Covered Expatriates

Covered Expatriate: When a person is either a U.S Citizen or Long-Term Legal Permanent Resident and they want to exit the U.S. permanently — they may have IRS tax consequences.  These consequences impact expatriates who are deemed covered expatriates, and do not have sufficient gain exclusion available to offset IRS exit tax or have deemed distributions of tax-deferred account or ineligible deferred compensation.

Stated another way, when certain U.S. persons relinquish their U.S. status (aka expatriation), they become a “covered expatriate” for tax purposes, and may become subject to the U.S. exit tax.

The covered expatriate rules apply to U.S. persons who were either U.S. Citizens or Legal Permanent Residents who qualify as an LTR (Long-Term Residents). Being a covered expatriate complicates expatriation. 

The IRS requires certain “expats” to calculate an exit tax when they exit the U.S., and file their 1040/1040NR tax return — along with Form 8854.

The failure to file the necessary U.S. expatriation forms, may result in FBAR penalties, FATCA penalties, PFIC tax, passport revocation, liens, levies, and examination.
We have prepared a 2021 covered expatriate IRS exit tax expatriation overview.

Tax Rules for Covered Expatriates

Unfortunately, the IRS has a whole set of additional rules for “covered expatriate” individuals who want to “renounce or relinquish,” beyond the requirements of submitting Form I-407.

When a Legal Permanent Resident wants to give-up their U.S. status, the (usual) first-step — after proper planning – is to file Form I-407.

This is not a tax form, but rather an immigration form (aka U.S. Citizenship and Immigration Services aka USCIS)

“Form I-407, Record of Abandonment of Lawful Permanent Resident Status, is designed to provide a simple procedure to record an individual’s abandonment of status as a lawful permanent resident (LPR) of the United States.

Use of Form I-407 also ensures that an individual abandoning his or her LPR status is informed of the right to a hearing before an immigration judge and that the individual has knowingly, willingly, and affirmatively waived that right.”

Covered Expatriate 2020 IRS Exit Tax Expatriation Overview

Covered Expatriate 2020 IRS Exit Tax Expatriation Overview

Expatriation Tax 

When the IRS levies a tax on a covered expatriate, it can be tough. Once a person is ready to relinquish their citizenship, or give up their U.S. legal permanent resident status to the IRS, the first step is generally submitting a form I-407 – but usually that is not the last step — which is where many unsuspecting applicants get lost.

Initial & Annual Expatriation Statement

Form 8854 is an “Expatriate” form, and required by the IRS. This form is required, irrespective of whether the individual is considered a covered expatriate or not.

As provided by the IRS:

You must file Form 8854 to:

  • Establish that you have expatriated for tax purposes; or
  • Comply with the annual information reporting requirements of section 6039G, if you are subject to tax under section 877.

Who is Eligible to be considered a Covered Expatriate?

  • U.S. Citizens
  • Legal Permanent Residents who are LTRs

What is a Long-Term Resident (for Expatriation)?

Generally, if you have had Legal Permanent Resident status for 8 of the last 15-years, you are a Legal Permanent Resident.

As provided by the IRS:

“You are an LTR if you were a lawful permanent resident of the United States in at least 8 of the last 15 tax years ending with the year your status as an LTR ends.

In determining if you meet the 8-year requirement, don’t count any year that you were treated as a resident of a foreign country under a tax treaty and didn’t waive treaty benefits applicable to residents of the country.”

What are the Exceptions to being Considered a Covered Expatriate?

There are a few exceptions to being considered a Covered Expatriate:

Exception for dual-citizens and certain minors

Dual-citizens and certain minors (defined next) won’t be treated as covered expatriates (and therefore won’t be subject to the U.S. exit tax) solely because one or both of the statements in paragraph (1) or (2) above (under Covered expatriate) applies.

However, these individuals will still be treated as covered expatriates unless they file Form 8854 and certify that they have complied with all federal tax obligations for the 5 tax years preceding the date of expatriation as required in paragraph (3) (under Covered expatriate, earlier).

Certain Dual-Citizens

You can qualify for the exception described above if you meet both of the following requirements.

You became at birth a U.S. citizen and a citizen of another country and, as of the expatriation date, you continue to be a citizen of, and are taxed as a resident of, that other country.

You were a resident of the United States for not more than 10 years during the 15-tax-year period ending with the tax year during which the expatriation occurred. For the purpose of determining U.S. residency, use the substantial presence test described in chapter 1 of Pub. 519.

Certain Minors

You can qualify for the exception described above if you meet both of the following requirements.

You expatriated before you were 181/2.

You were a resident of the United States for not more than 10 tax years before the expatriation occurs. For the purpose of determining U.S. residency, use the substantial presence test described in chapter 1 of Pub. 519.

What are the 3 Covered Expatriate Tests?

There are 3 main ways a person meets the covered expatriate test

Average Tax Liability Test

Your average annual net income tax liability for the 5 tax years ending before the date of expatriation is more than the amount listed next.

  • $139,000 for 2008.
  • $145,000 for 2009.
  • $145,000 for 2010.
  • $147,000 for 2011.
  • $151,000 for 2012.
  • $155,000 for 2013.
  • $157,000 for 2014.
  • $160,000 for 2015.
  • $161,000 for 2016.
  • $162,000 for 2017.
  • $165,000 for 2018.

Net Worth Test

Your net worth was $2 million or more on the date of your expatriation.

5-Year Tax Compliance

You fail to certify on Form 8854 that you have complied with all federal tax obligations for the 5 tax years preceding the date of your expatriation.

What if a Person is a Covered Expatriate?

When a person is a Covered Expatriate, they may have to pay an “exit tax,” in addition to an ongoing (annual) filing requirement of form 8854 (even after they relinquished their status).

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure

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