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What is a covered exptatriate? Why is it so bad?

by: Anthony Parent   2019-09-23

The IRS announced a new program "Relief Procedures for Certain Former Citizens" to help those who have expatriated incorrectly and are worried about being deemed a "covered expatriate." So before you convince yourself you need this program, it may be a good idea to know a covered expat is and what happened is you don't take any action, right?

 

 

So what makes someone a covered exptriate?

 

This perhaps an over-simplification, but it is really helpful think about it this way.   If you relinquish your US citizenship or are long-term US resident (Green Card holder) who ceases to be a lawful permanent resident in a way - by default -  you are covered expatriate.

 

So think of it that way - if you relinquish your citizenship and don't file anything with the IRS, you could really be deemed a covered expatriate, however likely or unlikely, by default.

 

So why is it bad to be a covered expatriate?

 

If you are a covered expatriate, you are subject to the exit tax. The exit tax sort of works like the federal estate tax. The concern Congress had is that prior to death, US persons subject to the estate or death tax as it has been referred to, could easily avoid it merely by expatriating - that is giving up citizenship - before death.

 

So Congress  created the exit tax, in large part, as a way to frustrate taxpayers from circumventing the estate tax.

 

So the thing is the federal estate tax only starts to apply when you have a lot of assets so too, does the exit tax. The difference is that the asset test for expatriating is lower around $2 million compared to the estate exemption which is something you don’t need to worry about until your assets go over $5 million. And also with the exit tax there is an income test as well. The point is that for many middle class Americans who are covered expatriates, this means nothing to them, as even if the tax were applied to them, they would owe nothing. 

 

Rather, the biggest downside for most people is that as covered expatriate, the law could still treat them as a US person for tax purposes - years after they gave up their US citizenship. That’s right - just because they are no longer a US citizen, it does not mean the IRS feels the same way.

 

So the problem is that the government - at some point - could try to claim you still owe taxes and subject you to the horrific penalty regimes of the FBAR and foreign account tax compliance act or FATCA - well after your ceased to be a US person. So for many people the real reason they don’t want to be a covered expat is because they want finality. They don’t have to wait and guess to see if the IRS is done with them.

 

So now you know what a covered expat is, let’s talk about how not to be one. 

 

  1. Certify a Form 8854. This means you need to be in compliance for the last 5 years. Now before you run off and file the last 5 years - stop right there and get legal advice - you may not actually have to file the last 5 years, and also you may want to use a disclosure program to reduce or eliminate massive penalty exposure.
  2. File and pay the exit tax if it applies.   The assets over a two million and income over around $161,000 could subject you to this. But this does not mean you have to pay. There are certainly ways to plan to avoid this tax bite.  And there are other exceptions. If you were born a dual national, you may not have to pay the exit tax even if you were a billionaire who did no planning. 
  3. And this is what is new - the IRS announced a program in September of 2019 called Relief Procedures for Certain Former Citizens. This is a way for certain kinds of US expats - many so-called accidental Americans - to obtain relief from being deemed a covered expatriate. 

 

 


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