Using a Tax Treaty to Avoid US Exit Tax Takes Proper Planning

Using a Tax Treaty to Avoid US Exit Tax Takes Proper Planning

Using a Tax Treaty to Avoid US Exit Tax

Expatriation is a very complicated aspect of international tax law. There are only a handful of international law firms that are Board-Certified Tax Law Specialists and specialize in this area of international tax — because of the inherent pitfalls and traps for taxpayers who want to formally expatriate from the United States. One common question we receive often (and have written about previously) is the often ill-fated strategy of using tax treaties to avoid expatriation tax through treaty elections. It is very important to note that Taxpayers have to heed caution before taking advice from tax practitioners claiming that they can just go ahead and file a treaty election with Form 8833 to be treated as a foreign resident for a tax year – in order to not fall into the eight out of 15-year Long Term Resident definition. Tax Treaty planning for expatriation has to be set up prior to being in the position of being a long-term resident because filing an 8833 after meeting the definition can inadvertently spark a formal expatriation, when the taxpayer may not have meant to expatriate at that time.

Long-Term Resident for Expatriation

Once upon a time, the exit tax only applied to U.S. citizens. Then, The United States changed the law so that a new category of Covered Expatriates could be included in the mix — and they are referred to as Long-Term Lawful Permanent Residents. To become a Long Term Lawful Permanent Resident, a US Taxpayer must be a green card holder for eight of the last 15 years. But, any year that the Taxpayer makes a treaty election to be treated as a foreign person for US tax purposes does not apply towards that eight-year threshold. Thus, Taxpayers who plan accordingly may be able to avoid becoming Covered Expatriates if they meet the non-resident requirement in conjunction with a specific treaty country. Essentially, it requires the Taxpayers to reside overseas with the foreign country or countries being their main tax home.

What if You Are Already a Long-Term Resident?

It is very very important to note that if you are already a Long-Term Resident because you have met the eight of 15-year requirement, then if you file the treaty election now, that will serve as the expatriating act. In other words, if you file Form 8833 to claim non-resident alien status under a tax treaty and you already met the eight out of 15-year test, then that is considered the expatriating act.

Filing Several Prior Years of Form 8833

Some tax practitioners recommend to their clients to go back and file one or several years of Form 8833s, claiming to have been non-residents for those tax years sufficient to not meet the LTR test. As you can imagine, there are various limitations to being able to do this — not the least being that you will gain the (unwanted) attention of the IRS. And, if they believe you are doing something improper to avoid covered expatriate status and ultimately circumventing the exit tax, this strategy may unfortunately result in you becoming subject to significant fines and penalties.

If you are considering expatriation, you may want to consider speaking with a Board-Certified Tax Law Specialist before making any further filings with the IRS.

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