Proposed Methods to Enhance the Implementation and Enforcement of the Expatriation Tax (Irc § 877A)

by

Proposed Methods to Enhance the Implementation and Enforcement of the Expatriation Tax (IRC § 877A)1

By Helen S. Cheng & Dina Y. Nam2

EXECUTIVE SUMMARY

Section 877A of the Internal Revenue Code of 1986, as amended ("IRC"), sets forth the current expatriation tax regime for U.S. citizens and long-term residents who relinquish their U.S. citizenship or terminate their long-term U.S. residency status. Although individuals choose to expatriate for different reasons, some of which could be construed as tax-motivated, the ultimate purpose of IRC Section 877A (hereinafter referred to as "Section 877A") is to provide an objective system for collecting what is colloquially referred to as an exit tax for those wanting to cut ties with the United States.

The current regime imposes a one-time tax liability on expatriating individuals who meet certain income, asset or reporting requirements. These individuals, who are considered "covered expatriates" under the law, are subject to a mark-to-market tax when they relinquish their citizenship or long-term residency status. In effect, a covered expatriate is treated as having sold all of his or her worldwide assets as of the date of expatriation, and is subject to tax on the deemed gain. Further, any gift or bequest from the covered expatriate to a U.S. person is considered a "covered" gift or bequest, and the U.S. transferee must pay transfer tax on this covered gift or bequest at the highest gift or estate tax marginal rate.

There are major challenges in implementing and enforcing the provisions of Section 877A, as the expatriating individual is required to affirmatively file a Form 8854 and fully disclose worldwide assets. If, however, an expatriating individual does not comply with this requirement, the IRS may not even be informed of the expatriation. Even if it were aware, enforcement is nearly impossible once the expatriate leaves the United States. This paper offers proposals to enhance the implementation and enforcement of Section 877A, including methods for putting individuals on notice of the requirements under Section 877A, coordinating communication between the Department of Treasury, the Department of State and the Department of Homeland Security, and providing for continued jurisdiction over expatriating individuals even after they renounce their U.S. citizenship or terminate their long-term U.S. residency status.

DISCUSSION

I. INTRODUCTION

Section 877A sets forth the current expatriation tax regime for U.S. citizens and long-term residents who plan to expatriate, and essentially applies an exit tax to certain persons deemed to be covered expatriates under the law.

For U.S. tax purposes, an expatriate generally includes U.S citizens who renounce their citizenship and U.S. long-term residents who have terminated their permanent resident status in the United States. An expatriate who is a "covered expatriate" is subject to an exit tax in which all of his or her assets are deemed to have been sold for fair market value as of the date of expatriation. Further, any gift or bequest from the covered expatriate to a U.S. person is considered a "covered" gift or bequest, and the U.S. transferee must pay transfer taxes on this covered gift or bequest at the highest gift or estate tax marginal rate.

A "covered expatriate" is defined as (1) an expatriate who has a 5-year average net income tax liability of more than $124,000, as indexed for inflation ($162,000 as of 2017), (2) an expatriate who has a net worth of $2,000,000 or more at the time of expatriation, or (3), an expatriate who fails to certify under penalty of perjury that he or she has not met the tax or net worth thresholds described above, or who fails to submit such evidence of compliance as the Secretary may require.3 Form 8854 is the required evidence of compliance, and if an individual fails to file this Form 8854, then that person will automatically be considered a covered expatriate, regardless of his or her asset base or net income tax liability.4

Despite multiple attempts over the past decades to apply an income tax on certain expatriating individuals, the implementation and enforcement of an expatriation tax, including the most recent iteration under Section 877A, remains problematic. First, there remain significant communication gaps which create challenges both in providing proper notice to expatriating individuals of the requirements under Section 877A, and in sharing information on expatriating individuals between governmental agencies. Second, under the current Section 877A mark-to-market regime, if an expatriating individual is considered a covered expatriate, either by virtue of the income tax or asset tests or because he or she did not file the Form 8854, it is virtually impossible for the IRS to enforce the exit tax.

[Page 29]

It is the authors’ belief that effective implementation and enforcement of the Section 877A exit tax cannot occur unless and until it is prioritized among government agencies. However, there are small administrative and/or legislative changes that could be implemented to provide incremental change.

II. BRIEF HISTORY OF THE EXPATRIATION TAX

A. Pre-2004 Law

1. Legislative History

The basic infrastructure of the modern U.S. tax regime was created after 1913, after the ratification of the Sixteenth Amendment. The Sixteenth Amendment gave Congress the power to levy and collect taxes on income, from whatever source derived, and paved the way for the United States to subject U.S. citizens to U.S. income tax reporting and liability on their worldwide income regardless of their country of residency. Thus, the only way for a U.S. citizen to avoid being subject to the U.S. income tax regime is to give up his or her U.S. citizenship.

There has been a long history of individuals expatriating to avoid U.S. tax liability, and although the legislature has recognized the right of any individual to leave the United States, it has also long sought to ensure that it is able to collect its fair share of any taxes due by those expatriating individuals. "The Congress does not believe that the Internal Revenue Code should be used to stop U.S. citizens and residents from relinquishing citizenship or terminating residency; however, the Congress also does not believe that the Code should provide a tax incentive for doing so. In other words, to the extent possible, an individual’s decision to relinquish citizenship or terminate residency should be tax neutral."5

The tension brought about by linking U.S. income taxes to citizenship was increased when, in 1966, Congress passed the Foreign Investors Tax Act, in which certain interest payments which were taxable to U.S. citizens became tax-free for nonresident non-U.S. citizens. In that same year, Congress enacted the first iteration of tax rules aimed at expatriating individuals. In this first round of expatriation taxes, U.S. citizens who relinquished their citizenship, and whose "primary motive" was tax avoidance, were subject to special tax rules for the ten-year period following expatriation (referred to as the "alternative tax regime"). In practical terms, however, it was difficult and cumbersome to demonstrate the intent of tax avoidance, and the IRS was often not even aware of the expatriating act. The then Commissioner of the IRS, Margaret Milner Richardson, stated that the alternative tax regime required monitoring an expatriate’s activities for ten years to ensure compliance, but that such monitoring effort was difficult because it "required the cooperation of taxpayers who no longer lived in the United States and who generally are no longer otherwise subject to U.S. law."6

In 1995, the issue again came to the national forefront when a number of wealthy U.S. citizens elected to give up their citizenship in order to avoid the long-arm of the U.S. income tax regime.7 The legislature responded by providing that where any individual had a net worth of at least $500,000 or had an average income tax in the five years prior to expatriation over $100,000, the assumption was that tax avoidance was the principal motivation for expatriation. The new law expanded the definition of expatriating individuals included in the alternative tax regime to certain long-term residents aliens defined as "lawful permanent residents" (otherwise known as green card holders), and also required the IRS to publish a list of ex-citizens in the Federal Register, effectively serving as a form of public shaming for those expatriating individuals.

2. Enforcement Issues

In 2003, the Joint Committee on Taxation issued a comprehensive analysis of the existing expatriation rules ("the 2003 Joint Committee Report"). 8 The 2003 Joint Committee Report stated that several fundamental problems undermined the ability of the IRS to effectively implement the existing expatriation regime, as described below. It concluded by stating that "there is little or no enforcement of the special tax and immigration rules applicable to tax-motivated citizenship relinquishment and residency termination,"9 and that the IRS made "no attempt to monitor and enforce" the alternative tax regime.10

i. Difficulty in Identifying Expatriating Individuals Who Are Potentially Subject to Alternative Tax Regime

An obvious, but critical, first step in enforcing the alternative tax regime was to identify those individuals who relinquish citizenship or long-term residency and thus were possibly subject to the alternative tax regime. The IRS did not independently obtain this information, but rather would rely on the expatriating individuals themselves or other government agencies to supply this information.11 "In many cases, the necessary information was not always being supplied by the former citizen or former long-term resident or requested by the appropriate agencies responsible for providing such information to the IRS." 12

The most common method to identify an expatriating individual is when he or she renounces U.S. citizenship. In such instances, a Certificate of Loss of Nationality ("CLN") is issued to the State Department, which would then forward a copy to the Secretary of the Treasury. 13 According to the IRS, no monitoring or compliance efforts were made with respect to these individuals, perhaps because the information required in the CLN contains little information required to enforce the alterative tax regime, including the social security number of the expatriating individuals.14 Further, not all U.S. citizens obtained a CLN when they relinquished their citizenship.

[Page 30]

Even more, the CLN database was not applicable to long-term residents who were giving up long-term residency status in the U.S. Although the INS did provide information to the IRS identifying whether a permanent resident’s status had been revoked, the IRS did not use the information provided by the INS, which may have been due, in part, to the fact that the information did not distinguish between former long-term residents from other green-card holders and was, therefore, not a useful identification tool.15

ii. Difficulty in Determining Whether Expatriating Act is Tax Motivated

The second step in the enforcement process was to determine whether the expatriating individual was doing so for tax-motivated reasons. Although this determination was primarily based on the monetary thresholds in Section 877, the IRS also permitted certain individuals wishing to avoid such treatment to submit their request via a private letter ruling process to obtain a favorable ruling that their expatriation was not due to tax reasons.

Even then, if the information was provided, the IRS still had to make a factual determination as to whether the primary purpose of the expatriation was tax-avoidance. The IRS’ ruling practice was recognized as subjective and difficult to implement.16 Despite having this process in place, the IRS, did not have any "special procedures in place to further investigate" if the expatriating individual was issued an unfavorable ruling, therefore, giving the private letter ruling process very little enforcement teeth.17

iii. Difficulty in Monitoring, Assessing and Collecting Under the Alternative Tax Regime

Even if an expatriate was determined to be subject to the alternative tax regime, the final step in the alternative tax regime enforcement required continued monitoring of former citizens and long-term residents for a 10-year period following expatriation. Expatriated individuals were required to file a Form 1040NR for each of the ten years following the year of expatriation if tax liability existed. Form 1040NR further required the expatriated individual to include all items of U.S. and foreign sourced gross income. Moreover, the estates of such individuals were also subject to this alternate tax regime if they died within the ten-year monitoring period and were generally required to file Form 706 or 706-NA if they were subject to U.S gift or estate tax.

However, problems continued to abound because the IRS did not have any "special procedures for monitoring former citizens’ or former long-term residents’ tax compliance during the 10-year period."18 The 2003 Joint Committee Report also implicitly recognized that enforcement efforts could be further hindered by a lack of coordination between the IRS and the various governmental departments involved in the immigration process.19

3. 2004 Legislative Change

Congress responded to the 2003 Joint Committee Report by creating an objective rule that any person who met the income or asset test would be subject to the ten-year alternative tax regime. It also tried to bridge the information gap by stating that any individual who renounced citizenship or long-term residency for immigration purposes would continue to be considered a U.S. person until such time as he or she informed the IRS of the expatriating act using Form 8854.

This second provision was intended to provide the IRS with a means for obtaining information on expatriating individuals and provide additional enforcement authority. Regardless of when an individual expatriated with the Secretary of State or Secretary of Homeland Security, he or she would continue to be treated as a U.S. person for tax purposes until he or she notified the IRS. Thus, until a person filed the Form 8854, he or she would still be subject to U.S. tax on worldwide assets. In other words, even if the person was no longer resident in the U.S. and did not file returns, the IRS could still file substitute income tax returns on that person’s behalf and enforce the taxes through liens on any U.S. situs assets.20

III. CURRENT LAW

In 2008, Congress overhauled the alternative tax regime and enacted a new expatriation regime under the Heroes Earnings Assistance and Relief Tax Act of 2008 (the "HEART Act"). The HEART Act created a simple and objective rule for the taxation of certain covered expatriates under the newly created Section 877A.

The Section 877A expatriation tax is applicable to expatriating U.S. citizens and long-term residents.21 Long-term residents include non-U.S. citizens who have been lawful permanent residents for at least eight of the last 15 tax years ending with the taxable year that includes the expatriation date.22 These expatriating individuals will be deemed "covered expatriates" if they meet any of the following criteria:23

  1. The average annual net income tax of such individual for the last five taxable years ending before the date of expatriation is greater than $124,000, as adjusted for inflation ($162,000 for 2017) (the "income tax test");
  2. The net worth of such individual is $2,000,000 or more as of the date of expatriation (the "asset test"); or

[Page 31]

The individual fails to certify under penalty of perjury that he or she has complied with all federal tax obligations for the preceding five taxable years or fails to submit such evidence of compliance as the IRS may require (the "compliance test"). This certification must be made on Form 8854 and must be filed by the due date of the taxpayer’s Federal income tax return for the taxable year that includes the day before the expatriation date.24

Certain individuals are exempted from the income tax test and the asset test, but not from the compliance test. The first exception applies to an individual who was born a dual citizen of the United States and another country, provided that (a) as of the expatriation date the individual continues to be a citizen of the other country and (b) the individual has been a resident of the United States under the substantial presence test for no more than ten of the last 15 taxable years.25 The second exception applies to a U.S. citizen who relinquishes U.S. citizenship before reaching age 18 ½ and has been a resident of the United States under the substantial presence test for no more than ten taxable years before such relinquishment.26

Section 877A effectively implemented what is referred to as a mark-to-market tax on covered expatriates. In other words, covered expatriates are subject to income tax on the net unrealized gain on their worldwide assets as if the assets had been sold for fair market value on the day before the date of expatriation. Any net gain on the deemed sale is generally reduced by $600,000, adjusted for inflation ($699,000 in 2017), to determine the amount that would be includible in the gross income of a covered expatriate.27 The mark-to-market tax applies to most assets, with special rules for deferred compensation items, tax deferred accounts and interests in nongrantor trusts.28

Any gift or bequest from a covered expatriate to a U.S. citizen or resident in excess of the annual exclusion amount ($14,000 for 2017) is considered a "covered" gift or bequest, and the U.S. transferee is subject to transfer tax on this covered gift or bequest at the highest gift or estate tax marginal rate.29

Under Section 877A, the date of expatriation is pegged to the date that the individual relinquished citizenship or long-term residency for immigration purposes, rather than the date that the individual notified the IRS that he or she was expatriating.

On the one hand, these new rules are relatively easy to understand and straightforward. They are objective rules that provide for a one-time mark-to-market tax, resulting in a step-up in basis for the assets. Moreover, this expatriation tax is similar to that which is imposed on the transfer of assets from a U.S. person to a foreign trust under IRC Section 684, and is arguably similar to the estate tax which is imposed on the death of an individual. In turn, the United States gets its fair share of the taxes that it would have received had the covered expatriate continued to be a U.S. person through his or her death.

There are, however, continued problems in implementation and enforcement.

IV. GAPS IN KNOWLEDGE AND COMMUNICATION CREATE INEFFICIENCIES AND CONTINUED ENFORCEMENT ISSUES

A. Lack of Knowledge by Expatriating Individual

One of the primary problems with the practical application of Section 877A is the informational gaps in the reporting process. Pursuant to Section 877A, every expatriating individual is required to file a Form 8854 to avoid becoming a "covered expatriate" even if he or she does not meet the income tax test or the asset test. However, many individuals do not know that they are required to file Form 8854 and simply leave the United States without filing in compliance with the law. For example, Form I-407 (Record of Abandonment of Lawful Permanent Resident Status) and its accompanying instructions do not contain any information or instruction that an individual giving up long-term permanent resident status is required to complete Form 8854. Likewise, Forms DS-4080 and DS-4081 regarding the relinquishment or renunciation of U.S. Citizenship do not contain any explicit statement that the expatriating individual is required to complete Form 8854 in order to avoid being classified as a "covered expatriate" under Section 877A. Similarly, the officials who oversee the expatriation process may not know about or may not inform the expatriate of this requirement. This causes many individuals to automatically become covered expatriates, even though they are well below the income tax or net asset thresholds.

B. Lack of Knowledge by the IRS

If an expatriating individual does not file Form 8854, it may be difficult for the IRS to discover this after physical separation from the U.S. has occurred. Specifically, there are no set methods of communication between the various departments overseeing this process—namely, the Department of State, Department of Homeland Security and the Department of Treasury—to ensure compliance with filing Form 8854. Further, the information that is provided to the IRS may not necessarily be relevant to the application of Section 877A. For example, although the IRS may receive certain information about expatriating permanent residents, it has no automatic process in place to determine whether such individuals are long-term or short-term residents.

[Page 32]

Even more, if an expatriating individual does file Form 8854, the IRS has no ability to ensure the accuracy of the information reported on the form. Generally, the IRS is able to ensure accurate income tax reporting and filing by its citizens and residents by requiring that all U.S. employers and financial institutions issue consistent informational statements to the payee and the IRS, such as a W-2 or 1099. The IRS can then compare these amounts to those that are reported by the payee to ensure that there is consistent and accurate reporting. In this situation, however, there are little to no parallel reporting requirements for expatriating individuals. As such, even if an expatriating individual files Form 8854, there is no way for the IRS to confirm what is stated on the return.

C. The IRS Has Limited Enforcement Remedies Against Individuals Who Have Already Expatriated

Section 877A places an affirmative reporting obligation on the expatriating individual to supply the IRS with Form 8854. This form requests information regarding the expatriating individual’s worldwide assets and income tax liabilities for the last five years. However, if an expatriating individual fails to file Form 8854, thus becoming a covered expatriate, the IRS would have almost no ability to determine the covered expatriate’s assets located outside of the United States. Further, Form 8854 is not due until the individual expatriates from the United States. As such, if the individual does not file Form 8854, it is likely that the IRS will not even learn about the citizenship relinquishment or residency termination until after the individual has physically left the country. Because the expatriating individual has already left the country, it is unclear whether the IRS can effectively claim personal jurisdiction over that individual.

In those instances in which an expatriating individual files a Form 8854, the IRS may want to challenge some of the items on the return, such as the ownership or valuation of one or more of the assets listed. Again, however, because the expatriating individual has already left the country, it is unclear whether the IRS can effectively claim personal jurisdiction over that individual.

Even assuming the IRS could determine with specificity the worldwide assets owned by the covered expatriate, there are additional problems with enforcement once physical separation has occurred. Further, even if assets were located offshore, in order to enforce such tax, the IRS may have to initiate an original action in a foreign court to enforce the taxes. The challenge is that international laws may limit the IRS’s ability to litigate abroad to enforce US tax laws in a foreign jurisdiction. This enforcement issue is exacerbated when the expatriating individual has minimal contacts or assets that remain onshore. For example, even if the IRS is able to identify non-compliant expatriating individuals, it may not have the ability to collect any owed taxes from an uncooperative taxpayer whose assets are entirely offshore.30 Although there may be treaties that aid in IRS enforcement, generally foreign governments lack any incentive to assist in enforcement of US tax laws that only serve to benefit the US government.

As stated succinctly in the 2003 Joint Committee Report, which analyzed the possibility of a mark-to-market tax, "enforcement of the tax may not be successful." 31

V. SMALL CHANGES MAY ALLOW FOR MORE EFFECTIVE INFORMATION GATHERING AND ENFORCEMENT

Certain processes and procedures that, if adopted, may help the IRS more effectively implement and enforce the provisions of Section 877A, as discussed below.

A. Coordination of the Expatriation Forms with the IRS May Increase Compliance and Allow for Greater Enforcement Authority

The simplest solution would be to make small changes to the official documents that are used during the expatriation process for both the renunciation of U.S citizenship and abandonment of lawful permanent resident status.

The simplicity of the change is that expatriation documents already exist, namely, the various forms expatriating individuals must complete to give up their citizenship or permanent resident status, as the case may be. In each case, the proposed change is that all of the documents should contain an allegation that the individual has filed a Form 8854 (along with proof of submission), and that he or she allows and consents to the Department of Treasury to maintain jurisdiction over such individual for a period of years solely with regard to ensuring compliance with Section 877A, Form 8854 and related taxes.

As an example, Form I-407, used to abandon permanent resident status, could be modified so that a box is added to check off that Form 8854 has been submitted to the IRS. As a belt and suspenders approach, the form could also contain another provision requesting that the expatriating individual consent to personal jurisdiction for a period of five years following expatriating for the limited purpose of determining compliance with the expatriation tax regime. There are minimal due process concerns with personal jurisdiction as it is well established that consent to jurisdiction does not offend due process. 32

It is believed that this change to the forms will result in greater communication and integration between the immigration and tax authorities, and will provide the Department of Treasury with a clearer method of informing all parties involved of the tax requirements associated with expatriation. It will also provide notice to the expatriating individual of the Form 8854 filing requirement, thus shifting more of the burden of administration and reporting to the expatriating individual.

[Page 33]

Further, many individuals who meet the income tax test or asset test are able to expatriate from the United States without filing Form 8854 because the Department of Treasury does not have the ability to assert jurisdiction over such individuals once they leave the United States, to ensure compliance with the filing of Form 8854 or to enforce any taxes owed. Changes to the expatriation forms would not only provide a path for ensuring compliance with filing Form 8854 but also increase the ability of the Department of Treasury to enforce payment of these bona fide taxes, thus raising tax revenue.

An IRS official, however, has stated that the Department of Treasury has tried to collaborate with the other agencies in regard to the expatriation issue, with very little success. As such, it is possible that legislative change would be required to permit greater coordination and information sharing between the agencies that oversee expatriation and tax enforcement.

B. The Legislature Could Mandate Coordination Between Government Agencies to Ensure Effective Implementation and Enforcement of Section 877A

There is a concern that the IRS lacks statutory authority or jurisdiction over immigration officials overseeing the expatriation process and therefore does not have any power to coordinate with them regarding the expatriation process. Specifically, Title 26 of the Code of Federal Regulations which relates to the IRS provides as follows: "The Internal Revenue Service is a bureau of the Department of the Treasury under the immediate direction of the Commissioner of Internal Revenue. The Commissioner has general superintendence of the assessment and collection of all taxes imposed by any law providing internal revenue. The Internal Revenue Service is the agency by which these functions are performed." On the other hand, immigration and the expatriation process are generally within the province of the Department of Homeland Security and the Department of State, depending on if the individual is a citizen. As such, it is possible that Congress would need to legislate the coordination of the expatriation process among agencies because, absent such mandate, the powers of each department are limited.

The legislature has tried to coordinate intergovernmental agency cooperation in the past. For example, the rarely used Reed Amendment was enacted as a provision in the Illegal Immigration Reform and Immigrant Responsibility Act of 1996.33 The Reed Amendment specifically gives the Attorney General the ability to declare inadmissible to the United States former "citizens who renounced citizenship to avoid taxation."34

Moreover, Section 7345 of the IRC is another relatively new example of legislative coordination between the IRS and the Department of State. Specifically, Section 7345 provides that if the Secretary "receives certification by the Commissioner of Internal Revenue that an individual has a seriously delinquent tax debt, the Secretary shall transmit such certification to the Secretary of State for action with respect to denial, revocation, or limitation of a passport pursuant to section 32101 of the FAST Act." "Seriously delinquent tax debt" is further defined as "an unpaid, legally enforceable Federal tax liability of an individual" which has been assessed and which is greater than $50,000, among other things.35 Although this Section 7345 applies solely to U.S. citizens, the directive is clear that if there are serious tax deficiencies as defined by statute, the IRS and Department of State can take coordinated action, albeit, only if there is legislative authority to do so.

It is clear that the expatriation process, by its very nature, involves different branches of the government—one overseeing tax compliance and another overseeing physical separation. The legislature could, as it has done so in the past, direct that the Department of State, the Department of Homeland Security, and the Department of Treasury work together to unify and coordinate the expatriation process. For example, the IRS could be given the authority to work with the Department of State and Department of Homeland Security Homeland on preparing the forms an expatriation individual will use to expatriate. Further, the IRS could be given specific statutory authority to disclose to the Department of State and Homeland Security, as the case may be, whether a Form 8854 or other qualifying information has been filed by the expatriation individual in compliance with Section 877A. In other words, the IRS’s ability to disclosure taxpayer information would be solely for the purpose of making such a determination, namely whether Form 8854 has been filed and all reporting requirements have been satisfied therefore not running afoul of the existing statutory restrictions preventing disclosure of return information.

Moreover, because the first officials expatiating individuals will interface with are those at the Department of State or Homeland Security, (depending on if the individual is a U.S. citizen or a long-term resident), before expatriation can become official, the IRC could be amended to contain a provision that unless and until the Secretary or Department of Homeland Security receives what can be referred to as "tax clearance certificate" or other form of certification from the IRS the expatriating individual is deemed not to have renounced U.S. citizenship or long-term residence status, as the case may be. This certification would effectively say that tax liabilities under Section 877A has been satisfied, that the expatriating individual has made arrangements to pay or defer such payment as permitted under the law, or that such individual is not a "covered expatriate" under the law because he or she does not meet the asset or income tests.

In fact, the IRS already has a procedure in place for non-resident aliens departing the U.S. to obtain a tax clearance certificate prior to departure that could be used as a template for the proposed expatriation tax clearance certificate.36 In this way, the IRS can more effectively capture those who would have already cut ties with the U.S. by virtue of having their expatriation paperwork completed without having their tax liabilities cleared. For example, in Section 877A(g) (4), regarding the definition and timing of relinquishment of U.S. citizenship, and provision could be added that a citizen is treated as relinquishing his U.S. citizenship "on the earliest of" having obtained a tax clearance certificate from the Internal Revenue Service and "(A) the date the individual renounces his United States nationality before a diplomatic or consular officer of the United States pursuant to paragraph (5) of section 349(a) of the Immigration and Nationality Act (8 U.S.C. 1481(a)(5)) . . . Each corresponding subsection regarding relinquishment of citizenship, as well as those in the relinquishment of long-term residency status would be subject to this same condition.

[Page 34]

The tax clearance certificate would incentivize expatriating individuals to coordinate their expatriation with the IRS because, without it, they would not be defined as having relinquished their citizenship or residence status for tax purposes. Even more, this would also give the IRS the opportunity to review assets, challenge and settle any valuation disputes prior to the individual’s physical separation from the United States.

C. Revise the Date of Expatriation to Allow for Continuing Jurisdiction Over Such Individuals

Under the current regime, an individual is considered to have expatriated as of the date that the individual relinquished citizenship or long-term residency for immigration purposes. This is problematic from an enforcement perspective because once the individual has expatriated for immigration purposes, he or she is no longer subject to the U.S. income tax regime, even if they have not informed the IRS or filed Form 8854.

Congress may consider legislation that would prohibit an individual from expatriating for immigration purposes unless and until the individual has filed Form 8854. However, such a change will require legislative action to not run afoul of Section 7 of the Privacy Act, found at 5 U.S.C. § 552a, which provides that shall be unlawful for any Federal, State or local government agency to deny to any individual any right, benefit, or privilege provided by law because of such individual’s refusal to disclose his social security account number.37 Alternatively, Congress may consider re-enacting a prior provision of the expatriation act, under which, regardless of whether an individual renounces citizenship or long-term residency for immigration purposes, he or she would continue to be considered a U.S. person until such time as he or she informed the IRS of the expatriating act using Form 8854.

A small legislative change as described above would have strong enforcement consequences because an expatriating individual would continue to be treated as a U.S. person for tax purposes until Form 8854 was filed. Until that time, he or she would still be subject to U.S. tax on worldwide assets. Even if the person was no longer resident in the U.S. and did not file returns, the IRS could still file substitute income tax returns on that person’s behalf and enforce the taxes through liens on any U.S. situs assets.

VI. ANTICIPATED CONSEQUENCES OF PROPOSED CHANGES

The themes of notice of the Section 877A requirements and the gathering of sufficient information from the expatriating individuals appear to be at the core of the problems surrounding the implementation and enforcement of Section 877A. If these changes can successfully be implemented, it is believed that first, it will result in the exclusion of a category of expatriating individuals who would not otherwise be covered under the law. In other words, it would correct the potentially over inclusive effect of the requirement that all expatriating individuals, regardless of net worth or income tax liability, file a Form 8854. Moreover, it may prompt more individuals to file a Form 8854. The second part of the proposal, again, speaks to greater information sharing and communication that will allow for more effective enforcement and monitoring of those leaving the U.S. before complete physical separation has happened. To that end, it is expected that the IRS response time would be more proactive rather than reactive.

VII. CONCLUSION

Recognizing that a simple change to the forms used for the expatriating process is not necessarily within the jurisdiction of the IRS currently, the authors propose there should first be legislative change that permits greater coordination between the Departments of State and Treasury of the expatriation process, both from an immigration standpoint as well as a tax perspective. Then, once authority is granted, the forms used during the expatriation process should be modified such that they put the expatriating individual, as well as those overseeing the immigration process, on notice of the Form 8854 submission requirements.

[Page 35]

——–

Notes:

1. This proposal was principally prepared by Helen S. Cheng and Dina Y. Nam, members ofthe State Bar of California Taxation Section as part of the annual Washington, D.C. delegation co-sponsored by the State bar of California and the Los Angeles County Bar Association Taxation sections. The comments contained in this paper are the individual views of the authors who prepared them, and do not represent the position of the State Bar of California, the Los Angeles County Bar Association, or of Withers Bergman LLP. Although the authors and/or presenters of this paper might have clients affected by the rules applicable to the subject matter of this paper and have advised such clients on applicable law, no such participant has been specifically engaged by a client to participate on this project.

2. Helen S. Cheng, Withers Bergman, LLP, (619) 564-6140, helen. cheng@withersworldwide.com; Dina Y. Nam, Withers Bergman, LLP, (310) 277-9956, dina.nam@withersworldwide.com. The authors wish to thank Michelle B. Graham, Michael Pfeifer, Sang Hong, Joshua Katz and Paul Sczudlo for their valuable insights.

3. IRC §§ 877(a)(2) and 877A(g)(1)(A).

4. IRS Notice 2009-85 (Nov. 9, 2009).

5. JOINT COMMITTEE ON TAXATION, GENERAL EXPLANATION OF TAX LEGISLATION ENACTED IN THE HO™ CONGRESS (JCS-1-09), March 2009 (the "2009 JCT Report").

6. STAFF OF THE JOINT COMM. ON TAXATION, 104TH CONG., JCS-17-95, Issues Presented by Proposals to Modify the Tax Treatment of Expatriation G-45 (1995).

7. See. e.g., Karen de Witt, Some of Rich Find A Passport Lost Is A Fortune Gained, N.Y. TIMES (Apr. 12, 1995).

8. JOINT COMMITTEE ON TAXATION, REVIEW OF THE PRESENT-LAW TAX AND IMMIGRATION TREATMENT OF RELINQUISHMENT OF CITIZENSHIP AND TERMINATION OF LONG-TERM RESIDENCY, (JCS-2-03), February 2003 (the "2003 JCT Report").

9. 2003 JCT Report, p. 5.

10. Id., p. 6.

11. Id., p. 85.

12. Id., p. 85.

13. Id., p. 86.

14. Id., pp. 86-7.

15. Id., p, 91.

16. Id., p. 93.

17. Id., p. 94.

18. Id., p. 96.

19. Id., at 100.

20. Former IRC § 7701(n), repealed in 2008.

21. IRC § 877A(g)(2).

22. IRC §§ 877A(g)(2) and (5).

23. IRC §§ 877(a)(2) and 877A(g)(1)(A).

24. I.R.S. Notice 2009-85 (Nov. 9, 2009).

25. IRC § 877A(g)(1)(B)(i). Under the substantial presence test, an individual is generally considered to be a U.S. resident for income tax purposes if he or she is physically present in the U.S. for at least 31 days during the calendar year and satisfies a physical presence test under the 3-year look back rule. IRC §7701(b)(3)(A).

26. IRC § 877A(g)(1)(B)(ii).

27. IRC § 877A(a)(3).

28. IRC § 877A(c).

29. IRC § 2801(a).

30. The IRS may request help from its treaty partners under the Exchange of Information and Administrative Assistance Article of an applicable income tax treaty. United States Model Income Tax Convention of November 15, 2006. See U.S. Dep’t of the Treasury, United States Model Income Tax Convention of November 15, 2006, art. 26, available at http://www.ustreas.gov/offices/tax-policy/library/model006.pdf

31. 2003 JCT Report, p. 198.

32. See e.g. Burger King Corp. v. Rudzewicz, 471 U.S. 462, 472 n. 14 (1985).

33. 8 U.S.C. § 1182(a)(10)(E).

34. Id. ("Former citizens who renounced citizenship to avoid taxation. Any alien who is a former citizen of the United States who officially renounces United States citizenship and who is determined by the Attorney General to have renounced United States citizenship for the purpose of avoiding taxation by the United States is inadmissible.")

35. IRC § 7345 (b)(1(A) & (B).

36. I.R.S Topic 858, available at https://www.irs.gov/taxtopics/tc858. html.

37. See also https://www.justice.gov/opcl/social-security-number-usage.