Written by Max Reed Ben Franklin famously said that nothing in life is certain except death and taxes. One wonders, then, what Franklin would say about taxes due on death?...
Whether for ideological reasons or tax complications, many people want to shed their U.S. citizenship. There are two ways to do so: renunciation and relinquishment. Renunciation requires swearing an oath at a U.S. consulate. A person who renounces is no longer a U.S. citizen from the date of that oath onward. Meanwhile, relinquishment refers to losing U.S. citizenship due to a prior external event called an “expatriating act.”
This article will focus on relinquishment. It is possible – although not without tax risk – to have lost U.S. citizenship for both tax and immigration reasons due to an “expatriating act” that occurred prior to 2004. The tax and immigration consequences of relinquishment are complex, so professional advice is a must.
Caroline was born in the United States, and came to Canada in 1968 as a result of her ideological opposition to the Vietnam War. She became a Canadian citizen in 1978. At that time, she thought she could only hold one citizenship and that she was trading her U.S. citizenship for Canadian. As a result, after obtaining Canadian citizenship, Caroline never used any benefits of U.S. citizenship, such as renewing her U.S. passport or voting in a U.S. election. However, she never got any official proof of her loss of U.S. citizenship such as a certificate of loss of nationality (CLN), which is like a diploma acknowledging her status as a former citizen.
Fast forward a few decades. As a result of FATCA, Caroline’s bank asks if she is a U.S. citizen. She thinks not, but has no proof. The bank informs her that unless she gets a CLN, it will report her to the IRS. Trouble is, since 1978, Caroline has become financially successful. Consequently, catching up on her tax obligations to the U.S. would be extremely expensive and potentially expose Caroline to significant penalties.
In September 2016, she goes to the U.S. State Department to get a CLN to document her loss of U.S. citizenship in 1978. But what is the exact date of Caroline’s loss of U.S. citizenship for both U.S. tax and immigration purposes?
We’ll look at this from an immigration perspective, and then from a tax perspective.
LOSING U.S. CITIZENSHIP FOR IMMIGRATION PURPOSES
The U.S. Immigration and Nationality Act (INA) sets out a variety of expatriating acts that could cause a U.S. citizen to lose citizenship. For Caroline, the most relevant options are “becoming a citizen of another country after age 18” and “swearing an oath of allegiance to a foreign state.” Caroline technically did both things when she became a Canadian citizen in 1978. In order to lose her U.S. citizenship, Caroline must prove that she intended to do so in 1978 upon becoming Canadian.
Intent can be proven in two ways. First, Caroline can state that she lost her U.S. citizenship. Second, she can point to the fact that since 1978, she has never taken advantage of the citizenship (e.g., she hasn’t voted, she doesn’t hold a U.S. passport and she’s never used U.S. consular services). If she can successfully prove this, she would be eligible for a CLN indicating that she lost her U.S. citizenship in 1978.
That’s not the end of the story, however. Caroline needs to think of the tax aspect as well.
LOSING U.S. CITIZENSHIP FOR TAX PURPOSES
Under current U.S. tax law, it’s uncertain when Caroline lost her U.S. citizenship for tax purposes. There are two competing views:
- the literal approach; and
- the common sense approach.
Many experienced U.S. tax lawyers support both views. There is no official IRS position or binding legal precedent – although clarifying this is on the IRS’s to-do list. Let’s look at both views.
The literal approach is based on a strict reading of the law. Since 2008, U.S. tax law has set the date that a person loses U.S. citizenship as the earlier of the date that he applies for a CLN at the Department of State or the date the CLN is issued. But many people in Caroline’s situation never obtained such a certificate. Under the literal approach, because Caroline never obtained a CLN, she remains a U.S. citizen until her State Department visit in September 2016. This means she would have had tax obligations to the U.S. government for the previous 38 years – despite losing her citizenship for immigration purposes in 1978. The financial consequences would be dire.
The common sense approach, on the other hand, relies less on the literal text of the law and more on its spirit. Among the numerous technical legal arguments in favour of this view is that courts are not supposed to interpret the law in ways that create absurd results. And the result of the literal approach would be absurd. Caroline went about her life thinking she had given up their U.S. citizenship (and had in fact done so for immigration purposes), but she still has U.S. tax obligations for 38 years after she lost her citizenship. Applying the common sense approach means somebody in Caroline’s situation would have lost her U.S. citizenship for tax purposes at the same time she lost it for immigration purposes – in this case, 1978.
Sorting out whether the literal or common sense approach applies is ultimately the task of the IRS or a U.S. court. Until that happens, uncertainty remains. Arguments in favour of both positions are sound, although the common sense view is more likely than not to prevail. So what should clients like Caroline do?
Those who, like Caroline, think they lost their U.S. citizenship prior to 2004 have three options:
- Obtain a CLN confirming the loss of nationality (for Caroline, in 1978) and take the position that the tax obligations terminated then. However, getting a CLN is a public act that might invite IRS scrutiny.
- Do nothing and wait for any IRS inquiry or clarification prior to obtaining a CLN. This has the advantage of not inviting IRS scrutiny as the former U.S. citizen remains underground. The disadvantage here is the person has no formal proof. One option in this scenario is to obtain and rely on a legal opinion if the person is ever asked about U.S. citizenship status by either a bank or the U.S. government.
- Catch up on U.S. tax returns and renounce citizenship. This option has the least risk but the most expense. It eliminates any argument that citizenship was lost many years ago and requires the U.S. citizen to catch up on five years of tax returns prior to renouncing to avoid a big tax bill.
Ultimately, anybody in a situation similar to Caroline’s ought to seek professional advice on how to navigate the interplay between immigration and tax citizenship.