- 1 Why Do Expatriates Get Audited by the IRS?
- 2 Miscategorization of Long-Term Resident Status
- 3 Did the Taxpayer Make an Untimely 8833 election?
- 4 Was The Taxpayer’s Net Worth Calculation Accurate
- 5 Mandatory Repatriation Act
- 6 Are you Five (5) Years Tax Compliant?
- 7 Interested in Expatriation from the U.S.?
Why Do Expatriates Get Audited by the IRS?
The process of expatriation is the process in which a U.S. person who is either a U.S. Citizen or Long-Term Lawful Permanent Resident of the United States formally renounces their US citizenship or relinquishes their permanent residency status. From a U.S. tax perspective, the Taxpayer who expatriates is no longer considered a U.S. person for tax purposes. As a result, they are no longer taxed on their worldwide income as a U.S. person but rather are only taxed on their U.S-sourced income. Thus, if an expatriate has no U.S.-sourced income, they will not be taxed by the U.S. Government. But, that does not mean that the IRS is prevented from going after them to audit or examine their prior tax returns if the IRS believes that the expatriate did not expatriate properly — or if they believe the Taxpayer filed incorrectly prior returns or international information reporting forms. Both the IRS and Department of Justice do pursue expatriates who they believe did not expatriate properly – which can also include criminal actions as was the case against a Russian National who expatriated but allegedly underreported his U.S. income and assets significantly (this included the U.S. pursuing extradition and cooperation with foreign country governments as well). Let’s look at five reasons why an expatriate may become subject to audit.
Miscategorization of Long-Term Resident Status
The method the US government uses to calculate the eight years for expatriates qualifying under the long-term lawful permanent resident statute is unfair. Essentially, if a person is a U.S. person for one day in the first year and one day in the eighth year, then they will be considered a long-term lawful permanent resident, even though technically they were not a U.S. Person for eight full years. Some taxpayers may take the position that they are not considered long-term residents because they were not in the United States for eight full years, but this can lead to an audit as the IRS disagrees with that position.
Did the Taxpayer Make an Untimely 8833 election?
One common situation we find is when taxpayers learn that they are Long Term Lawful Permanent Residents (when they did not believe that they were) begin filing Form 8833 elections to elect to be treated as a foreign person for tax purposes. It is important to note, that under the US tax rules if a person is already considered to be a long-term lawful permanent resident, then filing a Form 8833 election to be treated as a foreign person for tax purposes is considered a form of expatriation and may lead to audit, fines, and penalties if the proper paperwork was not submitting.
Was The Taxpayer’s Net Worth Calculation Accurate
One method that the IRS uses to determine if a person is considered a covered expatriate is if they meet the net worth test (unlike the net income tax liability test, the net worth test does not change with inflation, and has remained at $2 million for several years). When an expatriate completes their Form 8854, they must identify their assets and losses so that the IRS can determine whether they meet the $2 million mark or not. The IRS does pursue audits against taxpayers who they believe may have understated their assets on Form 8854. While this may be attributed to Fraud, sometimes the inaccuracies are unintentional. For example, even though a 401K is not deemed distributed at the time of expatriation — the value is still used to determine the net worth of the taxpayer and whether they meet the $2M net worth test or not. In addition, audits can lead the IRS to find that some taxpayers are unintentionally not including the value of their interest in non-grantor and grantor trusts and/or their ownership interest in vested and unvested employment shares or units (that the IRS may designate a value even though they have not fully vested yet).
Mandatory Repatriation Act
For Taxpayers who have previously untaxed income in controlled foreign corporations (CFC), there was a one-time transition tax back in 2017/2018. In the past few years, the Internal Revenue Service has learned that many taxpayers sought to expatriate in order to try to avoid this tax — and they did not pay the expatriation tax as part of their 2017 tax return at the time of expatriation. While the constitutionality of the Repatriation Tax Act is currently being decided by the Supreme Court in the case of Moore, until the court rules otherwise, the law is still on the books, and one of the more common reasons why a taxpayer may be audited after they expatriate.
Are you Five (5) Years Tax Compliant?
While the net worth test and the net income average tax liability tests are the two main tests to determine if a person is a covered expatriate, there is a third catch-all test (aka tax compliance test). If the taxpayer expatriate cannot state under penalty of perjury that they are five years tax compliant, the IRS can deem them to be a covered expatriate even if they would otherwise not be. Making matters worse, is the way the law is written is very ambiguous, and what is actually considered tax compliant versus ‘accurate tax filings’ and accurate international information reporting is up for debate. Oftentimes, this may lead the IRS to audit a taxpayer if they believe the expatriate did not at least substantially comply with their tax filings for the five years prior to their expatriation.
Interested in Expatriation from the U.S.?
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