Tax jurisdiction and residential ties
The two types of residential ties considered for all aliens
When considering the meaning of “residence” for tax purposes, attempting to ascribe a place of “residence “to an individual, and imposing taxation on individuals, the Internal Revenue Code considers:
A. The extent of “residential ties” to the United States; and
B. The extent of “residential ties” to another country.
We see both aspects of residence considered as a way to defeat the “substantial presence” test in Internal Revenue Code S. 7701(b). If the country of residence is uncertain, or if a person is considered to be a “tax resident” of the United States and another country, the Internal Revenue Code considers ties to both the United States and the other country in question.
For “resident aliens” (Green Card Holders):
– both past and present residential ties to the United States and to other nations are considered in at least three ways under the Internal Revenue Code itself; and
– residential ties to both the United States and the other country of residence are considered in determining residence under Article IV of the Canada U.S. (and other) tax treaties**.
Green Card Holders and tax residence
A previous post discussed the fact that:
- Internal Revenue Code S. 7701(a)(30) defines “U.S. Persons” as including “citizens” and “residents”
- The combined effect of Internal Revenue Code S. 7701(b)(1) and S. 7701(b)(6) define Green Card Holders in a way that ensures that they meet the statutory test of “residence”. (Of course Green Card Holders may be able to defeat the status of “resident” by making use of the Treaty Election in Article IV of the Tax Treaty)
- The statutory defenses to “residence” found in S. 7701(b) of the Internal Revenue Code, available to “aliens” who are NOT Green Card Holders, take into account and are a function of the extent of residential ties to other jurisdictions
Residence matters and residence matters hugely. Hence, the definition of “resident” matters and matters hugely.
Congress has directed its attention to the question of the kind of physical connection to the United States, that justifies deeming one to be a “resident” for tax purposes. Interestingly, the definition of “citizenship” has NOT received the same attention. Nor is “U.S. citizen” defined in the Internal Revenue Code.
The purpose of this post is to consider how actual U.S. residence affects the taxation of Green Card Holders.
Circa 1985 – The problem of defining “residence” for tax purposes
The proper time to tax has always been a central issue in the analysis of federal taxation. Related to the timing question is the equally difficult problem of determining the appropriate circumstances under which a tax may be imposed on those whose residential status is undetermined. People who were not born in this country or who are not citizens by blood are faced with a number of important questions concerning their resident tax liability; At what point does a person sufficiently enjoy United States benefits and privileges in order to justify imposition of a tax?’ Is the receipt of such benefits even necessary for the proper imposition of taxes?
The question of an alien’s residential status encompasses the traditional tax questions of gain, control, and timing, and augments them with a jurisdictional issue that by its nature demands resolution before any other. The United States may not impose a tax before it has sufficient jurisdictional contacts with the alien either through his citizenship or residence. Thus, analysis of the jurisdictional contacts necessary to impose taxation further complicates the already difficult issues involved in determining proper taxation of aliens.
Until 1984 the complexity involved in determining aliens residence was reflected in both conflicting case law’s and piecemeal legislation.” This made prediction of the likely tax consequences of contact with the United States difficult and uncertain. This confused state of the law, with its concomitant difficulties in administration led to enactment of section 7701(b) of the Internal Revenue Code.
Circa 1985: Rolf E. Kroll – Internal Revenue Section 7701(b): A More Certain Definition Of Resident“
Internal Revenue Code Section 7701(b)- A More Certain Definition
The initial version of Internal Revenue Code S. 7701(b), of which Mr. Kroll is writing, took effect in 1984. The initial version did NOT includes the current “expatriation by treaty provision” – which is the flush sentence added (as part of the 2008 HEART Act) at the end of Internal Revenue Code S. 7701(b)(6)(B).
The current version of Internal Revenue Code S. 7701(b)(6) defines when a Green Card holder is a U.S. resident for tax purposes as follows:
(6) Lawful permanent residentFor purposes of this subsection, an individual is a lawful permanent resident of the United States at any time if—
(A) such individual has the status of having been lawfully accorded the privilege of residing permanently in the United States as an immigrant in accordance with the immigration laws, and
(B) such status has not been revoked (and has not been administratively or judicially determined to have been abandoned).
An individual shall cease to be treated as a lawful permanent resident of the United States if such individual commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country, does not waive the benefits of such treaty applicable to residents of the foreign country, and notifies the Secretary of the commencement of such treatment.
The plain reading of the statute makes it clear that, in the case of Green Card Holders, “actual residence” in the United States is NOT required to be considered a “tax resident”. This principle has recently been confirmed by the courts in the 2014 Topsnik case. Nevertheless, even in the case of “Green Card Holders, past and present residential ties to other nations are relevant for determining how Green Card Holders are subjected to U.S. taxation.
Green Card Holders are treated as “residents” for U.S. tax purposes. Green Card Holders are the only category of “aliens” subject to the S. 877A Exit Tax.
Four ways that Green Card Holders (even though are treated as U.S. residents) are given preferential tax treatment based on residential ties to other nations
Redefining Residence: Article IV Of The Canada U.S. Tax Treaty
If a Green Card Holder is a resident of both the United States and Canada, the Green Card Holder may be able to use Article IV of the Tax Treaty to argue that he is a “tax resident of Canada and not of the United States. (This is available to a residents of almost any country with a U.S. Tax Treaty.)
There are two consequences to this:
– the individual is NOT treated as a U.S. resident for tax purposes; and
– the individual may able to defeat becoming a “long term resident” for the purposes of determining whether he is subject to the S. 877A Exit Tax. Internal Revenue Code S. 877(e)(2) states that:
an individual shall not be treated as a lawful permanent resident for any taxable year if such individual is treated as a resident of a foreign country for the taxable year under the provisions of a tax treaty between the United States and the foreign country and does not waive the benefits of such treaty applicable to residents of the foreign country
See further discussion of this below.
Effect:
Green Card Holders: Green Card Holders who (1)move from the United States (2) continue to be tax residents of the United States and (3) become tax residents of Canada are able to use the Treaty Election to cease being U.S. tax residents AND possibly avoid the S. 877A Exit Tax.
Americans abroad: The “savings clause” in the Tax Treaty ensures that Americans abroad who move from the United States are ALWAYS treated as U.S. citizens and therefore ALWAYS subject to U.S. taxation and (subject to the dual citizen exemption) the S. 877A Exit Tax.
Green Card holders, who can benefit from a Tax Treaty, are given favorable consideration when they become tax residents of other nations. American citizens abroad are always subject to U.S. taxation on their world income even if they live outside the United States and becoming “tax residents” of another nations.
What country treats its own citizens worse than it treats its immigrants?
Residence: Three Ways of Mitigating The Applicability and Effect of the S. 877A Exit Tax on Green Card Holders
Green card holders are the only kind of “alien” that “may” be subject to the S. 877A Exit Tax.
There are at least three circumstances in which “residence” (whether within or without the United States) affects the extent of the application of the S. 877A Exit Tax to “Green Card Holders”. (Americans abroad have NOT received the same legislative consideration.)
As we consider these three circumstances, note how a “bona fide” residential connection to another nation, allows a Green Card holder to escape (when compared to Americans abroad) the most punitive effect of the S. 877A Exit Tax.
Circumstance 1. When subject to the S. 877A Exit Tax: In order to be a “covered expatriate” a Green Card Holder must be a “long term resident” of the United States
S. 877 (e) Comparable treatment of lawful permanent residents who cease to be taxed as residents
(1) In general
Any long-term resident of the United States who ceases to be a lawful permanent resident of the United States (within the meaning of section 7701(b)(6)) shall be treated for purposes of this section and sections 2107, 2501, and 6039G in the same manner as if such resident were a citizen of the United States who lost United States citizenship on the date of such cessation or commencement.
(2) Long-term resident
For purposes of this subsection, the term “long-term resident” means any individual (other than a citizen of the United States) who is a lawful permanent resident of the United States in at least 8 taxable years during the period of 15 taxable years ending with the taxable year during which the event described in paragraph (1) occurs. For purposes of the preceding sentence, an individual shall not be treated as a lawful permanent resident for any taxable year if such individual is treated as a resident of a foreign country for the taxable year under the provisions of a tax treaty between the United States and the foreign country and does not waive the benefits of such treaty applicable to residents of the foreign country.
Notice that the first sentence of S. 877(e)(2) focuses on “residence in the United States”. The second sentence focuses on “residence outside the United States” in another country. In other words: Residence outside the United States, in another country, DOES matter for the purposes for the purposes of determining whether a “Green Card Holder” is a “long term resident”. If a “Green Card Holder” is NOT a “long term resident” the the S. 877A Exit Tax rules cannot be applied.
Effect:
Green Card Holders: Those Green Card Holders who terminate their Green Card Holders at the point where they are not treated as “lawful permanent residents” for 8 of the last 15 taxable years will NOT be subject to the S. 877A Exit Tax. Notice that if one is treated as a resident of a foreign country under a tax treaty, under certain circumstances, the S. 877A Exit tax rules will not apply.
Americans abroad: The fact that Americans abroad are NOT and may NEVER have lived in the United States, is NO defense to the applicability of the S. 877A Exit Tax.
When it comes to determining whether one is an “expatriate” Green Card holders are given favorable consideration for time spent living outside the United States. When considering the applicability of the S. 877A Exit Tax, American citizens abroad are given NO consideration for time spent living outside the United States.
What country treats its own citizens worse than it treats its immigrants?
Circumstance 2. How The Deemed Capital Gain Is Calculated: The basis for the determination of the “deemed capital gain” is different for “Green Card Holders”
(2) Step-up in basis
Solely for purposes of determining any tax imposed by reason of subsection (a), property which was held by an individual on the date the individual first became a resident of the United States (within the meaning of section 7701(b)) shall be treated as having a basis on such date of not less than the fair market value of such property on such date. The preceding sentence shall not apply if the individual elects not to have such sentence apply. Such an election, once made, shall be irrevocable.
When it comes to determining valuations for calculating the “Exit Tax”, S. 877A considers BOTH the time before the Green Card Holder was a U.S. resident and the time the Green Card Holder was resident of another nation.
Effect:
Green Card Holders: With a “stepped up” basis, the deemed capital gain will be less. This will result in a lower “Exit Tax” payable.
Americans Abroad: There is no equivalent rule exempting increases in value that took place with the person was NOT a U.S. resident. The deemed capital gain is calculated on the complete gain! The S. 877A Exit Tax specifically attacks the non-U.S. assets of Americans abroad that were accumulated AFTER the person moved from the United States.
Green Card holders are given consideration for time spent living outside the United States. American citizens abroad are given NO consideration for time spent living outside the United States.
What country treats its own citizens worse than it treats its immigrants?
Circumstance 3. Pensions accrued while the Green Card Holder was NOT a “resident of the United States” AND earned “outside the United States” are NOT subject to the S. 877A Exit Tax Rules.
Note: The section specifically refers to Internal Revenue Code S. 7701(b), which speaks only of “aliens”. Naturalized citizens would also benefit from this section because they must have a “Green Card” before becoming a naturalized citizen.
(5) Exception*
S. 877A(d)(5) Paragraphs (1) and (2) shall not apply to any deferred compensation item to the extent attributable to services performed outside the United States while the covered expatriate was not a citizen or resident of the United States.
Effect:
Green Card Holders: This means that non-U.S. pensions accrued prior to the person receiving the Green Card will NOT be subject to the S. 877A Exit Tax Calculation. (In other words they get to keep the pension). How might an Article IV Treaty Election made after the Green Card Holder leaves the United States effect this?
Americans Abroad: Their non-U.S. pensions accrued while they were living in other nations ARE subject to the S. 877A Exit Tax.
Green Card holders are given consideration for time spent living outside the United States. American citizens abroad are given NO consideration for time spent living outside the United States.
What country treats its own citizens worse than it treats its immigrants?
Conclusion: Because of their residential ties to other nations, Green Card Holders are able to either defeat or mitigate the effects of the S. 877A Exit Tax. “Americans abroad” have NO available mechanisms to defeat or mitigate the effects of the S. 877A Exit Tax. What are those effects? Well it’s called taxation, but it is functionally equivalent to confiscation. For some actual examples of “The Exit Tax In Action” see here.
Sorry, but what do you mean by “Americans abroad”?
Anybody who the U.S. Government deems to be a U.S. citizen living outside the United States. This includes “Accidental Americans” who may have (other than a few weeks after birth) NEVER even lived in the United States. Talk about unfairness and immorality!
#YouCantMakeThisUp
John Richardson
_________________________________________________________________________
*Full text
(d) Treatment of deferred compensation items
(1) Withholding on eligible deferred compensation items
(A) In general
In the case of any eligible deferred compensation item, the payor shall deduct and withhold from any taxable payment to a covered expatriate with respect to such item a tax equal to 30 percent thereof.
(B) Taxable payment
For purposes of subparagraph (A), the term “taxable payment” means with respect to a covered expatriate any payment to the extent it would be includible in the gross income of the covered expatriate if such expatriate continued to be subject to tax as a citizen or resident of the United States. A deferred compensation item shall be taken into account as a payment under the preceding sentence when such item would be so includible.
(2) Other deferred compensation items In the case of any deferred compensation item which is not an eligible deferred compensation item—
(A)
(i) with respect to any deferred compensation item to which clause (ii) does not apply, an amount equal to the present value of the covered expatriate’s accrued benefit shall be treated as having been received by such individual on the day before the expatriation date as a distribution under the plan, and
(ii) with respect to any deferred compensation item referred to in paragraph (4)(D), the rights of the covered expatriate to such item shall be treated as becoming transferable and not subject to a substantial risk of forfeiture on the day before the expatriation date,
(B) no early distribution tax shall apply by reason of such treatment, and
(C) appropriate adjustments shall be made to subsequent distributions from the plan to reflect such treatment.
(3) Eligible deferred compensation itemsFor purposes of this subsection, the term “eligible deferred compensation item” means any deferred compensation item with respect to which—
(A) the payor of such item is—
(i) a United States person, or
(ii) a person who is not a United States person but who elects to be treated as a United States person for purposes of paragraph (1) and meets such requirements as the Secretary may provide to ensure that the payor will meet the requirements of paragraph (1), and
(B) the covered expatriate—
(i) notifies the payor of his status as a covered expatriate, and
(ii) makes an irrevocable waiver of any right to claim any reduction under any treaty with the United States in withholding on such item.
(4) Deferred compensation item For purposes of this subsection, the term “deferred compensation item” means—
(A) any interest in a plan or arrangement described in section 219(g)(5),
(B) any interest in a foreign pension plan or similar retirement arrangement or program,
(C) any item of deferred compensation, and
(D) any property, or right to property, which the individual is entitled to receive in connection with the performance of services to the extent not previously taken into account under section 83 or in accordance with section 83.
(5) Exception
Paragraphs (1) and (2) shall not apply to any deferred compensation item to the extent attributable to services performed outside the United States while the covered expatriate was not a citizen or resident of the United States.
_________________________________________________________
** Article IV of the Canada U.S. Tax Treaty (Article IV has an equivalent in U.S. Tax Treaties with other nations.)
Article IV
Residence
2. Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then his status shall be determined as follows:
(a) he shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him; if he has a permanent home available to him in both States or in neither State, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closer (centre of vital interests);
(b) if the Contracting State in which he has his centre of vital interests cannot be determined, he shall be deemed to be a resident of the Contracting State in which he has an habitual abode;
(c) if he has an habitual abode in both States or in neither State, he shall be deemed to be a resident of the Contracting State of which he is a citizen; and
(d) if he is a citizen of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.
