IRS Exit Tax & Form 8854 (2018) – Expatriation Statement Filing Basics
The IRS Exit Tax does not apply to everyone. But, if you are either a U.S. Citizen or LTR (Long-Term Permanent Resident) then the form may apply to you.
Preparing an Exit Tax analysis requires a complicated analysis, in which a person had to assess their current net worth, along with potential “Gain” from an imaginary sale of assets (with the IRS of course limiting losses you can take) to determine if you owe the U.S. any taxes upon your expatriation.
IRS Expatriation Tax
For U.S. citizens, it does not come as much of a surprise that there may be an exit tax for renouncing your citizenship, but it often comes as a surprise to a green card holder (aka Legal Permanent Resident) who is not even considered a U.S. citizen.
From their perspective (understandably so) they are just giving back their green card, so why would they have to follow that up with a complicated and often times unnecessary exit tax form 8854 filing? Oftentimes the assets were acquired with money that was earned or generated from money earned before becoming a Legal Permanent Resident.
Threshold Question: Are You a U.S. Citizen or Long Term Resident?
Who Does Form 8854’s Exit Tax Apply To?
Expatriation tax provisions apply to U.S. citizens who have relinquished their citizenship and long-term residents who have ended their residency (expatriated).
Form 8854 is used by individuals who have expatriated on or after June 4, 2004.
Does it Apply to U.S. Citizens?
Yes. The following is a breakdown of when a U.S. Citizen is considered to have expatriated.:
U.S. Citizen – Day of Relinquishment of Citizenship
You are considered to have relinquished your U.S. citizenship on the earliest of the following dates:
– The date you renounced your U.S. citizenship before a diplomatic or consular officer of the United States (provided that the voluntary renouncement was later confirmed by the issuance of a certificate of loss of nationality).
– The date you furnished to the State Department a signed statement of your voluntary relinquishment of a U.S. nationality confirming the performance of an expatriating act (provided that the voluntary relinquishment was later confirmed by the issuance of a certificate of loss of nationality).
– The date the State Department issued a certificate of loss of nationality.
– The date a U.S. court canceled your certificate of naturalization.
Are All Legal Permanent Residents Required to File a Form 8854?
In order to be required to file this form, the person must be considered a long-term permanent resident, or stated another way – the person is a Legal Permanent Resident, who is a “Long-Term Resident”
Long-Term Resident (LTR)
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.A=
What is a Lawful Permanent Resident?
You are a lawful permanent resident of the United States if you have been given the privilege, according to U.S. immigration laws, of residing permanently in the United States as an immigrant.
What if I resided outside of the U.S?
Simply residing outside of the U.S. is no enough to relinquish your Green Card. Rather, you still retain your Green Card Status until you formally abandon the Green Card (actually or constructively).
You generally remain a Legal Permanent Resident if you have been issued an alien registration card, also known as a “green card,” and your green card hasn’t been revoked or judicially or administratively determined to have been abandoned, and you haven’t commenced to be treated as a resident of a foreign country under a tax treaty between the United States and such foreign country.
You aren’t treated as a lawful permanent resident if you commenced to be treated as a resident of a foreign country under a tax treaty, didn’t waive the benefits of such treaty applicable to foreign residents, and notified the IRS of such a position on a Form 8833 attached to a timely filed income tax return.
If you were already an LTR at the time you commence to be treated as a resident of such foreign treaty country, then you will be treated as having expatriated as of that date.
Date of Termination of Long-Term Residency
If you were a U.S. long-term resident (LTR), you terminated your lawful permanent residency on the earliest of the following dates.
– The date you voluntarily abandoned your lawful permanent resident status by filing Department of Homeland Security Form I-407 with a U.S. consular or immigration officer.
– The date you became subject to a final administrative order that you abandoned your lawful permanent resident status (or, if such order has been appealed, the date of a final judicial order issued in connection with such administrative order).
– The date you became subject to a final administrative or judicial order for your removal from the United States under the Immigration and Nationality Act.
– If you were a dual resident of the United States and a country with which the United States has an income tax treaty, the date you commenced to be treated as a resident of that country and you determined that, for purposes of the treaty, you are a resident of the treaty country and gave notice to the Secretary of such treatment on a Form 8833 attached to a timely filed income tax return. See Regulations section 301.7701(b)-7 for information on other filing requirements if you are such an individual.
Date of Expatriation
Date of Tax Expatriation For purposes of filling out Part I, the date of your expatriation is the later of the date you notified the relevant agency of your expatriating act or the date Form 8854 was first filed in accordance with these instructions. Apply the rules of section 7502 to determine the date on which this form is filed. Generally, the postmark date is the filing date
Will I Be Taxed Under IRC Section 877
There are three main situations which may result in Exit Tax Liability:
You are subject to taxation under section 877 if, within the 10-year period immediately preceding 2017, you lost your U.S. citizenship or you were an LTR who ceased to be a lawful permanent resident and any one of the following applies to you:
– Your average annual net income tax liability for the 5 tax years ending before the date of your expatriation is more than the amount listed by the IRS for the respective year:
- $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
Your net worth is $2 million or more on the date of your expatriation.
You fail to certify on Form 8854 that you have complied with all of your federal tax obligations for the 5 tax years preceding the date of your expatriation.
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.
You can qualify for the exception described above if you meet both of the following requirements:
– You expatriated before you were 18
– 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.
Exit Taxation under Section 877A – A Summary
The following is provided in the instructions of Form 8854, but we will provide an additional summary for you to provide a bit of clarity:
How is the Tax Calculated?
If you are a covered expatriate in the year you expatriate, you are subject to income tax on the net unrealized gain in your property as if the property had been sold for its fair market value on the day before your expatriation date (“mark-to-market tax”).
Does It Apply to All Property?
No. This applies to most types of property interests you held on the date of your expatriation. But see Exceptions, later.
Gains vs. Losses
The IRS will try to tax you on all Gain, while limiting your losses. As provided by the IRS: Gains from deemed sales are taken into account without regard to other U.S. internal revenue laws. Losses from deemed sales are taken into account to the extent otherwise allowed under U.S. internal revenue laws. However, section 1091 (relating to the disallowance of losses on wash sales of stock and securities) doesn’t apply.
Current Year (2017)
For 2017, the net gain that you otherwise must include in your income is reduced (but not below zero) by $699,000.
The Mark-to-Market tax does not apply to the following
- Eligible deferred compensation items.
- Ineligible deferred compensation items.
- Specified tax deferred accounts.
- Interests in nongrantor trusts.
Deferral of the Payment of Mark-to-Market Tax
You can make an irrevocable election to defer the payment of the mark-to-market tax imposed on the deemed sale of property.
If you make this election, the following rules apply:
- You make the election on a property-by-property basis.
- The deferred tax on a particular property is due on the return for the tax year in which you dispose of the property.
- Interest is charged for the period the tax is deferred.
- The due date for the payment of the deferred tax cannot be extended beyond certain dates.
If you are considering expatriation, and you’re either a US citizen or Long-Term Permanent Resident, that it is important to understand the exit tax implications.
Just as important, is that because the submission of form 8854 typically ignites a more in-depth review of your prior tax history and filings, it is important that you are in compliance prior to submitting the form.
Oftentimes, we will prepare both in offshore compliance package along with a form 8854 to make sure you are in compliance at the time you are expatriating.
What Is IRS Offshore Disclosure?
IRS Voluntary Disclosure of Foreign or Offshore Accounts is a legal method for getting into IRS Tax and Reporting compliance before the IRS finds you first. At Golding & Golding, we limit our entire tax law practice to IRS Offshore Voluntary Disclosure.
Why IRS Voluntary Disclosure?
With the introduction and enforcement of FATCA (Foreign Account Tax Compliance Act) and FATCA penalties, coupled by the renewed interest in the IRS issuing FBAR (Report of Foreign Bank and Financial Account Form aka FinCEN 114) penalties — which are both very steep – it is typically a better strategy to be proactive and get into compliance, than to play “defense.”
FBAR penalties alone can reach ~$12,500 per account, per year (adjusted inflation from $10,000). While this is the maximum penalty, the “recommended penalty” is still $12,500 per year (usually 3-6 years).
4 Types of IRS Offshore Voluntary Disclosure Programs
There are typically four types of IRS Offshore Voluntary Disclosure programs, and they include:
- Offshore Voluntary Disclosure Program (OVDP)
- Streamlined Domestic Offshore Procedures (SDOP)
- Streamlined Foreign Offshore Procedures (SFOP)
- Reasonable Cause (RC)
IRS Voluntary Disclosure of Offshore Accounts
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
When Do I Need to Use Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that for one or more years, you were required to file a U.S. tax return, FBAR or other International Informational Return and you did not do so timely, then you are out of compliance.
Common Un-filed IRS International Tax Forms
Common un-filed international tax forms, include:
- 1040 (Tax Returns)
- Schedule B (Ownership or Signature Authority over Foreign Accounts)
- FBAR (FinCEN 114)
- FATCA (Form 8938)
- Form 3520 (Gift from Foreign Person)
- Form 5471 (Foreign Corporations)
- Form 8621 (Foreign Investments, aka PFIC)
- Form 8865 (Foreign Partnership)
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to IRS Offshore Voluntary Disclosure.
Golding & Golding – Offshore Disclosure
At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.
In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.”
It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.
The Devil is in the Details…
If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.
It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.
Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.
What if You Never Report the Money?
If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported — then you are in a bit of a predicament, which you will need to resolve before it is too late.
As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.
Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).
Getting into Compliance
There are five main methods people/businesses use to get into compliance. Four of these methods are perfectly legitimate as long as you meet the requirements for the particular mechanism of disclosure. The fifth alternative, which is called a Quiet Disclosure a.k.a. Silent Disclosure a.k.a. Soft Disclosure, is ill-advised as it is illegal and very well may result in criminal prosecution.
5 IRS Methods for Offshore Compliance
- Streamlined Domestic Offshore Procedures
- Streamlined Foreign Offshore Procedures
- Reasonable Cause
- Quiet Disclosure (Illegal)
We are going to provide a brief summary of each program below. We have also included links to the specific programs. If you are interested, we have also prepared very popular “FAQs from the Trenches” for FBAR, OVDP and Streamlined Disclosure reporting. Unlike the technical jargon of the IRS FAQs, our FAQs are based on the hundreds of different types of issues we have handled over the many years that we have been practicing international tax law and offshore disclosure in particular.
After reading this webpage, we hope you develop a basic understanding of each offshore disclosure alternative and how it may benefit you to get into compliance. We do not recommend attempting to disclose the information yourself as you may become subject to an IRS investigation insofar as you will have to answer questions directly to the IRS, which you can avoid with an attorney representative.
If you retain an attorney, then you will get the benefit of the attorney-client privilege which provides confidentiality between you and your representative. With a CPA, there is a relatively small privilege which does provide some comfort, but the privilege is nowhere near as strong as the confidentiality privilege you enjoy with an attorney.
Since you will be dealing with the Internal Revenue Service and they are not known to play nice or fair – it is in your best interest to obtain an experienced Offshore Disclosure Attorney.
OVDP is the Offshore Voluntary Disclosure Program — a program designed to facilitate taxpayer compliance with IRS, DOT, and DOJ International Tax Reporting and Compliance. It is generally reserved for individuals and businesses who were “Willful” (aka intentional) in their failure to comply with U.S. Government Laws and Regulations.
The Offshore Voluntary Disclosure Program is open to any US taxpayer who has offshore and foreign accounts and has not reported the financial information to the Internal Revenue Service (restrictions apply). There are some basic program requirements, with the main one being that the person/business who is applying under this amnesty program is not currently under IRS examination.
The reason is simple: OVDP is a voluntary program and if you are only entering because you are already under IRS examination, then technically, you are not voluntarily entering the program – rather, you are doing so under duress.
Any account that would have to be included on either the FBAR or 8938 form as well as additional income generating assets such as rental properties are accounts that qualify under OVDP. It should be noted that the requirements are different for the modified streamlined program, in which the taxpayer penalties are limited to only assets that are actually listed on either an FBAR or 8938 form; thus the value of a rental property would not be calculated into the penalty amount in a streamlined application, but it would be applicable in an OVDP submission.
An OVDP submission involves the failure of a taxpayer(s) to report foreign and overseas accounts such as: Foreign Bank Accounts, Foreign Financial Accounts, Foreign Retirement Accounts, Foreign Trading Accounts, Foreign Insurance, and Foreign Income, including 8938s, FBAR, Schedule B, 5741, 3520, and more.
What is Included in the Full OVDP Submission?
The full OVDP application includes:
- Eight (8) years of Amended Tax Return filings;
- Eight (8) Years of FBAR (Foreign Bank and Account Reporting Statements);
- Penalty Computation Worksheet; and
- Various OVDP specific documents in support of the application.
Under this program, the Internal Revenue Service wants to know all of the income that was generated under these accounts that were not properly reported previously. The way the taxpayer accomplishes this is by amending tax returns for eight years.
Generally, if the taxpayer has not previously reported his accounts, then there are common forms which were probably excluded from the prior year’s tax returns and include 8938 Forms, Schedule B forms, 3520 Forms, 5471 Forms, 8621 Forms, as well as proof of filing of FBARs (Foreign Bank and Financial Account Reports).
The taxpayer is required to pay the outstanding tax liability for the eight years within the disclosure period – as well as payment of interest along with another 20% penalty on that amount (for nonpayment of tax). To give you an example, let’s pick one tax year during the compliance period. If the taxpayer owed $20,000 in taxes for year 2014, then they would also have to include in the check the amount of $4,000 to cover the 20% penalty, as well as estimated interest (which is generally averaged at about 3% per year). This must be done for each year during the compliance period.
Then there is the “FBAR/8938” Penalty. The Penalty is 27.5% (or 50% if any of the foreign accounts are held at an IRS “Bad Bank”) on the highest year’s “annual aggregate total” of unreported accounts (accounts which were previously reported are not calculated into the penalty amount).
For OVDP, the annual aggregate total is determined by adding the “maximum value” of each unreported account for each year, in each of the last 8 years. To determine what the maximum value is, the taxpayer will add up the highest balances of all of their accounts for each year. In other words, for each tax year within the compliance period, the application will locate the highest balance for each account for each year, and total up the values to determine the maximum value for each year.
Thereafter, the OVDP applicant selects the highest year’s value, and multiplies it by either 27.5%, or possibly 50% if any of the money was being held in what the IRS considers to be one of the “bad banks.” When a person is completing the penalty portion of the application, the two most important things are to breathe and remember that by entering the program, the applicant is seeking to avoid criminal prosecution!
2. Streamlined Domestic Offshore Disclosure
The Streamlined Domestic Offshore Disclosure Program is a highly cost-effective method of quickly getting you into IRS (Internal Revenue Service) or DOT (Department of Treasury) compliance.
What am I supposed to Report?
There are three main reporting aspects: (1) foreign account(s), (2) certain specified assets, and (3) foreign money. While the IRS or DOJ will most likely not be kicking in your door and arresting you on the spot for failing to report, there are significantly high penalties associated with failing to comply.
In fact, the US government has the right to penalize you upwards of $10,000 per unreported account, per year for a six-year period if you are non-willful. If you are determined to be willful, the penalties can reach 100% value of the foreign accounts, including many other fines and penalties… not the least being a criminal investigation.
Reporting Specified Foreign Assets – FATCA Form 8938
Not all foreign assets must be reported. With that said, a majority of assets do have to be reported on a form 8938. For example, if you have ownership of a foreign business interest or investment such as a limited liability share of a foreign corporation, it may not need to be reported on the FBAR but may need to be disclosed on an 8938.
The reason why you may get caught in the middle of whether it must be filed or not is due largely to the reporting thresholds of the 8938. For example, while the threshold requirements for the FBAR is when the foreign accounts exceed $10,000 in annual aggregate total – and is not impacted by marital status and country of residence – the same is not true of the 8938.
The threshold requirements for filing the 8938 will depend on whether you are married filing jointly or married filing separate/single, or whether you are considered a US resident or foreign resident.
Other Forms – Foreign Business
While the FBAR and Form 8938 are the two most common forms, please keep in mind that there are many other forms that may need to be filed based on your specific facts and circumstances. For example:
- If you are the Beneficiary of a foreign trust or receive a foreign gift, you may have to file Form 3520.
- If you are the Owner of a foreign trust, you will also have to file Form 3520-A.
- If you have certain Ownerships of a foreign corporation, you have to file Form 5471.
- And (regrettably) if you fall into the unfortunate category of owning foreign mutual funds or any other Passive Foreign Investment Companies then you will have to file Form 8621 and possibly be subject to significant tax liabilities in accordance with excess distributions.
Reporting Foreign Income
If you are considered a US tax resident (which normally means you are a US citizen, Legal Permanent Resident/Green-Card Holder or Foreign National subject to US tax under the substantial presence test), then you will be taxed on your worldwide Income.
It does not matter if you earned the money in a foreign country or if it is the type of income that is not taxed in the country of origin such as interest income in Asian countries. The fact of the matter is you are required to report this information on your US tax return and pay any differential in tax that might be due.
In other words, if you earn $100,000 USD in Japan and paid 25% tax ($25,000) in Japan, you would receive a $25,000 tax credit against your foreign earnings. Thus, if your US tax liability is less than $25,000, then you will receive a carryover to use in future years against foreign income (you do not get a refund and it cannot be used against US income). If you have to pay the exact same in the United States as you did in Japan, it would equal itself out. If you would owe more money in the United States than you paid in Japan on the earnings (a.k.a. you are in a higher tax bracket), then you have to pay the difference to the U.S. Government.
3. Streamlined Foreign Offshore Disclosure
What do you do if you reside outside of the United States and recently learned that you’re out of US tax compliance, have no idea what FATCA or FBAR means, and are under the misimpression that you are going to be arrested and hauled off to jail due to irresponsible blogging by inexperienced attorneys and accountants?
If you live overseas and qualify as a foreign resident (reside outside of the United States for at least 330 days in any one of the last three tax years or do not meet the Substantial Presence Test), you may be in for a pleasant surprise.
Even though you may be completely out of US tax and reporting compliance, you may qualify for a penalty waiver and ALL of your disclosure penalties would be waived. Thus, all you will have to do besides reporting and disclosing the information is pay any outstanding tax liability and interest, if any is due. (Your foreign tax credit may offset any US taxes and you may end up with zero penalty and zero tax liability.)
*Under the Streamlined Foreign, you also have to amend or file 3 years of tax returns (and 8938s if applicable) as well as 6 years of FBAR statements just as in the Streamlined Domestic program.
4. Reasonable Cause
Reasonable Cause is different than the above referenced programs. Reasonable Cause is not a “program.” Rather, it is an alternative to traditional Offshore Voluntary Disclosure, which should be considered on a case by case basis, taking the specific facts and circumstances into consideration.
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