The S. 877A “Dual Citizen” exemption: MUST certify tax compliance for the five years prior to relinquishment

Introduction:

This is the 7th of seven posts analyzing the “dual citizen exemption” to the S. 877A Exit Tax which is found in S. 877A(g)(1)(B) of the Internal Revenue Code. Please remember that the “dual citizen exemption” is available ONLY to those who meet the “five year tax compliance test”.

1. What is the S. 877A(g)(1)(B) “dual citizen exemption” and why does it encourage those “born dual citizens” to not renounce U.S. citizenship?

2. The history of Canada’s citizenship laws: Did the 1947 Canada Citizenship Act affirm citizenship or “strip” citizenship and create @LostCanadians?

3. The S. 877A “dual citizen” exemption – I was born before the first ever Canada Citizenship Act? Could I have been “born a Canadian citizen”?

4. The S. 877A “Dual Citizen” exemption: The 1947 Canada Citizenship Act – Am I still a Canadian or did I lose Canadian citizenship? (The “Sins Of The Father”)

5. The S. 877A “Dual Citizen” exemption: The 1947 Canada Citizenship Act and the requirements to be “born Canadian

6. “The S. 877A “Dual Citizen” exemption: I was born a dual citizen! Am I still “taxed as a resident” of Canada?

7. The S. 877A “Dual Citizen” exemption: “MUST certify tax compliance for the five years prior to relinquishment

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To begin: Any person who cannot meet the “tax compliance test” found in section 877(a)(2)(C) of the Internal Revenue Code will be a “covered expatriate”!

As a reminder, of what makes somebody a “covered expatriate”:

S. 877A(g) of the Internal Revenue Code includes:

(g) Definitions and special rules relating to expatriation For purposes of this section—

(1) Covered expatriate
(A) In general

The term “covered expatriate” means an expatriate who meets the requirements of subparagraph (A), (B), or (C) of section 877(a)(2).

(B) Exceptions An individual shall not be treated as meeting the requirements of subparagraph (A) or (B) of section 877(a)(2) 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,

Notice that the “dual citizen exemption” operates so that the individual does NOT become a “covered expatriate” if he meets the tests of “subparagraph (A) or (B) of section 877(a)(2)” (the income test or the asset test). The “dual citizen exemption” does NOT absolve the individual from meeting the “tax compliance test” found in section 877(a)(2)(C) of the Internal Revenue Code, which reads as follows:

(C) such individual fails to certify under penalty of perjury that he has met the requirements of this title for the 5 preceding taxable years or fails to submit such evidence of such compliance as the Secretary may require.

So, what does this mean? There appear to be two distinct requirements.

  1. The “Group Nature” of the certification: It is a certification for the complete five year period. This appears to imply that when making the “certification” is for the five years as a group. This is probably NOT the same thing as signing the returns for each year individually.
  2. The Complete Internal Revenue Code: It means that one must certify that he has met all the requirements imposed on him by the Internal Revenue Code. This includes: income tax, gift tax, self-employment tax and all required information returns. If you are/were required to do something by the Internal Revenue Code, then one must “certify” that those requirement have been met.

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What if you make mistakes? In discussing this issue at recent London information session

The question was discussed of what is the practical meaning of “certification”. Obviously “certification” means that you have made your best efforts and that you are NOT aware of any deficiencies. What happens if, in spite of your best efforts, you have made a mistake or you have a deficiency? This cannot be answered with certainty. Nevertheless, the statute does not appear to require perfection.

The morning after this discussion (right on cue), I learned that California lawyer Phil Hodgen had just “addressed this issue” in one of his newsletters. You will find his newsletter titled “Audits and the certification test” here.

He opines:

My opinion is that the “certify under penalty of perjury” stuff means that the IRS can make you a covered expatriate only if you screw up your prior year tax returns in some magnificently malevolent way. If a Federal Judge would be looking at throwing you in jail for perjury or some serious tax crime, then covered expatriate status would be warranted. Normal errors and foot faults? No.

But no one knows. At least, I don’t know. Maybe some of you who have expatriated have gone through the wars and come out on the other side unscathed. I have only had that experience with people who were covered expatriates anyway, due to high net worth. So there was no life-or-death consequence to failing the certification test.

Given the profound risk, the prudent person who wishes to expatriate should do two things:

Preventive Defense. Fix everything you can with the prior five years of tax returns. Be anal-retentive. Be obsessive compulsive. Give the IRS nothing to gnaw on. Yes, it is expensive to do, and yes, you might pay extra tax. But your objective is to get away from the IRS forever. Fix it. This is your preventive medicine.
Two-Level Audit Defense. If you are audited and you are not already a covered expatriate, defend vigorously. Take it to Tax Court. If your Revenue Agent gives you the assurance in writing that you will not be flipped to covered expatriate status as a result of the audit, you might relax a bit.

If you are audited, your strategy will be two-fold. First, you will fight to prove the IRS wrong in the audit. If that fails (because you had a malfunction – heh! – in your tax returns for prior years), and if they think you should flip from “not” to “definitely” covered expatriate status, you will need to fight this in Court. Concede the tax if you must but do not concede the conversion to covered expatriate status.

I suspect that this the correct approach. But, nobody knows for sure. So, you should do your best to ensure that:

1. You have done your very best to ensure that you qualify as having met the 5 year compliance test; and

2. Check off that you have me that compliance test.