If you're a U.S. citizen or long-term permanent resident ("green card" holder), you have a unique responsibility: you must pay tax on your worldwide income, even if you live outside the United States. Not to mention capital gains tax, gift tax, and estate tax.
Numerous additional obligations come with U.S. citizenship or permanent resident status. For instance, you must make detailed disclosures of your non-U.S. investments annually to the IRS and U.S. Treasury. The Treasury may share the information it collects with almost any U.S. or foreign government or police agency.
You face additional tax pitfalls with reference to your non-U.S. investments and business activities. U.S. tax provisions for interests in non-U.S.-registered mutual funds, controlling interests in non-U.S. corporations, and interests in non-U.S. trusts are but three examples of the many “tax landmines” that U.S. taxpayers may inadvertently detonate.
A rapidly growing number of U.S. citizens and permanent residents have fought back the only way they legally can—by giving up their green card, or their U.S. citizenship and passport. In 2011, IRS records show that at least 1,788 people went through this process of "expatriation." That's almost eight times more than the number of people who expatriated in 2008, and more than the total for 2007, 2008 and 2009 combined.
However, a much larger number of non-resident U.S. citizens and green card holders aren't even aware of their ongoing obligation to comply with U.S. tax and reporting requirements. An estimated seven million U.S. citizens live outside the United States, yet only a few hundred thousand of them file U.S. tax returns. One reason for this widespread ignorance is that it's relatively easy to be born a U.S. citizen. For instance, you're a U.S. citizen if you were born within the geographic boundaries of the United States, even if your parents were not U.S. citizens at the time. In most cases, you’re also a U.S. citizen if you were born outside the United States, and at least one parent was a U.S. citizen or green card holder.
Starting around 2008, the IRS began to enforce these rules much more vigorously, especially with respect to non-resident U.S. citizens. For instance, in Panama, armed IRS agents now roam the countryside looking for non-compliant U.S. taxpayers living or doing business there. In Austria, I recently learned of the IRS calling a U.S. citizen's unregistered phone number to remind her of her tax and reporting obligations.
Want to Become Compliant? Get Ready to Write a Big Check
Here's how it worked in one case related to me. A Mexican citizen, now well past retirement age, grew up in a tiny town in Mexico near the U.S. border. At the time of his birth, the town lacked any medical facilities, so when his mother went into labor, his parents drove to the nearest hospital, which happened to be just inside the U.S. border.
Fast forward 70 or so years, and this gentleman was longing for some relief from hot Mexican summers. So, he did what countless other wealthy Mexicans have done—he purchased a condo in San Diego. At closing, he encountered a strange anomaly. The closing documents listed him as a U.S. citizen. He tried to correct what he believed to be a mistake, but the broker assured him the documents were correct. Since he was born in the United States, he was indeed a U.S. citizen.
Our hero thought that was the end of it, but when he arrived in San Diego for the summer, he received a notice from the Internal Revenue Service. The notice informed him that he was obligated to file U.S. tax returns. And there was no record of him filing a U.S. tax return for the preceding three years. The notice invited him to respond immediately.
A few days later, he drove over to the local IRS office to see if he could resolve the situation. After a brief conversation, he was shocked to learn that the IRS had already commenced an examination. The agent started using terms such as “willful failure to file,” “criminal penalties,” and “jeopardy assessment.”
At this point, our hero hired a criminal tax defense attorney. He spent about $100,000 in legal fees, and eventually received a notice from the IRS informing him that he wouldn't face criminal penalties. Still, he had to pay 25% of the peak value of his unreported non-U.S. accounts for the period 2003-2010. Unfortunately for him, the value of these accounts fell about 35% in the global economic turmoil of 2008-2009. The accounts that were once worth $2 million are now worth about $1.3 million. Nonetheless, he paid a $500,000 penalty to avoid criminal prosecution.
In addition, he had to file six years of past due tax returns and information returns disclosing his interests in Mexican corporations and other Mexican entities. These returns had to be prepared according to U.S. Generally Accepted Accounting Procedures (GAAP), which means that the Mexican financial statements for each year had to be converted to U.S. GAAP. That expense cost him an additional $50,000.
To tally things up: our hero’s total cost of accidental U.S. citizenship: $650,000. Total benefit of U.S. citizenship: none.
Needless to say, this Mexican gentleman filed a formal petition with the State Department to surrender his U.S. citizenship and expatriate. That eliminates any future U.S. tax or reporting obligations on non-U.S. income or property, but doesn’t affect his past obligations.
Americans Now Locked Out of Non-U.S. Investments
At the same time, it has become much more difficult for anyone with even the most remote connection to the United States to invest or do business offshore. Recently, I met with a U.S. citizen who is also a citizen of another country. He and his wife plan to move back to that country to retire.
On his last visit to that country, he tried to open a bank account. To his surprise—and horror—the first document the banker gave him was a 10-question survey asking him to disclose all connections to the United States. Even a single "yes" answer could disqualify the applicant from opening an account. Indeed, citizens of this country who have never traveled to the United States must now complete this form when opening an account at this bank. Dozens of other clients have reported similar difficulties.
For all these reasons, I think the 1,788 expatriations the IRS reported in 2011 is only the beginning of a much larger trend. Indeed, I'm surprised the number isn't 10 times or even 100 times larger.
The Many Benefits of Expatriation
Expatriation is a major decision. It requires that you have a satisfactory passport and citizenship from another country. It also means that you no longer have the automatic right to live and work in the United States. Even for brief visits, you’ll need to obtain a visa, unless your non-U.S. passport qualifies you for visa-free entry.
The payoff, however, is immense. Once you expatriate, you no longer have any obligation to pay tax on your non-U.S. income, nor file any reporting forms to the IRS or U.S. Treasury with respect to your non-U.S. investments. You also eliminate all the offshore investment restrictions now imposed on U.S. citizens or green card holders. Plus, you'll no longer be expected to adhere to the numerous embargoes the United States has declared against its self-declared enemies (e.g., Cuba).
Our firm has helped dozens of U.S. citizens and green card holders permanently and legally eliminate future U.S. tax and reporting obligations through the process of expatriation. We can even help you obtain a second passport, if you don’t have one already. Contact us today for a consultation.
Copyright © 2012 by Mark Nestmann