When the IRS May Let Former U.S. Citizens Avoid Covered Expatriate Status
For some former U.S. citizens living abroad, the most frightening tax problem is not a large unpaid tax bill. It is discovering, often years too late, that relinquishing U.S. citizenship did not automatically close the door on U.S. tax compliance. Many “Accidental Americans” and other former citizens learn only after bank due diligence, FATCA questions, or professional review that they may have needed U.S. income tax returns, international information returns, FBARs, and Form 8854, Initial and Annual Expatriation Statement. By that point, a poorly handled filing can create potentially catastrophic civil and criminal tax exposure.
The IRS Relief Procedures for Certain Former Citizens can be a powerful solution, but only for a narrow class of taxpayers. These procedures are not a general amnesty for all expatriates, former green-card holders, offshore account holders, or delinquent international taxpayers. They also should not be confused with Streamlined Filing Compliance Procedures, Delinquent FBAR Submission Procedures, late Form 8854 reasonable-cause submissions, or the IRS Criminal Investigation Voluntary Disclosure Practice. Choosing the wrong path can turn what might have been a manageable international tax compliance issue into a high-risk civil and criminal tax exposure problem. They exist for certain individuals who relinquished U.S. citizenship after March 18, 2010 and need an alternative way to come into compliance with U.S. income tax and reporting obligations while avoiding “covered expatriate” treatment under Internal Revenue Code section 877A.
Why Covered Expatriate Status Matters After Relinquishing U.S. Citizenship
Avoiding covered expatriate status can be the central tax objective for a former U.S. citizen or long-term resident who wants to leave the U.S. tax system cleanly. Under section 877A, a covered expatriate can face the mark-to-market exit tax, which generally treats most worldwide property as if it were sold for fair market value on the day before expatriation. That deemed sale can trigger U.S. income tax on unrealized gain even though the individual did not actually sell the assets or receive cash. Although section 877A provides an inflation-adjusted exclusion from the amount of net gain included in income, the tax can still be significant for individuals with appreciated real estate, investment portfolios, closely held business interests, cryptocurrency, foreign assets, or other property that increased in value before expatriation.
The exit tax is only part of the problem. Covered expatriate status can also trigger special treatment for retirement, deferred compensation, tax-deferred accounts, and trust interests. Some deferred compensation items may become subject to special withholding rules. Certain ineligible deferred compensation items may be treated as received immediately before expatriation based on the present value of the accrued benefit. Specified tax-deferred accounts, such as certain individual retirement plans, qualified tuition programs, qualified ABLE programs, Coverdell education savings accounts, health savings accounts, and Archer MSAs, may be treated as fully distributed on the day before expatriation, although the early distribution tax generally does not apply by reason of that deemed distribution. Interests in nongrantor trusts may also trigger special withholding treatment and annual Form 8854 reporting requirements where the covered expatriate remains a beneficiary. These rules can create complex tax results that are very different from the ordinary tax treatment the taxpayer expected before expatriation.
Covered expatriate status can also create consequences that reach beyond the expatriate’s own exit year return. Under section 2801, certain U.S. citizens or residents who later receive covered gifts or covered bequests from a covered expatriate may be subject to a special transfer tax, subject to statutory exceptions and thresholds. In practical terms, covered expatriate status can complicate future estate planning, gifts to U.S. family members, trust distributions, and inheritances. That is why covered expatriate classification is not merely a technical label on Form 8854. It can affect the expatriate’s exit-year tax treatment, future reporting obligations, family wealth transfers, and the tax position of U.S. beneficiaries.
For many former citizens, the most dangerous covered expatriate trigger is not wealth. It is noncompliance. A person can become a covered expatriate if they fail to certify, under penalties of perjury, compliance with all federal tax obligations for the five tax years preceding expatriation, even if they do not exceed the net worth threshold or the average annual net income tax liability threshold. This is where the Relief Procedures for Certain Former Citizens can be so valuable. If the taxpayer qualifies and makes a complete submission, the procedures can allow certain former citizens to come into compliance without being treated as covered expatriates under section 877A. But if the taxpayer does not qualify, submits incomplete returns, understates assets, fails to disclose foreign accounts, or improperly certifies non-willfulness, the attempted relief submission can become a high-risk civil and criminal tax exposure event rather than a solution.
Who Can Use the Relief Procedures for Certain Former Citizens?
The threshold question is whether the person is actually a former U.S. citizen. These procedures are not designed for every expatriation problem, and they are not automatically available to former lawful permanent residents who abandoned green-card status without ever having been U.S. citizens. The IRS eligibility rules are strict. To use the procedures, the taxpayer’s past compliance failures must be non-willful, meaning they resulted from negligence, inadvertence, mistake, or a good-faith misunderstanding of the law. The taxpayer also must meet all eligibility requirements. The individual must have relinquished U.S. citizenship after March 18, 2010, have no filing history as a U.S. citizen or resident, satisfy the average annual net income tax liability threshold for the five years before expatriation, have a net worth of less than $2 million at both expatriation and submission, and have aggregate total tax liability of $25,000 or less for the expatriation year plus the five preceding tax years.
The “no filing history” requirement is especially important. These procedures are generally aimed at former citizens who did not know they were U.S. taxpayers, not taxpayers who selectively filed, stopped filing, or previously participated in the U.S. tax system as citizens or residents. The IRS, however, allows a person who filed Form 1040-NR in good faith, believing they were not a U.S. citizen, to use the procedures if they otherwise qualify.
The procedures also apply only to individuals, not estates, trusts, corporations, partnerships, or other entities. They are not designed for taxpayers with willful offshore noncompliance, hidden income, nominee accounts, intentionally false filings, or deliberate efforts to avoid U.S. tax reporting. A taxpayer who tries to force willful facts into a non-willful submission risks turning a relief procedure into evidence for a future civil examination or IRS criminal tax investigation.
What Must Be Submitted, and What Relief Can Apply?
A proper submission is more than a late Form 8854. The taxpayer must submit the required federal tax returns for the six years at issue: the year of expatriation and the five preceding tax years. For the year of expatriation, the submission generally includes a dual-status return, Form 8854, Form 1040NR, a Form 1040 attached as an information return reporting worldwide income up to the expatriation date, and all required information returns, including Form 8938 where applicable. For the five preceding years, the taxpayer must submit Forms 1040 with all required schedules and information returns.
FBAR filing is not an eligibility criterion, but the IRS states that taxpayers with an FBAR filing requirement should file FBARs electronically with FinCEN. If an eligible taxpayer files required FBARs before or contemporaneously with the submission, the IRS will not assert FBAR penalties. If FBARs are not filed and the submission is later selected for examination, FBAR penalties may be asserted.
The benefit can be significant. If the individual is eligible and makes a complete qualifying submission, the IRS says it will not treat the individual as a covered expatriate under section 877A and will not assert unpaid taxes and penalties for the covered years or previous years. If the taxpayer is eligible to use the procedures, no payment is required with the submission. But the reverse is equally important: if the taxpayer is not eligible and still submits under these procedures, the IRS will process the returns under normal procedures, and the taxpayer will be liable for taxes, penalties, and interest. A qualifying submission also should not be treated as immune from review. The IRS states that returns submitted under these procedures will not automatically be subject to audit, but they may be selected under existing audit-selection processes, and the IRS may verify the accuracy and completeness of the submission against information received from other sources.
Former Green-Card Holders and Form I-407 Require a Different Analysis
A related issue arises when a noncitizen who previously lived in the United States later files Form I-407 to abandon lawful permanent resident status and then discovers a possible Form 8854 problem. That fact pattern must be handled carefully. The Relief Procedures for Certain Former Citizens are for former U.S. citizens who relinquished citizenship. They are not automatically available to former lawful permanent residents who terminated long-term residency.
That does not mean a former green-card holder has no Form 8854 issue. The Form 8854 instructions state that section 877A applies both to U.S. citizens who relinquish citizenship and to long-term residents who end U.S. residency. A long-term resident generally means a lawful permanent resident in at least eight of the last fifteen tax years, subject to treaty-residency rules. If a long-term resident voluntarily abandons green-card status by filing Form I-407, that date can become the expatriation date for section 877A purposes. Therefore, a former lawful permanent resident who was a long-term resident may need a separate Form 8854 analysis, covered expatriate analysis, tax compliance certification analysis, and potential reasonable-cause strategy, even though the former-citizen relief procedures may not apply. The IRS FAQs also address separate late Form 8854 situations for taxpayers who do not meet the Relief Procedures eligibility criteria. Those paths are distinct from the Relief Procedures and do not produce the same acknowledgement process.
This distinction can decide the entire strategy. A former citizen with no U.S. filing history and non-willful conduct may be a strong relief-procedures candidate. A former long-term resident who filed U.S. tax returns for years and merely missed Form 8854 may need a different late Form 8854 or reasonable-cause approach. A person with willful offshore facts may need to consider IRS Criminal Investigation Voluntary Disclosure Practice before making any direct submission.
Contact the Tax Law Offices of David W. Klasing if You Relinquished Citizenship or Abandoned Long-Term Residency Without Completing U.S. Tax Compliance
At the Tax Law Offices of David W. Klasing, we analyze expatriation problems by first determining what actually happened: whether the taxpayer relinquished U.S. citizenship, abandoned long-term residency through Form I-407, became a covered expatriate risk because of Form 8854 noncompliance, or used the wrong compliance path. This is not a one-form problem. The answer may depend on citizenship history, green-card history, expatriation date, filing history, net worth, five-year tax compliance, worldwide assets, foreign accounts, foreign tax credits, FBAR exposure, Form 8938 exposure, and whether the failure was genuinely non-willful.
Our dual-licensed Civil and Tax Attorneys & CPAs can help determine whether the Relief Procedures for Certain Former Citizens, a late Form 8854 strategy, Streamlined Filing Compliance Procedures, delinquent FBAR filings, amended returns, or IRS Criminal Investigation Voluntary Disclosure Practice best fits the facts. Our CPAs are employees working under attorney supervision as part of the legal team, allowing us to combine international tax calculations, return reconstruction, expatriation analysis, and legal advocacy while preserving attorney-client privilege and work-product protections where applicable.
If you relinquished U.S. citizenship, filed Form I-407, missed Form 8854, failed to file U.S. returns while living abroad, or recently learned that your foreign bank or prior U.S. status created unresolved U.S. tax exposure, do not send a partial submission or assume the former-citizen procedures apply. Call the Tax Law Offices of David W. Klasing at 800-681-1295 or use our online contact options HERE to request a confidential, reduced-rate initial consultation before you file, certify non-willfulness, or make statements to the IRS that could worsen your civil and criminal tax exposure.
