By William M. Smith
Before determining the tax consequences of expatriation, it must be determined whether the U.S. citizen or resident alien has technically expatriated.
If a technical expatriation has occurred, tax consequences may result, including:
- An application of the exit tax.
- A Form 1040-NR filing requirement.
- A dual-status filing year.
- The availability of various elections.
- The possibility of certain treaty positions.
When there is a potential expatriation, caution should be used in analyzing the U.S. tax consequences.
The technical definition of expatriate
The term expatriate is often used broadly to mean an individual who has left their native country. For example, if an American citizen moves from the U.S. to live in France, they might be called an expat; however, the true technical definition is stricter.
For U.S. tax purposes, the technical definition of an expatriate is a U.S. citizen who has relinquished their U.S. citizenship or a U.S. resident alien who has become a nonresident alien.
To expatriate, a U.S. citizen can relinquish their citizenship by executing any one of four different official acts. The most common one is renouncing their U.S. nationality before a diplomatic or consular officer of the United States.
A U.S. resident alien can become a nonresident alien in one of two ways, depending on the basis for their resident alien status:
- A resident alien that is classified as a lawful permanent resident because they hold a green card can become a nonresident by administratively surrendering their green card or by having it judicially revoked, or by becoming a resident of another country under a tax treaty and notifying the IRS of the commencement of such treaty without waiving the benefits of such treaty applicable to residents of the foreign country.
- A resident alien that is classified as such because the substantial presence test has been met can become an expatriate by failing to meet the substantial presence test or by meeting all of the following criteria:
- Being in the U.S. for less than 183 days during the current year
- Having a tax home in the foreign country during the current year
- Having a closer connection to the foreign country than to the U.S.
The effect of not technically expatriating
If a U.S. citizen or a U.S. resident alien does not meet the technical tax definition for expatriation, there is no effect. They will still be taxed on their worldwide income.
The effect of technically expatriating
If a U.S. citizen or nonresident alien technically expatriates, the U.S. Exit Tax may apply. Form 1040 is no longer required to be filed, but Form 1040-NR may be required.
Filing Form 1040-NR
Unless an individual expatriates on December 31, a Form 1040-NR will be required for the year of expatriation. Form 1040-NR may also be required for years subsequent to the year of expatriation. The following considerations apply regarding the filing of Form 1040-NR by a nonresident alien:
- IRS Form 8854, Initial and Annual Expatriation Statement, must be included in the Form 1040-NR for the year of expatriation by U.S. citizens and resident aliens considered long-term permanent residents. (If expatriation occurs on December 31, Form 8854 must be included in Form 1040 for the year that includes the December 31 expatriation date.) Failure to file Form 8854 could subject the expatriate to the U.S. Exit Tax.
- For the year of expatriation (except if expatriation occurs on December 31), Form 1040-NR will be required provided the expatriate has a closer connection to a foreign country than to the U.S. for the portion of the year after expatriation. This return will be considered a dual-status year. This means that the year will be bifurcated into two periods: a period where the expatriate is taxed as a U.S. citizen or U.S. resident and a period where the expatriate is taxed as a nonresident. The expatriate will be taxed for each period according to the rules applicable to their status for the period (citizen/resident or nonresident).
- A filing status of Married Filing Jointly is not permitted. An exception may apply if the nonresident alien is married to a U.S. citizen or U.S. resident and the spouses elect to treat the nonresident spouse as a resident.
- Unless protected by treaty, the nonresident alien is taxed only on income that is effectively connected with a U.S. trade or business (Effectively Connected Income or ECI) or income other than ECI that is U.S. sourced. If the nonresident alien does not have either of these types of income and certain other requirements are met, Form 1040-NR is not required to be filed for that particular year.
- Various treaty positions may be available to the expatriate to alter their tax consequences that would otherwise result under the U.S. statutory rules.
- On Form 1040-NR, itemized deductions are prohibited except for charitable contributions and theft losses.
- On Form 1040-NR, the standard deduction is not permitted except for certain limited exceptions.
How Wipfli can help
Wipfli’s international tax specialists are ready to assist you in analyzing the potential tax consequences of expatriation. Our team can help you manage documentation, changing regulations and all the complexities of international taxes.
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