On December 17, 2019 Gary Carter published a post on Tax Connections, which outlined the “Options Available For U.S. Taxpayers With Undisclosed Foreign Financial Assets“. It contained an excellent overview and analysis which included a discussion of the IRS definition of “non-willfulness” under the Streamlined Program. In commenting on the definiton of “non-willful” he noted that:
The IRS definition of non-willful covers a lot of territory. Negligence, for example, includes “any failure to make a reasonable attempt to comply with the provisions of the Code” (IRC Sec. 6662(c)) or “to exercise ordinary and reasonable care in the preparation of a tax return” (Reg. Sec. 1.6662-3(b)(1)). Further, “negligence is a lack of due care in failing to do what a reasonable and ordinarily prudent person would have done under the particular circumstances.” (Kelly, Paul J., (1970) TC Memo 1970-250). The court also stated that a person may be guilty of negligence even though he is not guilty of bad faith. So the fact that you ignored the FBAR filing requirements for many years, and failed to report your foreign income, might be negligent behavior, but it’s probably not willful. That means you likely qualify for one of the new streamlined procedures. On the other hand, if you loaded piles of cash into a suitcase and lugged it over to Switzerland to conceal it from the IRS, you don’t qualify, because that is willful conduct. If you believe your behavior may have been willful under these guidelines, consult with an attorney before submitting returns through one of the streamlined procedures. We work with attorneys who are experts in this field and we would be happy to provide a referral, free of charge or obligation.
Notably, the definition of “non-willfulness” for the Streamlined Program is the same as the definition for the new “IRS Relief For Former Citizens Program”.
Part A – IRS Relief For Former Citizens Who Relinquished U.S. Citizenship After March 18, 2010 (the date FATCA became law)
The program was announced on September 6, 2019.
Note that this program can be used both prospectively (thinking of renouncing?) and retrospectively (I already have renounced but have not met the tax filing obligations). The date of relinquishment must be after March 18, 2010. This means that the program would NOT be available to individuals who received a “back dated CLN” indicating a relinquishment date prior to March 18, 2010. The relinquishment date is found in Paragraph 14 of Form DS-4083 (Certificate Of Loss Of Nationality).
Note the following from FAQ 11 indicating that the individual must include DS-4083:
Certificate of Loss of Nationality (CLN) of the United States, Form DS-4083, or copy of court order cancelling a naturalized citizen’s certificate of naturalization (described in IRC 877A(g)(4)(D)). If you supply Form DS-4083, the date in the field “That: he/she thereby expatriated __self on (Date) ______ under the provisions of Section…” must be after March 18, 2010. The CLN must be stamped “Approved” by the Department of State.
Inside The “Relief For Former Citizens Program”
The purpose of this post is explore the the newest compliance option for a narrowly targeted group of former (at the time of filing) U.S. citizens. On September 6, 2019 the IRS announced these relief procedures and I commented on them here. It is likely that these procedures were designed as a political reaction to pressure from European banks.
The program allows former U.S. citizens who expatriated after March 18, 2019, who are “non-willful” (same definition of “non-willful” as is used under “Streamlined”) and either:
– have never filed a U.S. 1040 Tax Return; or
– filed 1040s in the five years preceding the year of expatriation but who failed to file Form 8854 for the year of expatriation
to meet their tax obligations and avoid “covered expatriate” status.
Assuming the additional eligibility requirements have been met, those participating in the program will not be “Covered Expatriates”. The conditions for eligibility (as they continue to evolve) are described by the IRS here. A video (along with a transcript) describing the program is available here. (The video makes it clear that some form of Relief is also coming for former Green Card holders.)*
In a nutshell, it appears that Individuals (the program is available ONLY to individuals) who:
1. Have NEVER filed a 1040 U.S. tax return (See FAQs Questions 2 and 3) or filed five years prior to the year of expatriation but failed to file Form 8854 (See FAQs Questions 24 and 25)
2. Relinquished/renounced U.S. citizenship after March 18, 2010
3. File the five tax years in the year prior to relinquishment
4. File a tax return in the year of relinquishment
5. Have a net worth of less than 2 million USD at the time of relinquishment AND at the time of filing**
6. Have a total of less than $25,000.00 in U.S. tax liabilities over the six year period
7. Have an average U.S. tax liability of less than approximately 165,000 USD for the five preceding years**
8. Know that their failure to file was non-willful (note that a specific statement of “non-willfulness” is not required as part of the submission).
can file, avoid paying the U.S. taxes owed and NOT be a covered expatriate.
This is of value for a limited (but probably numerically large) group of people. The benefits appear to be:
1. Forgiveness of tax up to $25,000.00
2. The opportunity to exit the U.S. tax system cleanly and avoid covered expatriate status.
This is likely to upset those who previously went to the trouble of coming into compliance to expatriate.
Part B – What Can Be Learned About The Eligibility Criteria From The Hypotheticals In The IRS FAQ Question 9?
Foreign Mutual Funds AKA PFICs
Hypothetical 1 is very interesting and enlightening. Notably the IRS confirms its view that the non-U.S. mutual funds are PFICs, that they criteria in Form 8621 apply and that Form 8621 should be filed. The hypothetical includes:
Hypothetical 1 (Aggregate Total Income Tax Liability Below Threshold)
John was born in the U.S. while his non-U.S. parents were attending university for post-graduate studies. Shortly after he was born, the family returned to Country E. John is a citizen of Country E and lives and works in Country E.
John renounced his citizenship on October 1, 2019 and received a Certificate of Loss of Nationality. John has never filed a U.S. income tax return and never applied for or received a Social Security Number. He wants to use these procedures to come into compliance with his U.S. tax obligations. He must report his worldwide income on Form 1040 for 2019 and the preceding five tax years (and may claim all available deductions and credits, including foreign tax credits, to the extent permitted) to determine the total tax. In each year, John had various sources of income, including small amounts of income from foreign mutual funds that are passive foreign investment companies. For tax years 2014 through 2019, John submits the following tax returns required under these procedures:
2019 Form 1040NR (with Form 1040 attached as an information return reporting worldwide income through October 1, 2019), with a total tax of $1,000.00 USD
2018 Form 1040, line 15, total tax $4,800.00
2017 Form 1040, line 63, total tax $4,800.00
2016 Form 1040, line 63, total tax $4,800.00
2015 Form 1040, line 63, total tax $4,800.00
2014 Form 1040, line 63, total tax $4,800.00
John uses his best efforts in computing his total tax for each year. John computed the income from his foreign mutual funds and reported them as ordinary income on the “other income” line of his Forms 1040. He should have also used Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, to make additional computations, but he failed to include that form with his return. John adds the “total tax” amounts for all his six tax returns submitted under the procedures; the amount is $25,000. John’s total tax liabilities are within the limit for these procedures. John is eligible to use these procedures.
This hypothetical reinforces that the procedures are available to individuals without U.S. Social Security numbers. In addition, it suggests that the income from Foreign Mutual Funds can simply be reported as ordinary income without worrying about Form 8621. This makes the program much more user friendly and less expensive for individuals. This interpretation was confirmed in the October 10, 2019 IRS video where the transcript includes:
Now, here’s an important point. It was stated in the Hypothetical. John uses his best efforts in computing his total tax for each year. John computed the income from his foreign mutual funds and reported them as ordinary income on the other income line of his Forms 1040. Anybody that’s familiar with foreign mutual funds knows that they’re treated as special categories of investments. John should have used a Form 8621. The title of that form is Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund. We often refer to these as PFICs. So, John should have reported his PFIC on a Form 8621 with some special computation, but he didn’t. He tried his very best. He knew it was a special category of income and he reported it as other income. Now, implicit in this Hypothetical is that John explained what he did in his submission, so that the IRS could understand that he used his best efforts.
Think of it! An invitation to file without treating foreign mutual funds as PFICs!
The Determination of the $25,000 USD Tax Liability – So Much Depends On The Tax System Of The Country Of Residence
Hypothetical 6, 7, 8 and 9 illustrate how the U.S. tax liability is determined in different situations. The bottom line is that (using any available method) the U.S. tax owed must be no more than $25,000 in total for the six years in question. The hypotheticals provide examples considering both foreign tax credits and the Foreign Earned Income Exclusion. They should be carefully considered by anybody considering using the program.
Relief Procedures For Former Citizens vs. Streamlined
As always, it’s important to get competent advice. That said, (assuming you qualify) the “IRS Relief For Former Citizens” program offers the following advantages over Streamlined:
– no Social Security Number is required
– easier treatment of foreign mutual funds
– forgiveness of up to $25,000 USD in taxes
– no specific statement of non-willfulness is required
– strictly speaking there is no FBAR requirement (but filing the FBARs (for six years) at the same time is probably advisable)
The IRS description of the program as it continues to evolve is here https://www.irs.gov/individuals/international-taxpayers/relief-procedures-for-certain-former-citizens.
In closing …
The new “Relief Procedures For Former Citizens” is a program that should encourage renunciation and a clean break from the United States from both a tax and nationality perspective. The IRS states very clearly that one can renounce U.S. citizenship without being tax compliant. Many people do so. But, for many Accidental Americans (and others) this is a very easy way to “check out” of the U.S. tax system as well. To put it simply: The “Relief Procedures For Former Citizens” programs makes terminating your relationship with the United States much easier!
* The extension of the program to Green Card holders was recently discussed by Virginia La Torre Jeker.
** This mirrors the general requirements to avoid Covered Expatriate Status
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