Expatriates Face Harsh Consequences For Renouncing Citizenship

It is no surprise that the Department of Justice, State Department, and the Internal Revenue Service have teamed up over the past decade to try to put a stop to bank secrecy and other attempts to conceal overseas assets. And although legislation such as the Foreign Account Tax Compliance Act has been labeled a great success by the Obama administration, many tax professionals have linked its creation and enforcement to an increasing amount of Americans renouncing their citizenship. Although there are several advantages to becoming an expatriate, there are also a few lesser-known drawbacks that could negate any future benefit that motivated the renouncement to begin with.

FBAR and FATCA May Be Driving Expatriation

The Foreign Bank Account Reporting (FBAR) laws, coupled with the recent FATCA legislation have pushed U.S. residents with foreign bank accounts into a corner. FBAR requirements, which have been in effect for nearly 40 years, require that any U.S. resident with an ownership interest or signature authority over an account at a foreign financial institution document and report the existence of the account with the IRS. The FATCA legislation, which was signed into law by President Obama in early 2010, effectively created a worldwide reporting system that singles out U.S. residents. The law imposes a 30% withholding requirement upon any U.S. payor that is transferring money to a foreign financial institution that has not complied with the information reporting requirements outlined in the FATCA laws. In order to comply with FATCA, the law requires that foreign banks identify U.S. resident customers and transmit various types of information about their account activity to the IRS.

Tax practitioners suggest that one of the largest factors at play when a U.S. resident opts to become an expatriate is the harsh penalties associated with being caught with an undisclosed foreign bank account. If a person subject to U.S. tax is found to have willfully failed to disclose the existence of his or her foreign account, he or she will be subject to a civil penalty of up to 50% of the high balance of the undisclosed account and face a substantial amount of time behind bars. Not only do the harsh consequences of bank secrecy irk potential ex-pats, but also does the concept of worldwide taxation. The United States is one of a very small amount of countries that taxes U.S. residents on their income on a worldwide basis. Most other nations tax their subjects on a territorial basis, meaning that taxes are levied on monies earned within a jurisdiction’s territorial bounds.

Expatriation May Not Be The Best Option

Expatriation provides ex-pats with the ability to relocate in a jurisdiction that has more taxpayer-friendly laws and escape some of the taxation laws in the U.S. that many have called confiscatory. No longer would an ex-pat be required to inform the IRS of his or her foreign bank account or face life-altering consequences if they omitted the existence of an interest in a foreign account. But the grass may not always be greener on the other side, as many expatriates are discovering.

To combat the possibility of a U.S. resident leaving the U.S. tax net to avoid taxes, Congress and the IRS came up with legislation regarding what happens when a U.S. resident permanently heads abroad. Internal Revenue Code sections 877 and 877A deal with former U.S. residents that have expatriated. The harshest treatment of the Code sections is concerned with “covered expatriates” A person is a covered expatriate if:

  • Their average annual net income tax for the 5 years ending before the date of expatriation or termination of residency is more than a specified amount that is adjusted for inflation ($147,000 for 2011, $151,000 for 2012, $155,000 for 2013 and $157,000 for 2014).
  • Their net worth is $2 million or more on the date of your expatriation or termination of residency.
  • They fail to certify on Form 8854 that you have complied with all U.S. federal tax obligations for the 5 years preceding the date of your expatriation or termination of residency.

In essence, the IRS and Congress are attempting to identify those U.S. residents who are likely to be renouncing their U.S. citizenship for tax purposes. Upon expatriation, covered expatriates are deemed to have engaged in a hypothetical sale of all of their assets a day before the date that they expatriated. Any gains or income that would have been realized and recognized from that sale are considered income to the taxpayer and are to be included when calculating their tax liability for that year. Thus, the United States has created a mechanism that would require a taxpayer to realize and recognize any built-in gain or loss upon leaving the U.S. tax net. The deemed sale could result in a massive tax bill that an expatriate simply cannot afford.

The U.S. Can Still Find You Overseas

Another reason that a taxpayer may wish to become an expatriate is to withdraw themselves from the boundaries of the U.S. borders in the event that their offshore bank account is discovered. Their thought could be that it will be extremely hard to prosecute and levy a penalty against an individual that is not physically in the United States. But this too may be a misconception. The fact that a person is no longer subject to the U.S. tax net does not mean that the U.S. government will not pursue those who broke the laws of the U.S. while subject to them. In fact, with the relationships that have been established or strengthened by the various Intergovernmental Agreements that developed out of the FATCA legislation, it has become more and more likely that foreign governments will assist the United States in their efforts to apprehend and punish FBAR violators.

In reality, finding a way out of the predicament of having an undisclosed foreign bank account doesn’t have to be as complicated or costly as renouncing your U.S. citizenship. The government has established the Offshore Voluntary Disclosure Program (OVDP), mechanism that allows a taxpayer to voluntarily disclose details of their foreign bank account, pay any back taxes, interest, and penalty in exchange for an agreement that they will not be criminally prosecuted.  Typically, time in a federal prison is what scares those with undeclared accounts the most. In order to participate in the program, a taxpayer must prepare an application package that provides the government with detailed information pertaining to the overseas account. This process is most effectively done by an experienced tax attorney. But there is a catch: the OVDP is not available for taxpayers who are already being investigated for any tax transgression, whether it is related to an offshore account or not.

Contact An Experienced Tax Attorney Today

The tax and accounting professionals at the Tax Law Offices of David W. Klasing have a plethora of experience in assisting taxpayers in their time of need. From determining whether expatriation is right for you, to assisting with the OVDP process, to providing representation during an investigation or trial, our professionals are prepared to zealously advocate for your best interests. Choosing to permanently leave the United States is a major decision involving several important international tax factors that should be discussed with an experienced attorney. Contact the Tax Law Offices of David W. Klasing today for a reduced-rate consultation.