Who is an accidental American? One, who is born in America to foreign parents and by virtue of a birth in America, acquires American citizenship. (There are others who fall in the accidental category as well but this post refers to only the one category defined above) This accidental citizen may leave USA when the parents do, and never set foot in the country of his birth again, but he will still be liable to pay taxes in America because of his citizenship status. Anyone born in USA acquires US citizenship at birth. The US government taxes its citizens on worldwide income and irrespective of place of residence of length of residence. Please note we are only referring here to citizens. To clarify – Resident aliens are not a part of this discussion.
A US citizen, such as the one defined above is required to pay taxes on worldwide income. However, he may not even be aware of this regulation and may sincerely believe he has responsibly discharged his duty by paying taxes in the jurisdiction he currently resides in. In 2010, the US government passed the FATCA regulation – Foreign Account Tax Compliance Act. Under this Act, foreign financial institutions are required to determine whether any of their customers are US citizens and to report certain information of such accounts to the US government. This information exchange has now provided the US government an ability to track its citizens worldwide and ensure compliance. It has also enabled the government to track the “Accidental American”. Now, an accidental citizen may be justified in thinking that paying taxes in USA simply by virtue of his birth there is not warranted especially if he has no future plans to settle there. In such a situation the question of expatriation comes up. Assuming a citizen decided he wants to expatriate based on an analysis of his situation, residency and future plans, he must also take into account the tax implications of expatriation. Yes, expatriation has tax consequences.
US citizens who wish to relinquish citizenship must comply with federal tax requirements for the year in which they expatriate as well as 5 years prior to that date. In view of the fact that the citizenship may have been accidental and any non-compliance was probably not deliberate, the IRS has come up with certain relief procedures for such cases.
Before going into those relief procedures one must understand the definition of a “covered expatriate”. An individual who meets a certain level of income (eg: $160,000 for 2015) or has a net worth of more than $2 million or has failed to certify compliance with all US tax regulations for 5 years prior to date of expatriation on Form 8854 would be considered a covered expatriate. All the property of a covered expatriate is deemed sold for its fair market value on the day before the date of expatriation. Any gain is then taxed.
Under the relief procedures the following conditions hold good:
- Taxpayer’s expatriation should have occurred after March 18, 2010
- Taxpayer had a net worth of less than $2 million at the time of expatriation.
- Taxpayer had an aggregate liability of $25,000 or less for the year of expatriation and the prior five years.
- Taxpayer’s compliance failure (failure to file returns, FBAR etc) was absolutely due to non-wilful conduct. In other words it was not a deliberate/wilful act. It may have occurred due to negligence, good faith misunderstanding of legal requirements or inadvertently.
Based on the above, the taxpayer may submit the following information under the relief procedure rules:
- Certificate of loss of nationality of USA, or Form DS-4083 or copy of court order cancelling citizenship.
- Identification documents such as copy of valid passport or birth certificate.
- Year of expatriation Dual status return including Form 1040 NR, Form 8854, all other information returns including Form 8938.
If all of the above conditions are met the IRS may not consider the taxpayer a “covered expatriate”. These procedures are available without any termination/last date as of now. Under these procedures the taxpayer can make a submission even if he does not have an SSN.