For expatriation purposes there is a “dual national exception” contained in Internal Revenue Code (IRC) Section 877A(g)(1)(b). Meeting the exception permits the expatriating individual to escape treatment as a so-called “covered expatriate” subject to imposition of the “expatriation” regime rules such as the Exit Tax and Section 2801 transfer taxes.
In order for an individual to meet this exception, he or she must have full tax compliance for the 5 years prior to the expatriation year and must meet both statutory requirements (I) and (II) below:
An individual shall not be treated as [a covered expatriate] if—
(i) the individual—
(I) became at birth a citizen of the United States and a citizen of another country and, as of the expatriation date, continues to be a citizen of, and is taxed as a resident of, such other country, and
(II) has been a resident of the United States (as defined in section 7701 (b)(1)(A)(ii)) for not more than 10 taxable years during the 15-taxable year period ending with the taxable year during which the expatriation date occurs, …
The Fly in the Ointment
This “dual national” exception attempts to carve out a safe haven for a limited class of persons and absolve them from the statutory sanctions for expatriation. The exemption is meant to offer some shelter to those individuals who are at birth US citizens and also citizens of another country, who are resident in that other country and subject to its taxing jurisdiction, and furthermore, are lacking any meaningful ties to the United States for a significant period of time. Unfortunately, the soothing balm of this exception, has a few serious flies in the ointment.
1) Dual Nationality “At Birth”
I have written before on the fact that many persons who are citizens of another country and living outside of America are just learning that they are also US citizens and what the tax implications of such citizenship mean for them. Indeed, US citizenship with all of its ramifications, comes as unpleasant surprise to many. A great number of such individuals wish to renounce their US citizenship and to rely on the “dual national” exception.
For starters, in order to qualify for this exception, the individual must have acquired dual nationality “at birth”.
There are two general ways by which a person receives American citizenship “at birth”. The first way is simply by being born within the borders of the United States. This is a common law concept called “jus soli”, or the “law of the soil” “Jus soli” is a rarity in the modern world with the United States being one of only thirty countries which has it in place as a means for birthright citizenship. An exception is made to the American “jus soli” rule in cases of children born to certain visiting foreign diplomats. See INA 301(a) and INA 301(b). See 8 CFR 101.3.
Another general way for people to receive American citizenship at birth is to be born abroad to at least one American citizen parent, who has lived in the United States for a certain period of time. You can read more about birthright citizenship in the United States at the US Citizenship and Immigration Services website here. The laws have changed over time and can result is some surprising complexities.
Whether one acquires the nationality of another country “at birth” depends entirely on the nationality laws of the other country involved. I have recently learned that some of the foreign nationality laws can result in some very harsh discrimination. For this I reference the eye-opening article written by Mr. Dominic Ferszt of Cape Town, South Africa, titled “The Accidental Tax Invasion” and published in Forbes in 2014. My colleague John Richardson hosted Mr. Ferszt as a guest blogger on his website to write about this topic.
Provided below are some real life examples from Mr. Ferszt. These examples demonstrate how the laws of nationality of a particular country when compared to those of another country can bring about some very discriminatory results when applying the “dual national” exception. Quoting Mr. Ferszt’s blog piece:
“Example 1: U.S. citizenship acquired by birth in the United States:
Two babies are born next to each other in an American hospital: one to Argentinian parents, the other to Italian parents. Both families return back to their homelands. Thirty years later, the children choose to expatriate: the Argentinian (because he did NOT acquire Argentinian citizenship at birth) must pay the exit tax, while the Italian (because he DID acquire Italian citizenship at birth) is exempt from the exit tax.
Example 2: U.S. citizenship acquired by birth outside the United States to U.S. citizen parent(s):
Two American families emigrate; one to Australia the other to Greece. Shortly after arrival they have children. 30 years later, the children expatriate: the Australian pays no exit tax (the child was born an Australian citizen) , while the Greek citizen must pay the exit tax (the child was NOT born a Greek citizen).
Example 3: Dual citizenship denied on account of apartheid
This is my favourite hypothetical: two U.S. couples, one white and one black, emigrate to South Africa in the 1970s and start families. The babies are U.S. citizens at birth. Yet, under South African apartheid, blacks were denied citizenship of South Africa. In such circumstances, the black U.S. citizen would be required to pay the exit tax; while the white one wouldn’t.”
These are only illustrative examples. Many other fact patterns can come into play that will have a similar discriminatory result (e.g., until recently many nationality laws provided for rampant gender discrimination — fathers could pass on citizenship, whereas mothers could not) .
Ripe for a Court Challenge?
John Richardson and Mr. Ferszt are looking for individuals with factual circumstances that be used to bring a lawsuit in a US court challenging the discriminatory application of IRC Section 877A. If you, or someone you know, may have such a fact pattern, please get in touch with them. Read the blog post; there is a section at the very end explaining how to get in touch.
2) “Taxed as a Resident of”
Another hornet’s nest swarming with potential discrimination is the requirement that the expatriating individual be “taxed as a resident of” the country of his or her other citizenship. Some countries do not impose taxes, per se, on an individual, preferring to raise revenue through VAT (this is common in the Middle East; for example, the United Arab Emirates). Other countries may have an income tax but exempt their citizens, taxing only expatriates who come to work in the country (e.g. Saudi Arabia does not impose an income tax on individuals who are Saudi or GCC nationals residing in Saudi. However, non-Saudi and non-GCC nationals are subject to this income tax).
When expatriating the United States, should citizens of those countries lacking direct taxes on the individual be treated differently from citizens of another country which imposes a direct tax if the individual is resident there? What if the individual who is expatriating is a citizen of one European country (say, Switzerland), but he has been living, working and paying taxes in another European country (say, Germany). He will be denied the ability to use the dual national exception because he is not being “taxed as a resident of” the country of his other citizenship. Must he leave his employment in Germany, move back to Switzerland and establish tax residency there, simply in order to expatriate the US and use the dual national exception?
Often, in the tax world there are no clear answers. And in the world of expatriation, some things just don’t make much sense.
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