more aware of their obligation to file U.S. tax returns.
Ever Increasing Compliance Burden
There are many potential U.S. tax forms that apply to individuals living outside the U.S. Some of the items that need to be disclosed to the I.R.S. include:
- Worldwide income from all worldwide assets;
- Foreign bank accounts;
- Foreign brokerage accounts;
- Foreign mutual funds;
- Foreign pensions;
- Foreign life insurance;
- Foreign annuities;
- Foreign real estate held thru foreign entities;
- Assets held through foreign trusts;
- Shares of foreign companies not held thru brokerage accounts;
- Interests in foreign partnerships;
- Receipt of large gifts and inheritances from non-U.S. persons;
- Reliance on tax treaties to reduce U.S. taxes; and
- More . . .
The rules to determine which assets need to be included on the forms can be very complicated. Attribution rules can apply to cause an individual to be considered to have an interest in an asset, even if he or she does not directly own the asset. Individuals living outside the U.S. often have to pay significant fees to U.S. tax advisors just to remain compliant with the I.R.S.
FATCA increased the compliance burden by creating additional reporting requirements, some of which overlap existing reporting requirements, creating duplicate reporting requirements. Starting in July of 2014, if a foreign financial institution, such as a bank, does not report its U.S. account holders to the I.R.S., U.S. payors must withhold 30% of the gross of any payments made to such foreign financial institution. When faced with the administrative burden of complying with FATCA or being withheld upon, some foreign financial institutions are simply closing the accounts of their U.S. clients.
Huge Potential Penalties
Although each form carries its own penalty, the “standard” penalty for failing to file many of the forms is $10,000. That is, the $10,000 penalty applies per year and per form. If an individual should have been filing 3 of the disclosure forms for the past 6 years, the penalties could be $180,000 or more (10,000 X 3 X 6). Potential penalties of this magnitude are quite common, even for individuals of modest means.
Of course, the “elephant in the room” penalty is for intentionally failing to file the FBAR (Report of Foreign Bank and Financial Accounts --- now FinCEN Form 114). The monetary penalty for a willful failure to file this form is the greater of $100,000 or 50% of the account balance at the time of the violation. For example, say an individual has retired overseas and has accumulated a life savings of $1,000,000 that has been deposited in a foreign bank account. If that individual intentionally does not file the FBAR for 4 years, the penalty would be $2,000,000 (twice the amount of the cash in the bank).
The penalty for unintentionally failing to file the FBAR is the “standard” penalty --- a mere $10,000 (per year).
And, of course, you had better now have Internet access in your foreign retirement retreat. Starting July of last year, the FBAR must be filed electronically.
A more detailed summary of the potential penalties can be found here.
2008 Change to Expatriation Rules
In 2008, the expatriation rules were changed. Many individuals can now expatriate without paying any U.S. tax and without having to continue to file U.S. tax returns for 10 years. An individual expatriating in 2014 faces an “exit tax” only if he or she:
- Has a net worth of $2 million or more on the date of expatriation,
- Has an average annual net income tax liability exceeding $157,000 for the 5 years ending before the date of expatriation, or
- Fails to certify on Form 8854 that all U.S. federal tax obligations have been complied with for the 5 years preceding the date of expatriation.
If one of these conditions is met, a mark-to-market regime is triggered and all worldwide property of the expatriate is deemed sold for its fair market value on the day before expatriation.
For 2014, an expatriate subject to the mark-to-market regime can exclude up to $680,000 of gain from being taxed under the exit tax. With the $680,000 exclusion, many individuals can expatriate without paying any U.S. tax.
It is important to note, however, that some individuals, especially those with assets in foreign pension plans, may unexpectedly pay more tax than they realize. Further, future gifts or bequests to U.S. persons can be subject to special gift and estate taxes (imposed on the recipient of the gift or inheritance). The circumstances of each individual considering expatriation must be closely analyzed to determine the amount of U.S. tax that will be due upon expatriation.
Also, with the new rules in 2008, expatriates can now annually visit the U.S. for 120 or more days without becoming taxed as U.S. residents. Under the pre-2008 rules, visits to the U.S. for more than 30 days during any of the 10 years following expatriation caused the individual to be treated as a U.S. resident for that year.
As stated above, we believe that the primary reasons for the increase in expatriations are due to: (i) the increased awareness of the obligation to file U.S. tax returns, (ii) the increasing burden of complying with U.S. tax laws, and (iii) the fear generated by the magnitude of the potential penalties.
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Andrew Mitchel LLC is a law firm located in Centerbrook, Connecticut that focuses on the U.S. taxation of international transactions. It also operates Tax-Charts.com and the International Tax Blog.