Could The 2015 Obama budget proposal for "dual citizens" have been implemented without Congressional approval?

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Note: This post was originally written in 2015. Parts of this post have been updated in January of 2021. (The original post is here.) The changes reflect the evolution of my thinking. I now believe that Treasury could (or could have) accomplished much of this proposal through Treasury regulations.

Part 1 – The Obama 2015 Budget Proposal – Change you can believe in?

This was the subject of significant discussion at the Isaac Brock Society. It was also the subject of an insightful blog post by U.S. Tax Lawyer Virginia La Torre Jeker.

It is possible that (at long last) the U.S. government is beginning to recognize that there is a difference between “technical citizenship” and a voluntary U.S. connection indicative of “substantive citizenship” that might (but is not required to) justify taxation of U.S. citizens abroad in the 21st century.

The relevant provision (page 282) includes:

PROVIDE RELIEF FOR CERTAIN ACCIDENTAL DUAL CITIZENS

Current Law

An individual may become a U.S. citizen at birth either by being born in the United States (or in certain U.S. territories or possessions) or by having a parent who is a U.S.
citizen. All U.S. citizens generally are subject to U.S income taxation on their worldwide income, even if they reside abroad. In contrast, nonresident aliens are taxed on certain income derived from U.S. sources and on income that is effectively connected with a U.S. trade or business.

U.S. citizens that reside abroad also may be subject to tax in their country of residence. Potential double taxation is generally relieved in two ways. First, U.S. persons can credit foreign taxes paid against their U.S. taxes due, with certain limitations. Second, U.S. individuals may exclude from their U.S. taxable income a certain amount of income earned from working outside the United States ($100,800 for 2015).

Section 877A imposes special rules on certain individuals who relinquish their U.S. citizenship or cease to be lawful permanent residents of the United States (“expatriates”). Expatriates who are “covered expatriates” generally are required to pay a mark-to-market exit tax on a deemed disposition of their worldwide assets as of the day before their expatriation date.

An expatriate is a covered expatriate if he or she meets at least one of the following three tests:

(1) has an average annual net income tax liability for the five taxable years preceding the year of expatriation that exceeds a specified amount that is adjusted for inflation (the “tax liability test”),

(2) has a net worth of $2 million or more as of the expatriation date (the “net worth test”), or

(3) fails to certify, under penalty of perjury, compliance with all U.S. Federal tax obligations for the five taxable years preceding the taxable year that includes the expatriation date (the “certification test”).

The definition of covered expatriate includes a dual citizen exemption from the S. 877A expatriation tax. This is a special rule for an expatriate who became at birth a citizen of both the United States and another country at birth and, as of the expatriation date, continues to be a citizen of, and taxed as a resident of, such other country. Such an expatriate will not be treated as a “covered expatriate” because of the tax liability and net worth tests if he or she has been a resident of the United States for not more than 10 taxable years during the 15-taxable year period ending with the taxable year during which the expatriation occurs. However, such an expatriate remains subject to the certification/compliance test. Because U.S. citizens are subject to U.S. Federal income tax on their worldwide income, dual citizens who choose to expatriate may be required to pay a significant amount of U.S. tax before they are able to certify that they have satisfied their U.S. tax obligations for the five taxable years preceding the year in which they expatriate.

Reasons for Change

Individuals who became citizens of both the United States and another country at birth may have had minimal contact with the United States and may not learn until later in life that they are U.S. citizens. In addition, these individuals may be citizens of countries where dual citizenship is illegal. Many of these individuals would like to relinquish their U.S. citizenship in accordance with established State Department procedures, but doing so would require them to pay significant U.S. tax.

Proposal

Under the proposal, an individual will not be subject to tax as a U.S. citizen and will not be a covered expatriate subject to the mark-to-market exit tax under section 877A if the individual:

1. became at birth a citizen of the United States and a citizen of another country,

2. at all times, up to and including the individual’s expatriation date, has been a citizen of a country other than the United States,

3. has not been a resident of the United States (as defined in section 7701(b)) since attaining age 18½,

4. has never held a U.S. passport or has held a U.S. passport for the sole purpose of departing from the United States in compliance with 22 CFR §53.1,

5. relinquishes his or her U.S. citizenship within two years after the later of January 1,
2016, or the date on which the individual learns that he or she is a U.S. citizen, and

6. certifies under penalty of perjury his or her compliance with all U.S. Federal tax obligations that would have applied during the five years preceding the year of expatriation if the individual had been a nonresident alien during that period.

The proposal would be effective January 1, 2016.

general-explanations-fy2016

Part 2 – My thoughts on this part of the Obama budget proposal

To repeat, the objective of the proposal is two-fold:

Under the proposal, an individual will:

1. not be subject to tax as a U.S. citizen; and

2. will not be a covered expatriate subject to the mark-to-market exit tax under section 877A if the individual …

Therefore, it’s clear that the proposal is advancing two different ideas. The proposals would become reality if they were passed into law. But, what if they are not passed into law?

The question is whether they can be passed via a Treasury Regulation. I believe that:

Treasury CAN use it’s general regulatory power to enact regulations that would give effect to the Obama or other similar proposals.

Although this will not be passed into law, it actually would (I think) help a large number of people. Yes, the requirement of “not having applied for a U.S. passport” (except to leave the U.S.) will be a problem for some. (You would be surprised how many “accidentals” living in Canada have never applied for a U.S. passport.)

This seems to be designed to provide relief for ALL dual citizens from birth  (regardless of whether they knew they were a U.S citizen), for a two year period commencing Jan. 1/16. Those who didn’t know they were U.S. citizens will be allowed an additional two years from the point of learning that the U.S. considers them to be a citizen.

It’s also interesting that there does not appear to be an “age limitation”.

The “passport limitation” is significant. It reflects the view of the administration that applying for a U.S. passport is somehow an affirmation of U.S. citizenship (which is a highly questionable assumption).

I believe that this proposal is VERY significant. It indicates that the administration accepts that there is a difference between a “technical definition of U.S. citizenship” and U.S. citizenship in a meaningful sense. For many, the use of U.S. passport is NOT an affirmation of U.S. citizenship. It is simply regarded as a “travel document”.

Put another way, it suggests that the administration is coming around to the idea that taxation is NOT appropriate unless there is a substantive connection to the United States.

The Obama budget proposal  is clearly NOT a retreat from U.S. “citizenship-based taxation”. It is simply a recognition that NOT all people born in the U.S. have ties to the U.S. that could justify taxation.

But, why should those who were NOT born dual citizens, but who ARE dual citizens be excluded? It’s quite possible that they may also have had “minimal contact with the U.S.” and have fewer ties to the U.S. than those born with dual citizenship.

I predict that this is the beginning of a dialogue that will eventually result in residence based taxation.

All things considered good news. It is evidence of a rethinking  of the relationship  between taxation and  connection to the United States. This kind of thinking should provide the foundation for further change.

That said, the Obama budget  is a reinforcement of U.S. citizenship (AKA “place of birth”)  taxation. It underscores the need to continue organized opposition to U.S. “place of birth” taxation.

Part 3 – Differing perspectives on exempting a “sub-group” of “technical U.S. citizens” from the compliance and tax horror which is part of the U.S. “Tax responsibilities of expatriation“

Differing perspectives are illustrated by the following comments at the Isaac Brock Society:

A comment against the proposal:

The United States used to be a country that prided itself in being number one in just about everything. All we hear about now is settling for second-best, including this latest underachieving idea of putting lipstick on the twin scourge of FATCA and CBT instead of outright eliminating it. I’m sick and tired of proponents of “incremental, achievable change”. Those people said the same thing about slavery and civil rights and why it would take generations more to make any inroads.

Make no mistake – the strategy here is classic divide and conquer since only a few lucky people might qualify for relief while others will be left out in the cold – again. Same approach that Democrats Abroad is taking – treating the symptom instead of the disease.

A comment in favor of the proposal:

How could we oppose something that is a positive, small step forward? I certainly would not oppose it but this in no way should shake our resolve to have the problems of CBT solved for everyone, not just a subset of everyone. They’ve shown they have at least given the problems a glance so now we have to keep pressing them to give the problems full and complete deliberation and when they do, provided they do it with open minds, they will have to conclude that RBT is the right solution.

A comment suggesting that the benefits of the proposal are exaggerated:

I don’t know what the motivation is for their administration to include this provision in the budget, but I can explain the tax relief again.

It’s exactly what you quoted. For this unfortunately too-small set of dual-citizens, they can relinquish their US citizenship and not file any FBARs and only file taxes on their US-sourced income instead of on their world-wide income, for the last 5 years. If a person has less than about $3900 in US-sourced income, they don’t have to file at all and therefore also don’t have to apply for a US Social Security Number. For the people who benefit, this is huge.

The proposal exaggerates in one regard. It’s written as if this proposal is newly relieving these people of being a covered expat and paying the exit tax. But, in certain circumstances, those born-dual citizens are already exempt from the exit tax if they certify to the 5 years of tax compliance. The difference is only in being able to file those 5 years (if needed) as a non-resident alien instead of a US citizen.

Part 4 – S. 7701(a)(50)(B) And The Delegation Of Regulatory Authority: Can this Obama budget proposal be implemented by Treasury without Congress?

Many who were born “dual citizens”, who have had “minimal contact” with the U.S. are at best “technical U.S. citizens abroad”. They are happy and encouraged by this proposal.  Furthermore, members of the Cross-border tax community are understandably excited about this proposal. There is, however,  a strong consensus that the Obama budget will be rejected by a Republican controlled Congress.

Is Congress necessary to implement the “dual citizen” relief provision of the Obama  budget?

It has been reported that some believe that the proposal can be legally implemented by Treasury without the approval of Congress.

An article by Andrew Velarde – “Budget Proposal May Offer Escape From U.S. Tax for Dual Citizens” apparently quoted various tax professionals as saying:

“By allowing these individuals to renounce without forcing five years of compliance on them, the U.S. fisc will benefit,” …. What’s more, the administration may not have to wait for legislation from Congress to give effect to the proposal, he argued.

“While the proposed relief was contained in the revenue proposal, there is a chance that it could be given near-immediate effect if Treasury issues regulations to that effect. Section 7701(a)(50)(B)authorizes Treasury to adopt regulations that address the same dual citizen issues as does the proposal. This is very exciting,” ….

Section 7701(a)(50) addresses the termination of U.S. citizenship and states that individuals do not cease to be treated as citizens before the date on which their citizenship is treated as relinquished under section 877A(g)(4). It also allows the prescription of regs that would except individuals who are dual citizens from birth.

… agreed with …  assessment that regs without legislation were possible. “I do think this provision does seem to have a chance,” he said. “It doesn’t expand the taxing authority in any way, and it does seem to deal with an issue of fundamental fairness . . . where [taxpayers] haven’t had any meaningful contact with the U.S. as an adult. It is probably inappropriate to tax that kind of person on their worldwide income.”

Does S. 7701(a)(50)(B) allow for this proposal to be implemented without Congressional legislation?

An interesting question. I believe that S. 7701(a)(50)(B) gives Treasury great latitude.

We begin our analysis with what the Internal Revenue Code actually says.

Definitions: S. 7701(a)(50)

(50) Termination of United States citizenship

(A) In general

An individual shall not cease to be treated as a United States citizen before the date on which the individual’s citizenship is treated as relinquished under section 877A (g)(4).

JR Comment: Since June 3, 2004 this means that a Certificate of Loss Of Loss Of Nationality is required to relinquish U.S. citizenship for tax purposes.

(B) Dual citizens

Under regulations prescribed by the Secretary, subparagraph (A) shall not apply to an individual who became at birth a citizen of the United States and a citizen of another country.

The S. 7701(a)(50)(B) exception to the application of S. 877A(g)(4)

What is the effect of S. 877A(g)(4)?*

S. 877A(g)(4) says that those are no longer U.S. citizens for Immigration and Nationality purposes will continue to be subject to U.S. taxation until the date they NOTIFY the State Department that they are NO longer U.S. citizens. In effect, S. 877A(g)(4) creates a class of persons who are “tax citizens” but are no longer “citizens”. To put it another way, the U.S. is saying:

We don’t care that you are no longer a U.S. citizen according to our citizenship and nationality laws. If you attempt to travel to the United States we will treat you as though you are an “alien”. For tax purposes, we are going to pretend that you are still a U.S. citizen until you notify the State Department of your relinquishment of U.S. citizenship. In other words, you get NONE of the rights of citizenship but you are STILL required to pay U.S. taxes as though you are a citizen.

“We the people of the United States of America, proudly endorses the principle of taxation without representation.”

Please note that S. 877A came into law on June 16, 2008. I will soon be writing a separate post discussing the effective date of the S. 877A rules. Hint: The the S. 877A rules should NOT be considered to be retroactive!

What does S. 7701(a)(50)(B) mean?

If S. 7701(a)(50)(B) is applicable then the “Notice requirements” of S. 877A(g)(4) do NOT apply and need NOT be met. A dual citizen at birth would cease to be a “Tax Citizen” on the date that he ceased to be a “Citizen” for nationality purposes. He would NOT be subject to the “taxation without representation principle”. How might this matter?

7701(a)(50)(B) and the date of loss of citizenship for tax purposes …

At a minimum, S. 7701(a)(50)(B) can be used to ensure that the date that a “dual citizen” ceases to be a “tax citizen”, is the same as the date that the “dual citizen” ceases to be a citizen for “immigration and nationality purposes”.

Can S. 7701(a)(50)(B) be used to exempt dual citizens from sections of the Internal Revenue Code that impose taxation and reporting?

S. 7701(a)(50)(b) is NOT subordinate to 7701(a)(50)(A). Nevertheless, 7701(50)(a)(B) appears to be written to operate as an exception to 7701((a)(50)(A).

S. 7701(a)(50(B) reads …

(50) Termination of United States citizenship

(A) In general

An individual shall not cease to be treated as a United States citizen before the date on which the individual’s citizenship is treated as relinquished under section 877A (g)(4).

(B) Dual citizens

Under regulations prescribed by the Secretary, subparagraph (A) shall not apply to an individual who became at birth a citizen of the United States and a citizen of another country.

At a minimum, 7701(a)(50(B) provides an exception to the notice requirement in 7701(a)(50)(A).

So, how could S. 7701(a)(50)(B) matter to a dual citizen?

It could matter in at least two ways:

1. If “loss of citizenship” is NOT dependent on notification to the State Department, then a dual citizen would relinquish U.S. citizenship under Nationality Law only. There would be No requirement that the State Department be notified of the relinquishment. This doesn’t mean that he avoids the “Tax responsibilities of expatriation”. It does mean that his tax obligations end and crystallize on the date of his actual relinquishment without having to notify the State Department.

2. The “valuation” of assets is determined on the date of “relinquishment” for “nationality purposes”. Note that if S. 877A(g)4 applies, the “valuation of assets” would be determined on the day notice is given to the State Department as per  S. 877A(g)(4 ). A dual citizen would have less flexibility in “gaming the relinquishment date”.

Bottom line: The effect of S. 7701(A)(50)(B) is that, dual citizens from birth, are NOT required to notify the State Department to complete their “relinquishment”. This is clearly advantageous. In other words dual citizens, use their “relinquishment date” for immigration purposes and move on. Since they are NOT required to notify the State Department of their relinquishment, the IRS may never learn of their relinquishment. If the IRS pursues them, then they would deal with it at that time. They can legitimately argue that their U.S. tax obligations ended on the date that they ceased to be “Citizens”.

From a practical perspective, it becomes an issue of who is required to do what.

S. 7701(a)(50)(A) – Puts the onus on the taxpayer to “notify the State Department”. Tax liability continue until notice has been made.

S. 7701(a)(50)(B) – Removes the requirement to “notify the State Department”. Allows the dual citizen to escape further tax liability from the date he, pursuant to a relinquishment (under S. 349(a) of the Immigration and Nationality Act), ceased to be a “Citizen”.

This allows life to be much easier for those born “dual citizens”.

Finally, “Under regulations prescribed by the Secretary, subparagraph (A) shall not apply” …

Note the use of the word “shall”. This is mandatory.

There are no regulations. Since there are no regulations, can it be argued that no regulations are required?

The two questions helpful in interpreting the statute

1. Does S. 7701(a)(50)(B) mean S. 877A(g)(4) does NOT apply to a dual citizen of birth and that the Secretary can regulate the way in which the rule applies?

2. Does S. 7701(a)(50)(B) mean that IN ORDER for S. 877A(g)(4) to not apply to dual citizens, the Secretary must make a regulation to that effect?

A possible answer was suggested by Patrick Martin:

http://tax-expatriation.com/2014/05/06/why-section-7701a50-is-so-important-for-those-who-relinquished-citizenship-years-ago-without-a-cln/

Section 7701(a)(50)(B) allows the Treasury to adopt regulations modifying this rule, for a limited class of “expatriates” who were dual nationals from birth. To date, no regulations were issued, although proposed regulations under section 2801 are forthcoming.

The question is whether specific regulations are required to exempt dual citizens from the S. 877A requirements.

If regulations are NOT required then “dual citizens” may be able to argue that they are always exempt from the S. 877A(g)(4) requirements

In conclusion …

Internal Revenue Code S. 7701(a)(50)(B) is operates to affect whether notice to Treasury is required for the relinquishment of U.S. citizenship. Therefore it has the potential to affect the “date of the relinquishment”. It cannot be used to exempt “dual citizens” from tax or compliance obligations that exist on the date of reqlinquishment.

Therefore, the Obama budget proposal cannot be implemented without Congressional approval.
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*Here is what S. 877A(g)(4) actually says.

(4)Relinquishment of citizenship

A citizen shall be treated as relinquishing his United States citizenship on the earliest of—
(A)the date the individual renounces his United States nationality before a diplomatic or consular officer of the United States pursuant to paragraph (5) of section 349(a) of the Immigration and Nationality Act (8U.S.C. 1481 (a)(5)),
(B)the date the individual furnishes to the United States Department of State a signed statement of voluntary relinquishment of United States nationality confirming the performance of an act of expatriation specified in paragraph (1), (2), (3), or (4) of section 349(a) of the Immigration and Nationality Act (8U.S.C. 1481 (a)(1)–(4)),
(C)the date the United States Department of State issues to the individual a certificate of loss of nationality, or
(D)the date a court of the United States cancels a naturalized citizen’s certificate of naturalization.
Subparagraph (A) or (B) shall not apply to any individual unless the renunciation or voluntary relinquishment is subsequently approved by the issuance to the individual of a certificate of loss of nationality by the United States Department of State.
 

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