On Friday 6 September, the IRS announced new “Relief Procedures for Certain Former Citizens.” These procedures mirror the current Streamlined Offshore Filing Procedures with some differences that might be attractive to some who have renounced or wish to renounce their US citizenship. Taken in conjunction with other recent IRS announcements, this new procedure is a “carrot” to encourage compliance before the IRS applies the “stick” of recently announced compliance campaigns. However, this begs the question of why the IRS would want to encourage compliance among non-citizens whose US tax liability would be dwarfed by the combination of the cost to the IRS of processing their returns and the cost to the individual of having the returns prepared.
These new procedures are available only to individuals who have never filed a US form 1040 and renounced (or plan to renounce) their US citizenship after 18 March 2010. In order to qualify, the individual must have a total US tax liability of less than USD25,000 for the 5 full years prior to renunciation plus the dual status year of renouncing, must have a net worth less than USD2 million (measured both at the time of renunciation and at the time of compliance), and their lack of compliance must be non-willful. In a move that will be helpful to many Accidental Americans, unlike the Streamlined Procedure, a Social Security Number (SSN) is not required under the new procedure for former citizens (See FAQ 16).
One interesting aspect of the IRS description of the background to this announcement is their acknowledgement that:
Compliance with all U.S. income tax filings or obtaining a Social Security number is not a pre-condition to relinquishing citizenship under the Immigration and Nationality Act.
For those who wish to be free of US control over their financial lives via FATCA and who have no remaining connection to the US, renouncing without tax compliance has been a viable alternative. As the Department of State does not collect SSNs when processing a Certificate of Loss of Nationality (CLN), the IRS would have great difficulty in determining whether a non-compliant former citizen owed any US taxes for income earned prior to expatriation. And, even if the IRS were to compute a liability on a substitute return (most likely penalties for failure to file information returns), their ability to collect US taxes and/or penalties from a non-citizen with no US assets is limited. There are a few countries with mutual collection agreements in their bilateral tax treaty with the US, but these agreements specifically exclude tax debts that accrued while the taxpayer was a citizen of the other country (although see this article for a discussion of the collection agreement in the new US/Japan tax treaty). Outside of these few countries, the local tax authority will not assist the IRS with collection. And there are no cases of the US extraditing a foreign national for US tax debts that were not related to fraud, terrorism, drug trafficking or other serious offences.
So, the new procedures are likely aimed at getting former citizens to self-report US tax liabilities that are essentially uncollectable, and forgiving those liabilities.
What’s in it for the IRS? There are probably two incentives for the IRS that have precipitated this policy change. First, there has been pressure from Europe on Congress and Treasury to fix the problem of Accidental Americans and FATCA. This is a big problem for “foreign” banks, who have many clients they have identified as US citizens who do not have a SSN. It is also a big problem for the Accidental Americans themselves, many of whom do not wish to acknowledge their forced US citizenship. Now the IRS can say that they have offered the affected Accidental Americans amnesty from their US tax obligations. However, to take advantage of this procedure an Accidental American would have to acknowledge their US citizenship, pay the compliance cost of US tax compliance, and pay the USD2,350 renunciation fee to obtain a CLN.
The second incentive for the IRS is that any take up of the procedure will assist them in collecting information on former citizens without requiring any investigation on the part of the IRS. There are thousands of CLNs that the IRS would have to investigate to make good on its announced compliance program for expatriates. It is well known that the IRS budget is inadequate to the task, and any program/procedure that cuts costs will be welcomed. Getting former citizens to self-report may actually represent a cost savings. If sufficient numbers participate, this may also allow the IRS to develop a model to help determine which former citizens are not going to generate enough additional tax and penalties to justify the cost of attempting to force compliance with US tax law.
Why would someone who has already received a CLN want to participate in this new procedure? Most who previously renounced without tax compliance would probably be comfortable with that position, and would not be inclined to give the IRS a road map of their financial dealings now that they are finally free of US interference. However, for those who are nervous following the announcement of the IRS compliance campaign targeting expatriates, the procedure will offer some closure. Additionally, there will be some individuals who have been sitting on the sidelines because of the fear of double taxation, and the difficulty of obtaining a SSN from outside of the US. The new procedure can be used to avoid paying up to US25,000 of US tax and avoid covered expatriate status.
The new procedure specifically applies only to former citizens who have never filed a US form 1040 tax return. There are many who have learned of their US tax obligations since 2010, often from their bank, and have rushed to comply with US tax laws. They may be waiting until they have 5 years of compliance so they can exit the US tax system without being a covered expatriate. Those who rushed to comply are now at a significant disadvantage. As noted by the National Taxpayer Advocate in reference to the Streamlined Program, it is not fair when the IRS reduces the compliance cost only for those who have delayed compliance:
It is difficult to see how such an approach will encourage future compliance by them or anyone else. Instead, it creates an incentive for anyone facing potentially severe penalties to wait for the government to become more reasonable, which is inconsistent with the objective of promoting voluntary compliance.National Taxpayer Advocate, 2014 Annual Report to Congress, Volume 1 at page 341
I would hope that the Taxpayer Advocate would take a similar position with regard to these new procedures for former citizens.
If you want to learn more about the new procedures, they have been covered in the Wall Street Journal (paywall) and American Expat Finance Journal. You can also read John Richardson’s analysis on his blog and a discussion of the procedure in the comments on this Isaac Brock Society post.