Update to Tax Laws Regarding Expatriation: Comply or Be Penalized!

C&G Review
Fall 2005

In the American Jobs Creation Act of 2004, Congress substantially amended Section 877 of the Internal Revenue Code, making the application of the expatriation tax system far more onerous for long-term residents who surrender their green cards after June 3, 2004. Specifically, green card holders residing in the United States for 8 out of the 15 years preceding expatriation ("long-term residents") who meet certain income and net worth criteria are subject to the expatriation tax system set forth in Section 877. Once subject to the expatriation tax system, expatriates are required to pay tax in the United States, at the graduated income tax rates for individuals, on an expanded class of U.S. source income during the 10-year period following expatriation. Further, the expatriation tax system would cause expatriates to be subject to U.S. estate and gift taxes on transfers of taxable estates and gifts of intangible property made during the 10-year period following expatriation (which would otherwise be nontaxable to a nonresident of the United States).

Income and Net Worth Criteria

Departing long-term residents will automatically be subject to the expatriation tax system if the expatriate: (i) has an average U.S. tax liability for the prior five years of $124,000; (ii) has a net worth of $2 million or more on the date of expatriation; or (iii) does not certify to the IRS under penalty of perjury that he or she has complied with applicable U.S. tax law for the previous five years.

Expatriates Present in U.S. 30 Days or More Taxed as a U.S. Resident

An expatriate who is physically present in the United States for 30 days or more in any tax year during the 10-year period following expatriation will be subject to full U.S. taxation on worldwide income for such year as though he or she were a U.S. citizen or resident alien. This amendment applies (with very limited exceptions) regardless of the expatriate's reason for returning to the United States.

Required Compliance: Notice of Expatriation and Annual Reporting Information

The legislation also requires all long-term residents who surrender their green cards both to notify either the Secretary of State or the Secretary of Homeland Security of the individual's intention to expatriate and to file an information statement listing the expatriate's assets, liabilities and income. This information return is required of all expatriates, whether or not he or she will be subject to the expatriation tax system. If an expatriate fails to provide the necessary information statement, the expatriate will be treated for U.S. federal income tax purposes as though he or she did not expatriate, and, as such, will be subject to U.S. federal income tax on his or her worldwide income until the notification and information return are filed.

The new tax legislation also requires expatriates who are subject to the expatriation tax system to file a tax return (along with an information statement) with the Internal Revenue Service (“IRS”) each year of the 10-year period that such expatriate is subject to the expatriation tax system. The expatriate is required to file this return even in years when the expatriate does not have U.S. source income subject to tax under the expatriation tax system.

Newly revised IRS Form 8854, Initial and Annual Expatriation Information Statement, functions as both the initial expatriation and the annual expatriation information statement. Form 8854 also addresses how expatriates should certify that they have met their federal tax obligations for the five preceding taxable years and what constitutes notification to the Secretary of State or the Secretary of Homeland Security. This form is effective for individuals who terminate long-term resident status after June 3, 2004, and it must be filed in order for termination of residency to be effective for tax purposes.

Failure to comply with the filing of Form 8854 will not only result in a $10,000 penalty but will also cause an expatriate to be subject to U.S. income tax as a resident alien, i.e. on his or her worldwide income. Penalty for non-compliance can be substantial. Be sure to take these possible tax requirements and into consideration when planning residency and travel.

For more information, please contact hnevin@cohenlaw.com, dnaccarato@cohenlaw.com or tcrombie@cohenlaw.com