Covered vs Non-Covered Expatriate: Tax Implications 2024

Covered Expatriate

Who is a Covered Expatriate?

When a Taxpayer is either a U.S. Citizen or a Long Term Lawful Permanent Resident (LTR) and wants to end their U.S. person status, the general process is referred to as expatriation. Expatriation from the United States has two key components:

• • • Immigration: The immigration process entails renouncing U.S. Citizenship or terminating Lawful Permanent Resident Status.

    • Taxation: The tax process of giving up U.S. Person status involves filing a final tax return, Form 8854 and sometimes additional tax forms as well.

Even when a person is considered a U.S. citizen or Long-Term Resident, they will only become subject to U.S. exit taxes if they are considered a covered expatriate. To be considered a covered expatriate, there are three (3) different tax tests, and the Taxpayer must qualify under only one test to be considered covered. In other words, the Taxpayer does not have to meet all three tests to be deemed a covered expatriate. If possible, the Taxpayer should try to avoid being a covered expatriate because even if there is no exit tax implication at the time they expatriate there could be future U.S. tax implications especially if the covered expatriates plan on giving gifts to U.S. persons in the future. Let’s look at some common examples of how a person qualifies as a covered expatriate.

*For all examples, please note that the Taxpayers are U.S. persons for tax purposes who have not made any treaty elections to be treated as a Non-Resident Alien (NRA). Also, these examples are for illustrative purposes only and Taxpayers should consult with a Board-Certified Tax Law Specialist if they have specific questions about their reporting requirements and not rely on this article for legal advice.

Net-Worth Test

The net-worth test is the most common test regarding being a covered expatriate. If a person has a net worth of $2M then they can be considered a covered expatriate Unfortunately, unlike the net income average tax liability (which adjusts for inflation) the net-worth test does not adjust for inflation. While many years ago, $2M would have been a very large amount of money — and it still is a lot of money — many Taxpayers who may have purchased a home several years ago in areas such as Southern California or Northern California may have seen the value of their home grow exponentially, making them make covered expatriate based on the equity in their home alone.

• • • Example: David is a U.S. citizen who has $4M in equity assets in the United States. David may be considered a covered expatriate.

    • Example: Jennifer is a U.S. Citizen who has $3M in foreign assets located outside of the United States. Jennifer may be considered a covered expatriate.

    • Example: Michelle is a U.S. Citizen and has been unemployed for several years but the value of her home that she purchased for $400,000 nearly 30 years ago is now worth $3.1M (with no mortgage). Michelle may be a covered expatriate.

    • Example: Dean is a Lawful Permanent Resident who has been residing in the United States for 20 years. He has a home worth $3M which is the majority of his assets, but the house has a $2.1 million mortgage. Dean’s net worth is below $2M and he is not a covered expatriate under this test.

Net Income Average Tax Liability Test

The next test to determine whether or not a person is considered a covered expatriate is the net income average tax liability test. To qualify as a covered expatriate under the net income average tax liability test, a person must average the five prior years of their net income average tax liability and if that amount is over the current year threshold (currently around $190,000) they are considered a covered expatriate. Unfortunately, this is not a per-person test but rather a per tax return so that joint filers may become subject to the covered expatriate status even if they are not the primary earner.

• • • Example: Peter is a U.S. Citizen who earns $600,000 a year and pays $200,000 a year in tax. Peter would qualify as a covered expatriate.

    • Example: Michelle is a U.S. Citizen who is married to Peter but does not work. They file tax returns jointly, and even though Michelle does not have any income, she would also be considered a covered expatriate based on the net income average tax liability on their joint return.

    • Example: Danielle is a lawful permanent resident who lives outside of the United States. She earns $900,000 a year and pays $400,000 a year in tax overseas but then she gets a foreign tax credit so her net income average tax liability in the United States is only $70,000 a year. Danielle is not a covered expatriate under this test because her net income average tax liability has not averaged $190,000 over the past five years.

5 Years Tax Compliance

The final test to determine if a person is a covered expatriate is whether they can sign under penalty of perjury that they have been tax-compliant for the past five years. It is similar to how the substantial presence test is a catch-all test to determine a non-permanent resident’s U.S. person status. The main issue with this test is that the definition of what is considered ‘tax compliant’ is ambiguous at best. For example, while being tax compliant does not mean the Taxpayer necessarily filed perfect tax returns, the tax returns must be for the most part accurate.

• • • Example: Steven has not filed U.S. tax returns for several years even though he knew he was required to file returns. Steven may be considered a covered expatriate because he renounced his U.S. citizenship before getting into tax compliance.

    • Example: Daniel is a U.S. Citizen who has been filing tax returns timely but has been knowingly underreporting his income each year and not filing certain forms that he knows are required to be included with his tax filing. If Daniel renounces his U.S. citizenship before he gets into compliance, daniel would be considered a covered expatriate.

    • Example: Melissa is a Long Term Lawful Permanent Resident who files her tax returns timely each year but inadvertently missed a small amount of income. Melissa files her I-407 to give up her green card and does not meet the requirements of either the net worth or the net income average tax liability Technically, melissa’s tax returns were not perfect because she missed a few hundred dollars of interest income over the past five years, but would that mean that Melissa is a covered expatriate — probably not.

Exception to Covered Expatriate

Some U.S. Taxpayers who may be considered a covered expatriate may qualify for certain exceptions that may eliminate any tax implication of being a covered expatriate. The two main exceptions involve certain minors and taxpayers who are dual citizens and living outside of the United States.As provided by the IRS:

• • • Exception for dual-citizens and certain minors.

      • Dual-citizens and certain minors (defined next) won’t be treated as covered expatriates (and therefore won’t be subject to the expatriation tax) solely because one or both of the statements in paragraph (1) or (2) under Covered expatriate, earlier, applies. However, these individuals will still be treated as covered expatriates unless they file Form 8854 and certify that they have complied with all federal tax obligations for the 5 tax years preceding the date of expatriation as required in paragraph (3) (under Covered expatriate, earlier).

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.