Congress is taking notice that expatriations (relinquishing US citizenship or “long-term” green cards) have been steeply on the rise and that the players are sometimes big ones (such as Eduardo Saverin, Denise Rich and Tina Turner). During the second week of June, three US Senators (Robert Casey (D-PA), Jack Reed (D-RI) and Charles Schumer (D-NY)) proposed an amendment to the pending immigration reform bill. Their proposal (“Proposal”) targets former US citizens (and possibly former “long-term” green card holders) who are deemed to have expatriated for tax avoidance purposes. The Proposal is a basic carbon copy of the 2012 “Ex-PATRIOT” Act, which had been introduced in the Senate last year by Senators Schumer, Casey, Blumenthal and Harkin. Last year’s proposal was short-lived and was dropped by the Senate Committee on Finance. The fact that we are seeing this resurrection being snuck into the immigration reform bill means it stands a greater chance of being passed because it will not be as strongly “noticed”. At a minimum it is a very clear indication that giving up US citizenship (and possibly green cards held for long periods) will become increasingly more difficult to achieve without a very hefty price tag.
A bit of background is first required. Current US tax rules impose harsh tax consequences on so-called “covered expatriates” (including an “exit tax” ). Other draconian tax penalties are assessed on any US persons receiving gifts or bequests from such “covered expatriates”. Full information about the current expatriation tax regime can be found on my tax blog posting here.
The term “covered expatriate” means a former US citizen or “long-term permanent resident” (defined later) (i) with a net worth of at least $2 million (“Net Worth” Test), or (ii) an average income tax liability of at least $155,000 over the last five years (“Tax Liability” Test), or (iii) who fails to certify under penalty of perjury that he has met all his US tax obligations for the five year period prior to expatriation (“Tax Compliance” Test). This tax certification requirement acts as an effective bar to expatriation for those who have not filed tax returns and met all of their US tax liabilities for the relevant five year period. A “long term permanent resident” (sometimes commonly referred to as “long-term green card holder”) is an individuals who has held a US green card in 8 of the last 15 tax years.
The 2013 Proposal
Under the 2013 Proposal, when any one of these tests is triggered, the burden of proof would shift to the “covered expatriate” to demonstrate to the IRS that his loss of US citizenship did not result in a “substantial reduction in taxes.” How this would work in practice was not specified, and likely the exception would be the subject of IRS Treasury Regulations. If the expatriate cannot meet his burden of proof, he will be classified as a so-called “specified expatriate”. If the expatriation did not result in a “substantial reduction in taxes” then he will not be classified as a “specified expatriate” and the new and additional draconian expatriation penalty, discussed below, will not apply. As under current law, certain exceptions exist pursuant to detailed rules for those born with dual nationality and those who expatriate before age 18 ½ provided they have had limited US physical presence.
This provision requires the IRS, an already overburdened government agency, to make a decision regarding tax-avoidance for every individual who loses US citizenship and is subject to any one of the Net Worth / Income Tax Liability / Tax Compliance Certification tests, mentioned earlier. Furthermore, it is retroactive and will apply to individuals who meet the “covered expatriate” definition who have lost US citizenship during the 10-year period prior to the enactment date. Whether such retroactivity would ever be upheld by a court of law is another issue, and in my view a highly doubtful proposition.
Expatriation Penalty – Tax on US Source Capital Gains
The Ex-Patriot Act proposal of 2012 and the 2013 Proposal would amend the current law to impose new and additional taxes on any “covered expatriate” who qualifies as a so-called “specified expatriate”. Such persons will suffer a 30% tax on their US-source capital gains. Gains from “US sources” here generally means gains on the disposition of US stocks. The tax will hit no matter where the individual resides. It would be imposed through withholding by the payor. Remember this is in addition to the current law Exit Tax and Gift / Estate tax penalty sanctions imposed with regard to “covered expatriates”.
Under current law, when a nonresident alien individual sells stocks in US companies, he is not taxed on the gains, provided he did not have a physical presence in the US for 183 days or more in the year of the sale. This exemption from tax was specifically carved out in the law in order to build a strong incentive for foreigners to invest in the US stock market. Seems a bit silly to discourage foreign investment in the US by the likes of an Eduardo Saverin!
The Proposal seeks to have the expatriation rule be retroactive by applying it to anyone who is a “covered expatriate” who gave up his citizenship in the last ten years! As a practical matter, how was such an expatriate who gave up citizenship, in say, 2006 supposed to now come and demonstrate to the IRS that he did not have the prohibited tax avoidance purpose for expatriating? While the proposed law seeks to apply its terms retroactively, it would only tax capital gains earned in the USA after the enactment date. Surely it will just be easier for the expatriate to avoid investing in the US at all. One has to wonder if this is a sound economic policy especially in light of the current economic turmoil in the US.
Banned from Entering the USA
Of great concern to practitioners is a provision regarding denial of entry into the US. Under the new Proposal, a “specified expatriate” will be inadmissible (again, a “specified expatriate” is a “covered expatriate” who cannot establish to the IRS that the “loss of his citizenship” did not result in a “substantial reduction in taxes”). Of particular interest in the new Proposal is the fact that the Secretary of Homeland Security may grant waivers to certain “specified expatriates” on the issue of inadmissibility if the individual satisfies requirements relating to his tax status “such as a tax or penalty equal to the loss in tax revenue to the United States” as a result of the individual’s loss of citizenship. The Secretary of Homeland Security and Secretary of State are to liaise with the IRS on implementing guidelines for this issue.
You can read the press release of Senator Jack Reed here announcing his proud “Amendment to Prevent Ex-Citizen Tax Dodgers from Reentering the U.S.”
Current US immigration laws provide that former US citizens who are deemed to have renounced their US citizenship for tax avoidance purposes may be banned from entering the US by including them in a class of “inadmissible” aliens. This law is commonly referred to as the “Reed Amendment” and was enacted in 1996. [Public Law 104-208, § 352; INA § 212(a)(10)(E); 8 USC § 1182(a)(10)(E)]. The law has never been enforced probably because of doubts as to its constitutionality. Legal scholars have questioned the constitutionality of the Reed Amendment on grounds that the right to expatriate is a fundamental right protected by the Constitution. Any infringement of a Constitutionally protected fundamental right is subject to strict scrutiny by the courts and is almost never upheld. It would seem that a similar analysis would apply to the ban imposed by the new Proposal.
Ambiguity as to Application
It appears that the intention is for the new Proposal to apply only to former US citizens, but the drafting is ambiguous because it refers to “covered expatriates” which includes “long term permanent residents” (sometimes commonly referred to as “long-term green card holders”). Practitioners are wondering if the reach of the proposal would extend to such individuals. It is uncertain that the new Proposal would apply to such long term green card holders. It should be noted, however, that the current version of the expatriation laws first applied only to former citizens and the law was then expanded to include long-term green card holders.
What is in the Future?
While I believe it is doubtful that this version of the Proposal would be enacted into law, the writing is clearly on the wall. Expatriation will surely be met with further sanctions by the US government. Penalizing individuals who give up their citizenship has apparently become the order of the day.
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